Pathfinder Bancorp, Inc. PBHC US Equity☆

ITEM 7: MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

INTRODUCTION

Throughout Management’s Discussion and Analysis (“MD&A”) the term, the “Company”, refers to the consolidated entity of Pathfinder Bancorp, Inc. Pathfinder Bank (the “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 (see Note 13 of the consolidated financial statements). Pathfinder Risk Management Company, Inc., and Whispering Oaks Development Corp. are wholly owned subsidiaries of Pathfinder Bank.

On October 16, 2014, Pathfinder Bancorp, MHC converted from the mutual holding company form of organization to the stock holding company form of organization (the “Conversion”). Following the completion of the Conversion, the Company was created substantially in its current form and Pathfinder Bancorp, MHC ceased to exist. The Company had 6,099,571 and 6,032,112 shares of voting and non-voting common stock in aggregate outstanding at December 31, 2023 and December 31, 2022, respectively.

Since the Conversion, we have substantially transformed our business activities from those of a traditional savings bank to those of a commercial bank. This transformation of activities has significantly affected the overall composition of our balance sheet. While not reducing our role as a leading originator of one-to-four family residential real estate loans within our marketplace, which had been our primary focus as a savings bank, we have substantially grown our commercial business and commercial real estate loan portfolios since the Conversion. As a commercial bank, we have been able to offer customized products and services to meet individual commercial customer needs and thereby more definitively differentiate our services from those offered by our competitors. As a result, we have been able to create a substantially more diversified loan portfolio than the one that was in place before the completion of the Conversion. When compared to the Bank’s loan portfolio composition prior to the Conversion, it is our view that our current asset portfolio (1) significantly improves upon the distribution of credit risk across a broader range of borrowers, industries and collateral types, and (2) is more likely to generate consistent net interest margin in a broader range of interest rate environments due to the portfolio’s increased percentage of shorter-term and/or adjustable-rate assets. In a concurrent effort, the Bank has been able to fund the majority of the high level of growth in our loan portfolios primarily with deposits gathered from our local community. We believe that we have gathered these deposits at a reasonable overall cost in terms of deposit interest rates, as well as at a reasonable overall level of related infrastructure and customer support service expenses.

On May 8, 2019, the Company entered into a Securities Purchase Agreement (the “Securities Purchase Agreement”) with Castle Creek Capital Partners VII, L.P. (“Castle Creek”), pursuant to which the Company sold: (i) 37,700 shares of the Company’s common stock, par value $0.01 per share, at a purchase price of $14.25 per share (the “Common Stock”); (ii) 1,155,283 shares of a new series of preferred stock, Series B convertible perpetual preferred stock, par value $0.01 per share, at a purchase price of $14.25 per share (the “Series B Preferred Stock”); and (iii) a warrant, with an approximate fair value of $373,000, to purchase 125,000 shares of Common Stock at an exercise price equal to $14.25 per share (the “Warrant”), in a private placement transaction (the “Private Placement”) for gross proceeds of approximately $17.0 million. The Securities Purchase Agreement contains significant representations, warranties, and covenants of the Company and Castle Creek.

On May 8, 2019, the Company filed Articles Supplementary with the Maryland Department of Assessments and Taxation to issue 1,155,283 shares of Series B Preferred Stock to Castle Creek. Each share of the Series B Preferred Stock was convertible on a one-for-one basis into either (i) Common Stock under certain circumstances or (ii) non-voting common stock, par value $0.01 per share (which will also be convertible into Common Stock), subject to approval of the creation of such class of non-voting common stock by the Company’s stockholders.

The Company also entered into subscription agreements dated as of May 8, 2019 (the “Subscription Agreements”) with certain directors and executive officers of the Company as well as other accredited investors. Pursuant to the Subscription Agreements, the investors purchased an aggregate of 269,277 shares of Common Stock at $14.25 per share for gross proceeds of approximately $3.8 million, before payment of placement fees and related costs and expenses. The Subscription Agreements contain representations, warranties, and covenants of the purchasers and the Company that are customary in private placement transactions. The subscription agreements were also part of the Private Placement, and the term “Private Placement” includes both transactions.

In total, therefore, the Company issued 306,977 shares of Common Stock, 1,155,283 shares of Series B Preferred Stock and the Warrant at the conclusion of the Private Placement. The transaction raised $20.8 million in gross proceeds and the final net cash received from the Private Placement, after all issuance expenses, including placement fees and all other issuance/due diligence costs of $927,000 and $342,000, respectively, was $19.6 million. The fair value of the Warrant at the time of issuance was $373,000.

Pursuant to NASDAQ rules, Castle Creek could not convert the Series B Preferred Stock or, in the future, the non-voting common stock into Common Stock, or exercise the Warrant if doing so would cause Castle Creek, when combined with the purchases of certain directors and executive officers of the Company as well as other accredited investors in the Private Placement, to own more than 19.99% of the Common Stock outstanding immediately prior to the execution of the Securities Purchase Agreement (the “Exchange Cap”). The Company was required to request stockholder approval to eliminate the Exchange Cap no later than at the 2021 annual meeting of Company shareholders. In addition, at the same meeting, the Company was required to seek shareholder approval to create a class of

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non-voting convertible common stock. Castle Creek will need the approval or non-objection of the Board of Governors of the Federal Reserve System and the New York State Department of Financial Services if it seeks to increase its ownership of shares of Common Stock in excess of 9.9% of the outstanding shares of Common Stock.

