Pathfinder Bancorp, Inc. — Q2 2018 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2018; comparative operating results are for the same periods in 2017. Balance-sheet comparisons are with December 31, 2017. Pathfinder is a bank holding company whose primary business is Pathfinder Bank, serving primarily Central New York.
Financial performance and position
- Q2 earnings: Net income attributable to Pathfinder was $945,000, up 2.7% from $920,000; diluted EPS was $0.22, unchanged. Pretax income declined to $1.067 million from $1.197 million, while income tax expense fell to $166,000 from $238,000.
- First-half earnings: Net income attributable to Pathfinder was $1.949 million versus $1.720 million; diluted EPS increased to $0.46 from $0.41. Pretax income was nearly flat at $2.283 million versus $2.269 million, with lower tax expense contributing to earnings growth.
- Net interest and margin: Q2 net interest income was $6.467 million, up 15.9%; net interest margin rose to 3.07% from 2.93%. First-half net interest income was $12.860 million, up 16.1%, and margin was 3.05% versus 2.95%. Higher loan and taxable-securities yields and asset growth supported results, partly offset by higher deposit costs.
- Revenue and expenses: Q2 noninterest income declined 2.5% to $1.024 million, mainly because securities gains in 2017 became a $22,000 net loss in 2018. First-half noninterest income declined 3.4% to $1.919 million for the same principal reason. Noninterest expense increased 22.3% in Q2 to $6.127 million and 16.0% in the first half to $11.586 million, led by staffing, professional services, advertising, data processing, and FDIC assessments.
- Assets and funding: Total assets increased 2.5% from year-end to $903.5 million. Loans rose 4.5% to $607.2 million; cash and cash equivalents increased to $36.7 million. Deposits were $733.2 million, up 1.3%; borrowed funds totaled $84.1 million, up from $73.9 million at year-end. Shareholders’ equity was $62.6 million, excluding $252,000 of noncontrolling interest.
- Cash flow and liquidity: First-half operating cash flow was $5.1 million, investing cash outflow $9.7 million, and financing cash inflow $19.4 million. The company reported $98.3 million of unused credit-line capacity out of approximately $194.4 million available, including facilities and letter-of-credit encumbrances. Management reported compliance with its liquidity guidelines.
- Credit quality: Allowance for loan losses was $7.6 million, or 1.25% of loans, versus $7.1 million, or 1.23%, at year-end. Nonperforming loans were $5.4 million, 0.90% of loans, compared with 0.84% at year-end and 0.80% a year earlier. Past-due loans totaled $7.8 million, down from $12.3 million at year-end. The allowance covered 139.7% of nonperforming loans.
- Capital and shareholder returns: Pathfinder Bank reported a 13.79% total core capital ratio to risk-weighted assets and an 8.35% Tier 1 leverage ratio; management said the Bank exceeded applicable “well-capitalized” requirements, including the fully phased-in capital conservation buffer. The quarterly dividend was $0.06 per share, up from $0.0525 in Q2 2017.
Material changes and unusual items
- Loan growth and higher yields increased interest income, but interest expense rose as deposit costs and balances increased. Average Q2 interest-bearing deposit cost increased 37 basis points year over year; competitive pricing and rising short-term rates were cited.
- Q2 and first-half 2017 results included gains from short-term interest-rate hedging transactions; no such hedging activity occurred in the first half of 2018. The 2018 securities sales and redemptions generated net losses of $22,000 in Q2 and $129,000 in the first half. Management described these transactions as portfolio optimization and liquidity management, with proceeds intended for reinvestment in potentially higher-yielding assets.
- The Q2 expense increase included a $100,000 reserve for possible accelerated postemployment benefits related to an earlier-than-planned senior-officer retirement; the first-half reserve was $150,000. Management said certain increased agency commission accruals reflected timing and were expected to partially reverse during the rest of 2018.
- The federal corporate tax rate reduction and New York tax-law changes helped reduce the effective tax rate to 14.3% in Q2 and 15.1% for the first half, from 21.3% and 22.6%, respectively, in 2017.
- One $1.7 million commercial real-estate loan became nonperforming during Q1. Management expected it to be refinanced by a new borrower and did not anticipate materially significant additional losses beyond specific reserves already recorded. The filing reported one new $300,000 troubled debt restructuring in the first half.
- Accumulated other comprehensive loss widened to $5.5 million from $4.2 million at year-end, primarily reflecting lower fair values of available-for-sale securities. Management stated that it did not consider the identified unrealized security losses to be credit impairment and did not intend, nor expect to be required, to sell the securities before recovery.
Outlook, risks, and contingencies
The filing provides no formal earnings or margin guidance. Management cited continued expansion into the greater Syracuse/Onondaga County market, loan demand, and a strategic increase in short-term liquidity in anticipation of loan fundings in the second half of 2018. The company expects to reinvest securities-sale proceeds in potentially higher-yielding assets, but gives no quantified forecast.
Key risks identified include credit quality and allowance adequacy; interest-rate, market, and economic changes; securities impairment; competition for loans and deposits; regulatory and compliance costs; cyber and technology threats; and dependence on local economic conditions. The company expects the upcoming credit-loss standard (CECL) to increase its allowance, but the amount was not yet determined. It also expected lease accounting adoption to increase reported assets and liabilities; $1.1 million of operating-lease payments were committed, with approximately $1.0 million of lease receipts expected.
At June 30, outstanding commitments to extend credit and standby letters of credit totaled $108.8 million; standby letters alone were $1.8 million. The Bank had pledged securities and mortgage loans to support municipal deposits, borrowings, and a letter of credit. Management stated there were no material legal proceedings with an adverse effect expected on the company’s financial condition or results.
Investor verification priorities
- Track whether loan growth translates into sustainable earnings and whether the net interest margin holds as deposit pricing and funding costs rise.
- Review the drivers and duration of elevated operating expenses, including expansion-related hiring, consulting, advertising, and the senior-officer benefit reserve.
- Monitor the $1.7 million nonperforming commercial real-estate loan, impaired and potential problem loans, delinquencies, charge-offs, and allowance adequacy.
- Assess liquidity and funding dependence, including brokered/CDARS deposits, FHLB borrowing, and the availability of credit lines after collateral and letter-of-credit encumbrances.
- Follow unrealized securities losses, securities portfolio repositioning, future hedge use, and the expected impact and implementation of CECL.