Holders of the Series B Preferred Stock were entitled to receive dividends if declared by the Company’s Board of Directors, in the same per share amount as paid on the Common Stock. No dividends would be payable on the Common Stock unless a dividend identical to that paid on the Common Stock was payable at the same time on the Series B Preferred Stock. The Series B Preferred Stock would rank, as to payments of dividends and distribution of assets upon dissolution, liquidation or winding up of the Company, pari passu with the Common Stock pro rata. Holders of Series B Preferred Stock had no voting rights except as was required by law. The Series B Preferred Stock was not redeemable by either the Company or by the holder.

As discussed above, pursuant to the Securities Purchase Agreement, on May 8, 2019, the Company issued a Warrant to Castle Creek to purchase 125,000 shares of non-voting common stock at an exercise price equal to $14.25 per share. At the same time, the Company entered into a Warrant Agreement with Castle Creek, to, among other things, authorize and establish the terms of the Warrant. The Warrant is exercisable at any time after May 8, 2019, and from time to time, in whole or in part, until May 8, 2026. However, the exercise of such Warrant remains subject to certain contractual provisions, and regulatory approval if Castle Creek’s ownership of Common Stock would exceed 9.9%. At December 31, 2023, Castle Creek owned approximately 8.8% of the Company’s common voting stock. The Warrant will receive dividends equal to the amount paid on the Company’s common stock. The dividend payment shall be calculated on (1) the unexercised portion of the 125,000 notional shares encompassed within the terms of the Warrant, less (2) any exercised portion of the 125,000 shares, times (3) the amount of the quarterly dividend paid to common shareholders. Dividend payments, if declared on the Company’s common stock, will be made on the Warrant until its expiration date.

Following the Private Placement, the Company used the net cash received from the transaction to strengthen the Company’s general capital and liquidity positions, fund growth within our marketplace, purchase certain loan assets, and increase the regulatory capital position of the Bank. The Company will continue to use the additional capital raised through the Private Placement primarily to support the realization of continued growth opportunities within our marketplace and, to a lesser extent, for general corporate purposes.

Pursuant to the terms of the Securities Purchase Agreement, Castle Creek is entitled to have one representative appointed to the Company’s Board of Directors for so long as Castle Creek, together with its respective affiliates, owns, in the aggregate, 4.9% or more of all of the outstanding shares of the Company’s Common Voting Stock. If Castle Creek, together with its respective affiliates, owns, in the aggregate, 4.9% or more of all of the outstanding shares of the Company’s Common Voting Stock and does not have a board representative appointed to the Company’s Board of Directors, the Company will invite a person designated by Castle Creek to attend meetings of the Company’s Board of Directors as an observer. On June 30, 2023, the Company’s Board of Directors appointed Anthony R. Scavuzzo, a representative of Castle Creek, to the Board of Directors.

On November 13, 2020, the Company entered into an agreement (the “Exchange Agreement”) with Castle Creek providing for the exchange of 225,000 shares of the Company’s Common stock owned by Castle Creek for 225,000 shares of the Company’s Series B Preferred Stock. The exchange was consummated simultaneously with the execution and delivery of the Exchange Agreement. The Company and Castle Creek entered into the Exchange Agreement to enable the equity ownership of Castle Creek to comply with applicable banking laws and regulations.

As a result of the Exchange Agreement, on November 13, 2020, the Company issued to Castle Creek 225,000 shares of its Series B Preferred Stock in exchange for an equivalent number of shares of Company Common Stock held by Castle Creek in a transaction exempt from registration under Section 3(a)(9) of the Securities Act of 1933, as amended. Castle Creek was the only stockholder of the Series B Preferred Stock. The Company received no cash proceeds as a result of the exchange. In addition, the Company did not pay any commission or remuneration for the solicitation of the exchange.

On November 13, 2020, the Company filed an amendment to the Articles Supplementary to the Articles of Incorporation of the Company designating the Series B Preferred Stock with the Maryland Department of Assessments and Taxation to increase the classified number of shares of the Series B Preferred Stock from 1,155,283 to 1,506,000 to allow for the additional issuance of Series B Preferred Stock to Castle Creek. There were no other changes made to the preferences, limitations, powers and relative rights of the Series B Preferred Stock.

On June 4, 2021, shareholders of the Company approved an amendment to the Company’s Articles of Incorporation to authorize Non-Voting Common Stock, and to eliminate the Exchange Cap. On June 9, 2021, the Company filed Articles Supplementary to the Articles of Incorporation of the Company (the “Articles Supplementary”) with the Maryland State Department of Assessments and Taxation creating a Class A Non-Voting Common Stock, par value $0.01 per share (“Non-Voting Common Stock”). The Articles Supplementary authorized 1,505,283 shares of the Non-Voting Common Stock which Castle Creek received in exchange for the Company’s outstanding Series B Preferred Stock on a one for one basis and allowed for the issuance of 125,000 shares of Non-Voting Common Stock that may be issued upon the exercise of the Warrant.

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The preferences, limitations, powers and relative rights of the Non-Voting Common Stock are set forth in the Articles Supplementary, a summary of which follows:

Ranking: The Non-Voting Common Stock will rank, as to the payment of dividends and distribution of assets upon dissolution, liquidation or winding up of the Company, (i) pari passu with the Company’s Common Stock, and (ii) subordinate and junior to all other securities of the Company which, by their respective terms, are senior to the Non-Voting Common Stock or the Company’s Common Stock.

Dividend Rights: Holders of the Non-Voting Common Stock will be entitled to receive dividends when, as and if declared by the Company’s Board of Directors, in the same per share amount as paid on Company’s Common Stock. No dividends will be payable on the Company’s Common Stock unless a dividend identical to that paid on the Company’s Common Stock is payable at the same time on the Non-Voting Common Stock in an amount per share equal to the product of (i) the per share dividend declared and paid in respect of each share of the Company’s Common Stock and (ii) the number of shares of the Company’s Common Stock into which such share of Non-Voting Common Stock is then convertible (without regard to limitations on conversion of such Non-Voting Common Stock); provided that if any stock dividend is declared on the Company’s Common Stock, the holders of Non-Voting Common Stock will be entitled to receive such dividend payable in shares of Non-Voting Common Stock.

Voting: The holders of shares of Non-Voting Common Stock have no voting rights, except as may be required by Maryland law and as set forth in the Articles Supplementary. So long as any shares of Non-Voting Common Stock are issued and outstanding, the Company will not (including by means of merger, consolidation or otherwise) without obtaining the approval of the holders of a majority of the issued and outstanding shares of Non-Voting Common Stock:

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alter or change the rights, preferences, privileges or restrictions provided for the benefit of the holders of the Non-Voting Common Stock so as to affect them adversely;

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increase or decrease the authorized number of shares of Non-Voting Common Stock; or

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enter into any agreement, merger or business combination, or engage in any other transaction, or take any action that would have the effect of adversely changing any preference or any relative or other right provided for the benefit of the holders of the Non-Voting Common Stock.

Redemption and Repurchase: The Non-Voting Common Stock is not redeemable by the Company or the holder. However, in the event that the Company offers to repurchase shares of the Company’s Common Stock, the Company must offer to repurchase shares of the Non-Voting Common Stock pro rata based upon the number of shares of the Company’s Common Stock such holders would be entitled to receive if such shares were converted into shares of the Company’s Common Stock immediately prior to such repurchase.

Conversion: Each share of Non-Voting Common Stock will be convertible into one share of the Company’s Common Stock (i) at any time and from time to time at the request of the holder thereof or at the written request of the Company; provided that upon such conversion, the holder, together with all affiliates of the holder, will not own or control in the aggregate more than 9.9% of the Company’s Common Stock (or of any class of the Company’s voting securities), excluding for the purpose of this calculation any reduction in the ownership resulting from transfers by such holder of voting securities (which, for the avoidance of doubt, does not included the Non-Voting Common Stock); or (ii) automatically, without any further action of the part of the holder, on the date that the holder transfers such share of Non-Voting Common Stock to a non-affiliate of the holder in a permissible transfer.

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SELECTED FINANCIAL DATA

The following selected consolidated financial data sets forth certain financial highlights of the Company and should be read in conjunction with the consolidated financial statements and related notes:

At or for the year ended December 31,

Year End

For the Year

Net income attributable to noncontrolling interest 129 101 103 96 10

Convertible preferred stock dividends - - 97 291 208

Per Share

Performance Ratios

Shareholders' Equity to total assets at end of year 8.15 7.93 8.58 7.94 8.27

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At December 31,

Asset Quality Ratios

Regulatory Capital Ratios (Bank Only)

Number of:

(a)

See table below for reconciliation of the non-GAAP financial measures.

(b)

The efficiency ratio is calculated as noninterest expense divided by the sum of net interest income and noninterest income, excluding net gains on sales, redemptions and impairment of investment securities and net gains (losses) on sales of loans and foreclosed real estate.

NON-GAAP FINANCIAL INFORMATION

Regulation G, a rule adopted by the Securities and Exchange Commission (SEC), applies to certain SEC filings, 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 and are not easily reconcilable to the closest comparable GAAP financial measures, even in those cases where a comparable measure exists. 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, and does so without compliance with Regulation G, on the widely-shared assumption that the SEC regards such non-GAAP measures to be exempt from Regulation G. The Company uses in this regulatory filing additional non-GAAP financial measures that are commonly utilized by financial institutions and have not been specifically exempted by the SEC from Regulation G. The Company provides, as supplemental information, such non-GAAP measures included in this document as described immediately below.

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At or for the year ended December 31,

Per Share

Book value per common share

Total common equity

Tangible book value per common share

Performance Ratios

Efficiency ratio

Less : (Losses)/Gains on marketable securities (255 ) 352 382 (629 ) 81

Dividend payout ratio

Return on average common equity

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At or for the year ended December 31,

Regulatory Capital Ratios (Bank Only)

Total capital (to risk-weighted assets)

Tier 1 capital (to risk-weighted assets)

Tier 1 capital (to adjusted assets)

Tier 1 Common Equity (to risk-weighted assets)

CRITICAL ACCOUNTING ESTIMATES

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 consolidated 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. 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 credit losses, deferred income tax assets and liabilities, pension obligations, the annual evaluation of the Company’s goodwill for possible 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. These areas could be the most subject to revision as new information becomes available.

Allowance for Credit Losses. On January 1, 2023 the Company adopted the Current Expected Credit Loss ("CECL") model, as required under Accounting Standards Update (ASU) 2016-13, Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. The Company adopted the standard, which replaced the incurred loss methodology with CECL for financial instruments measured at amortized cost and other commitments to extend credit. The allowance for credit losses on loans and unfunded commitments is a valuation allowance for management’s estimate of expected credit losses in the loan portfolio and commitments to extend credit. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires

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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. The Company also establishes a specific allowance, regardless of the size of the loan, modified due to borrowers experiencing financial difficulties. In addition, an accruing substandard loan could be identified as being individually evaluated. 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 December 31, 2023, the Bank’s position in individually evaluated loans consisted of 69 loans totaling $22.6 million. Of these loans, 17 loans, totaling $1.6 million, were valued using the present value of future cash flows method; and 66 loans, totaling $20.9 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 loss for each risk-rating category. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for credit losses and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in this report.

As noted above, the allowance for credit losses (“ACL”) represents management’s estimate of lifetime losses in the Bank’s loan portfolio. Determining the amount of the ACL requires significant judgment on the part of management and 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, as correlated to historical economic metrics and in consideration of current economic trends and conditions, and other qualitative factors, all of which may be susceptible to significant change.

The Company utilizes the Discounted Cash Flow (“DCF”) method for its pooled segment calculation. The DCF method implements a probability of default with loss given default and loss exposure at default estimation. The probability of default and loss given default are applied to future cash flows that are adjusted to present value and these discounted expected losses become the Allowance for Credit Losses.

Management also considers Qualitative Factors (“QF”) that are likely to cause estimated credit losses with the Company’s existing portfolio to differ from historical loss experience, including but not limited to: national and local economic trends and conditions, levels and trends in delinquencies, non-accrual loans and classified assets, trends in volume, terms and concentrations of loans, changes in lending policies and procedures, quality of credit review function and administration, and changes in regulatory environment, management, markets and product offerings. The Company quarterly assesses the magnitude of QF adjustments necessary to be applied to the quantitatively-derived ACL in order to incorporate forward-looking projections in its final evaluation of current expected credit losses.

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 December 31, 2023, the Bank held $520.6 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 $10.7 million to the ACL for these loans, including $3.4 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 $891,000, 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 December 31, 2023 in the final recorded estimation of the ACL on loans recognized on the Statement of Financial Condition.

If the assumptions underlying the determination of the ACL prove to be incorrect, the ACL may not be sufficient to cover actual credit losses and an increase to the ACL may be necessary in future periods to allow for different assumptions or adverse developments. In addition, future problems with one or more specifically-identified loans or one or more specifically-identified borrower relationships could require a significant increase to the ACL.

Management’s methodology and policy in determining the allowance for credit losses can be found in Note 1 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K. The activity in the allowance for credit losses is depicted in supporting tables in Note 6 to the consolidated financial statements included in Item 8 of this Annual Report on Form 10-K.

At December 31, 2022 the Company calculated its ALLL utilizing the Incurred Loss Model ("ILM") methodology, as required under GAAP on that date. As noted above, on January 1, 2023, the Company adopted the Current Expected Credit Loss ("CECL") model methodology in accordance with GAAP requirements that became effective on that date. At December 31, 2022 the Company had a total allowance for loan and lease losses ("ALLL") of $15.3 million, of which $4.8 million was related to impaired loans and $10.5 million was related to loans analyzed collectively on an aggregate pool basis.

As a consequence of the adoption of the CECL model, the Company recorded a one-time transition adjustment (recorded as an adjustment, net of taxes, to retained earnings) of $1.9 million related to its aggregate loan portfolio that reversed the $10.5 million in the

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December 31, 2022 ALLL, that was related to pooled loans evaluated in the aggregate, as previously calculated under the phased-out ILM methodology, and replaced it with the ACL, as calculated under CECL, in the amount of $12.4 million. The $12.4 million CECL ACL at January 1, 2023 was composed of $8.4 million in reserves calculated using quantitative methodologies based on historical loss experience and $4.0 million based on qualitative factors, as determined by management. The $4.8 million in ALLL related to specifically-identified loans at December 31, 2022 was not affected by the transition to the CECL methodology on January 1, 2023.

The transition to CECL also required that new reserves be created in the amounts of $450,000 and $552,000, related to held-to-maturity investments and unfunded commitments, respectively. Including the $1.9 million CECL transition adjustment related to loans, described above, the total CECL transition adjustment, recorded to retained earnings, was $2.9 million on January 1, 2023. This transition adjustment, which had no effect on reported earnings in 2023, was booked to retained earnings in the first quarter of 2023 and was therefore a nonrecurring subtraction from tangible book value, after tax effects of approximately $2.1 million.

Deferred Income Tax Assets and Liabilities. 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 from 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. For additional information regarding the Company's deferred income taxes, see Note 17 to the consolidated financial statements.

Pension Obligations. Pension and postretirement 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. The assumptions used by management are discussed in Note 14 to the consolidated financial statements contained herein.

Evaluation of Goodwill. Management performs an annual evaluation of the Company’s goodwill for possible impairment. Based on the results of the 2023 evaluation, management has determined that the carrying value of goodwill is not impaired as of December 31, 2023. The evaluation approach is described in Note 10 of the consolidated financial statements contained herein.

Estimation of Fair Value. The estimation of fair value is significant to several of our assets; including investment securities available-for-sale, interest rate derivative (discussed in detail in Note 22 of the consolidated financial statements), intangible assets, 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 consolidated financial statements. Fair values on our available-for-sale 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 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 individually analyzed 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.

RECENT EVENTS

On December 22, 2023, the Company announced that its Board of Directors had declared a cash dividend of $0.09 per share on the Company’s voting common and non-voting common stock, and a cash dividend of $0.09 per notional share for the issued Warrant relating to the fiscal quarter ended December 31, 2023. The dividend was paid on February 2, 2024 to shareholders of record on January 12, 2024.

On March 4, 2024 Pathfinder Bank entered into a purchase and assumption agreement (the “Purchase Agreement”) with Berkshire Bank, the banking subsidiary of Berkshire Hills Bancorp, Inc. (“Berkshire Bank”). Under the Purchase Agreement, Pathfinder Bank will acquire approximately $32 million in loans and one branch location (along with associated personal property and fixtures), and will assume approximately $198 million in deposits. With respect to loans, Pathfinder Bank will pay an amount equal to the sum of 95% of the aggregate unpaid principal balances, measured as of the closing date, plus any accrued interest through closing on the loans. Pathfinder Bank will pay 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 will assume all non-Core Deposits associated with the branch, measured as of the closing date, at par value. The total deposit premium to be paid by Pathfinder Bank equates to approximately 4.0% when applied to the aggregated Core Deposits and non-Core Deposits. Pathfinder Bank will assume Berkshire Bank’s existing commercial lease for the real property associated with the branch (including anticipated annual lease payment costs of approximately $946,000). The transaction is expected

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to close by the end of the third quarter of 2024 and is subject to receipt of regulatory approvals and certain other customary closing conditions.

EXECUTIVE SUMMARY AND RESULTS OF OPERATIONS

The Company reported net income of $9.3 million for 2023, a decrease of $3.6 million as compared to net income of $12.9 million in 2022. Net income decreased during 2023, as compared to the previous year, due to a decrease in net interest income after provision for credit losses of $2.7 million, a decrease in total noninterest income of $724,000, and an increase in noninterest expense of $521,000. These decreases in net income were partially offset by a $294,000 decrease in the provision for income taxes, and a $28,000 increase in net income attributable to noncontrolling interest. Basic and diluted earnings per share in 2023 were both $1.51 per share, as compared to $2.13 per share in 2022.

Return on average assets decreased 29 basis points to 0.67% in 2023 from 0.96% in 2022. Return on average equity decreased 368 basis points to 8.09% in 2023 as compared to 11.77% in 2022. The decreases in return on average assets and return on average equity in 2023, as compared to the previous year, were both primarily due to the aforementioned decrease in net income. Average assets increased in 2023 by $44.4 million, or 3.3%, as the Company grew its total assets from $1.40 billion for the year ended December 31, 2022 to $1.47 billion for the year ended December 31, 2023.

Net interest income, before provision for credit losses, decreased $2.5 million, or 6.0%, to $38.9 million in 2023 on average interest earning assets of $1.32 billion, as compared to net interest income before provision for loan losses of $41.4 million in 2022 on average interest earning assets of $1.28 billion. Interest and dividend income increased $16.6 million in 2023 to $67.7 million, as compared to $51.1 million in 2022. The income effects of the aggregate increase in the average balance of interest-earning assets of $42.2 million were enhanced by an increase of 113 basis points in the overall average yield earned on those assets. These increases in interest income were more than offset by increases in interest expense, as interest expense increased $19.0 million due to an increase in the average rate paid on interest-bearing liabilities of 171 basis points in 2023 as compared to 2022, enhanced by an increase in the average balance of interest-bearing liabilities of $55.0 million during the same time period.

The Company recorded a provision for credit losses of $2.9 million in 2023 as compared to $2.8 million in the prior year. The $176,000 year-over-year increase in provision for credit losses was primarily due to the downgrading of a limited number of relatively large commercial real estate and commercial loan relationships. Additionally, the provision for credit losses in 2023 reflected an increase in nonperforming loans of $8.2 million at December 31, 2023, as compared to December 31, 2022. The Company recorded $4.2 million in net charge-offs in 2023 as compared to $370,000 in 2022. The increase in charge-off activity in 2023, as compared to the previous year, was primarily related to the aforementioned limited number of large commercial real estate and commercial loan relationships. The charge-offs in 2023 involved loans for which the charged-off amounts had been fully reserved for in prior periods.

Total noninterest income was $5.2 million in 2023, a decrease of $724,000, or 12.2%, from $5.9 million in 2022. This decrease was due in part to the receipt of one-time Federal and New York State historical tax credits, totaling $521,000, granted in 2022 in connection with the restoration of our Southwest Corridor branch. The decrease was also in part due to a $607,000 increase in net losses on marketable equity securities. Fluctuations in the market value of equity securities are recorded as periodic net gain or loss, and the net losses recorded in 2023 are considered to be transitory. Partially offsetting these decreases in noninterest income were a $525,000 increase in gains on sales of securities, fixed assets, loans, and foreclosed real estate, as well as a $123,000 increase in service charges on deposit accounts, and a $41,000 increase in bank-owned life insurance revenues.

Noninterest expenses totaled $29.4 million for 2023, which was an increase of $521,000, or 1.8%, from the $28.9 million reported for the previous year. This modest increase can be primarily attributed to the incremental expenses associated with the Company's growth activities, including the opening of the Southwest Corridor branch in late 2022, and investments in technology to enhance digital banking services, which align with Pathfinder Bancorp’s long-term strategic plans.

Salaries and employee benefits, constituting the largest component of noninterest expenses, saw a moderate year-over-year decrease of $102,000, indicative of the Company’s commitment to cost saving measures even in a competitive labor market. An increase of $183,000 in occupancy and equipment expenses contributed to the annual increase in overall noninterest expenses, reflecting the Bank's investment in physical infrastructure and branch network expansion. Professional and other services expense increased $491,000 in 2023, as compared to 2022. This increase was primarily due to a $390,000 increase in third-party software service costs, related in part to the Company's continuing efforts to increase process automation, and a $136,000 increase in non-recurring legal fees. FDIC assessments expense increased $279,000 during 2023, primarily attributable to an increase in fees calculated on total liabilities and insured deposits, as well as certain nonrecurring adjustments made in 2022.

Net loan charge-offs to average loans were 0.47% for 2023, as compared to 0.04% for 2022. Nonperforming loans to total loans increased to 1.92% at December 31, 2023, compared to 1.00% at December 31, 2022. The allowance for credit losses to non-performing loans at December 31, 2023 was 92.73%, compared with 169.93% at December 31, 2022. Total nonperforming assets increased $8.1 million, or 88.2%, between December 31, 2022 and December 31, 2023, largely driven by an increase of $6.6 million in commercial and commercial real estate loans, and increases of $957,000 and $658,000 in nonperforming consumer and residential real estate loans respectively.

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Management monitors its loan portfolio closely and has incorporated our current estimate of the ultimate collectability of all loans into the reported allowance for credit losses at December 31, 2023. Overall, the ratio of the allowance for credit losses to year end loans increased to 1.78% at December 31, 2023 from 1.71% at December 31, 2022.

Total past due loans measured as a percent of total loans, increased from 2.89% at December 31, 2022 to 3.79% at December 31, 2023, primarily due to an increase of $3.8 million in past due commercial loans, a $2.3 million increase in past due residential loans, and a $1.9 million increase in past due consumer loans. The level of nonperforming loans increased in aggregate by $8.2 million led by an increase of $6.6 million in commercial and commercial real estate loans, a $957,000 increase in consumer loans, and a $658,000 increase in residential mortgage loans. Commensurate with the increase in nonperforming loans to year end loans, the ratio of nonperforming assets to total assets increased to 1.19% at December 31, 2023 from 0.66% at December 31, 2022.

The Company’s shareholders’ equity increased $8.5 million, or 7.7%, to $119.5 million at December 31, 2023 from $111.0 million at December 31, 2022. This increase was primarily due to a $4.7 million increase in retained earnings, a $2.6 million decrease in accumulated other comprehensive loss, a $1.0 million increase in additional paid in capital, and a $180,000 increase in ESOP shares earned. The increase in retained earnings resulted from $9.3 million in net income recorded in 2023. Partially offsetting these increases in retained earnings during 2023 were a one-time $2.1 million CECL transition adjustment, as well as $1.7 million for cash dividends declared on voting common stock, $497,000 for cash dividends declared on non-voting common stock, $45,000 for cash dividends declared on issued warrants, and $199,000 for cumulative effect of affiliate capital allocation.

Net Interest Income

Net interest income is the Company's primary source of operating income. It is the amount by which interest earned on interest-earning deposits, loans and investment securities exceeds the interest paid on deposits and borrowed money. Changes in net interest income and the net interest margin ratio resulted from the interaction between the volume and composition of interest-earning assets, interest-bearing liabilities, and their respective yields and funding costs.

The following comments refer to the table of Average Balances and Rates and the Rate/Volume Analysis, both of which follow below.

Net interest income, before provision for credit losses, decreased $2.5 million, or 6.0%, to $38.9 million in 2023 as compared to $41.4 million in the previous year. Our net interest margin for the year ended December 31, 2023 decreased to 2.95% from 3.24% for the comparable prior year. The decrease in net interest income was primarily due to an increase in interest expense of $19.0 million, or 196.5%, offset by a lesser increase in interest and dividend income of $16.6 million, or 32.4%. The increase in interest expense was primarily a result of the increase in average cost of deposits resulting from the rapidly rising interest rate environment and increased competition.

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Average Balances and Rates

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Interest income and resultant yield information in the table has 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. Yields and amounts earned include loan fees. Nonaccrual loans have been included in interest-earning assets for purposes of these calculations.

For the year ended December 31,

Average Average

Unaudited Average Yield / Average Yield /

(In thousands) Balance Interest Cost Balance Interest Cost

Interest-earning assets:

Noninterest-earning assets:

Net unrealized losses on available-for-sale securities (13,600 ) (9,580 )

Interest-bearing liabilities:

Noninterest-bearing liabilities:

Net interest rate spread 2.47 % 3.05 %

Net interest margin 2.95 % 3.24 %

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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 years 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.

Years Ended December 31,

Increase/(Decrease) Due to Increase/(Decrease) Due to

Total Total

Increase Increase

(In thousands) Volume Rate (Decrease) Volume Rate (Decrease)

Interest Income:

Interest Expense:

Money management accounts (2 ) (1 ) (3 ) - 1 1

Interest Income

Changes in interest income result from changes in the average balances of loans, securities, and interest-earning deposits and the related average yields on those balances.

Interest and dividend income increased $16.6 million, or 32.4%, to $67.7 million in 2023 as compared to $51.1 million in 2022 due principally to the $42.2 million, or 3.3%, increase in average interest-earning assets and a 113 basis points increase in the average yield on average interest-earning assets. The average yield earned on loans increased 85 basis points in 2023, when compared to 2022, as a result of rising interest rates associated with variable rate loans. The average balance of loans increased $30.0 million, or 3.4%, in 2023, as compared to the previous year due to the increase in average commercial real estate and commercial and industrial loans. The average yields earned on taxable investment securities increased 151 basis points to 4.76% in 2023 as compared to 3.25% in 2022, primarily as a result of the rising interest rate environment in 2023. In addition, the average balance of taxable investment securities increased $27.7 million, or 7.9%, when compared to the prior year primarily due to increased purchases of securities in the fourth quarter of 2023 intended to take advantage of certain dynamics in the interest rate environment present at that time. In combination, these factors resulted in a $6.6 million increase in interest income associated with taxable investment securities in 2023, as compared to 2022.

Interest Expense

Interest expense increased $19.0 million, or 196.5%, to $28.7 million in 2023, as compared to $9.7 million in the previous year. The year-over-year increase in interest expense was primarily driven by the rising interest rate environment in 2023 and lagged effects from the rising interest rate environment in 2022. The average rate paid on interest-bearing deposits increased by 225 basis points to 3.26% in 2023 as compared to 1.10% in the previous year. The average cost of all interest-bearing liabilities increased from 0.94% in 2022 to 2.65% in 2023. In addition, the year-over-year increase in interest expense resulted from increases in the average balances of deposits and borrowings. The average balance of total interest-bearing liabilities increased $55.0 million, or 5.3%, in 2023, as compared to 2022, and the average balance of all deposits increased by $20.5 million, or 2.2% in 2023, as compared to the previous year.

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Provision for Credit Losses

We establish a provision for credit losses, which is recorded 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 and amount of loans in the loan portfolio, adverse situations that may affect a 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 represents management’s estimate of the amount necessary to maintain the allowance for credit losses at an adequate level.

The Company recorded a provision for credit losses of $2.9 million in 2023 as compared to $2.8 million in the prior year. The $176,000 year-over-year increase in provision for credit losses was primarily due to the downgrading of a limited number of relatively large commercial real estate and commercial loan relationships. The Company recorded $4.2 million in net charge-offs in 2023 as compared to $370,000 in net charge-offs in 2022. The ratio of net charge-offs to average loans therefore increased to 0.47% in 2023 from 0.04% in 2022. Further information on earnings per share can be found in Note 1 to the consolidated financial statements of this Form 10-K.

Nonperforming loans to total loans increased to 1.92% at December 31, 2023 as compared to 1.00% at December 31, 2022. The allowance for credit losses to non-performing loans at December 31, 2023 was 92.7%, compared with 169.9% at December 31, 2022.

Noninterest Income

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

The following table sets forth certain information on noninterest income for the years indicated.

For the year ended December 31,

Earnings and gain on bank owned life insurance 630 589 41 7.0 %

(Losses) gains on marketable equity securities (255 ) 352 (607 ) -172.4 %

Total noninterest income was $5.2 million in 2023, a decrease of $724,000, or 12.2%, from $5.9 million in 2022. The decrease was in part due to a $607,000 increase in net losses on marketable equity securities. Fluctuations in the market value of equity securities are recorded as periodic net gain or loss, and the net losses recorded in 2023 are considered to be transitory.

Noninterest income before recorded gains and losses, decreased $642,000, or 11.0%, to $5.2 million in 2023 as compared to $5.8 million in 2022. The largest contributor to the year-over year decrease in noninterest income was due to the receipt of Federal and New York historical tax credits related to the restoration of the newly opened Southwest Corridor branch in 2022. The credits of $521,000 were received in 2022 concurrently with the opening of the branch facility and were not applicable in 2023. Also of note, debit card interchange fees decreased $251,000 year over year. This decrease is correlated to a decrease in transactional revenues volume and increases in rewards expense. The $154,000 year-over-year decrease in other charges, commissions and fees was the result of the 2022 sale of real estate held by our subsidiary, Whispering Oaks.

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Noninterest Expense

The following table sets forth certain information on noninterest expense for the years indicated.

For the year ended December 31,

Noninterest expense increased $521,000, or 1.8%, to $29.4 million in 2023 from $28.9 million in 2022. The increase in noninterest expenses in 2023, as compared to 2022, was primarily due to increases in building and occupancy, professional and other services, audits and exams, and insurance agency expense totaling $848,000. Increased foreclosure activity in 2023 when compared to 2022 caused an increase in foreclosed real estate expenses of $33,000. An increase of $183,000 in occupancy and equipment expenses contributed to the annual increase, reflecting the Bank's increased investment in physical infrastructure and branch network expansion. Professional and other services expense increased $491,000 in 2023, as compared to 2022. This increase was primarily due to a $390,000 increase in third-party software service costs, related in part to the Company's continuing efforts to increase process automation, and a $136,000 increase in non-recurring legal fees. FDIC assessments expense increased $279,000 during 2023, primarily attributable to an increase in fees calculated on total liabilities and insured deposits, as well as certain nonrecurring adjustments made in 2022. Strategic decreases in advertising in combination with decreases in salaries and employee benefits, data processing, community service activities, and other operating expenses help to offset noninterest expense by $639,000. Salaries and employee benefits, constituting the largest component of noninterest expenses, saw a moderate year-over-year decrease of $102,000, indicative of the Company’s commitment to cost saving measures even in a competitive labor market.

Income Tax Expense

The Company reported income tax expense of $2.4 million in 2023 and $2.7 million in 2022, a decrease of $300,000 when compared to the previous year. This decrease was primarily the result of a decrease in income before income taxes.

The Company’s effective tax rate was 20.8% in 2023, as compared to 17.5% in 2022. The Company’s effective tax rate in 2023 increased 3.3% primarily due to fluctuations in permanent tax differences, including state taxes, the reversal of a deferred tax asset valuation allowance for the year ended December 31, 2022, and the benefit of Federal and New York State historical tax credits claimed for the year ended December 31, 2022.

As a Maryland business corporation, the Company is required to file an annual report with, and pay franchise taxes to, the State of Maryland.

See Note 17 to the consolidated financial statements for the reconciliation of the statutory tax rate to the effective tax rate.

Earnings Per Share

Basic and diluted earnings per share for the year ended December 31, 2023 were both $1.51, as compared to basic and diluted earnings per share of $2.13 for the year ended December 31, 2022. The decrease in earnings per share between these two years was due to the decrease in net income available to common shareholders between these two time periods. Further information on earnings per share can be found in Note 3 to the consolidated financial statements of this Form 10-K.

CHANGES IN FINANCIAL CONDITION

The Company's total assets were $1.47 billion at December 31, 2023 as compared to $1.40 billion at December 31, 2022. The increase in total assets of $65.9 million, or 4.7%, was primarily the result of a $67.0 million increase in available-for-sale securities, a $13.5 million increase in interest-earning deposits, partially offset by a $15.1 million decrease in held-to-maturity securities. All other asset categories had a net increase of $500,000.

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Investment Securities

The average investment portfolio represented 31.0% of the Company’s average interest-earning assets in 2023 and is designed to generate a favorable rate of return in consideration of all risk factors associated with debt securities while assisting the Company in meeting its liquidity needs and interest rate risk strategies. All of the Company’s investments, with the exception of marketable equity securities, are classified as either available-for-sale or held-to-maturity. The Company does not hold any trading securities. The Company invests in securities issued by United States Government agencies and sponsored enterprises (“GSE”), mortgage-backed securities, collateralized mortgage obligations, state and municipal obligations, mutual funds, equity securities, investment grade corporate debt instruments, and common stock issued by the FHLBNY. By investing in these types of assets, the Company reduces the credit risk of its asset base through geographical and collateral-type diversification but must accept lower yields than would typically be available on loan products. Our mortgage-backed securities and collateralized mortgage obligations portfolios include privately-issued but substantially collateralized pass-through securities as well as pass-through securities guaranteed by GSEs.

At December 31, 2023, available-for-sale investment securities increased 34.9% to $258.7 million and held-to-maturity investment securities decreased 7.6% to $179.6 million as compared to December 31, 2022. There were no securities that exceeded 10% of consolidated shareholders’ equity.

Our available-for-sale investment securities are carried at fair value and our held-to-maturity investment securities are carried at amortized cost.

The following table sets forth the carrying value of the Company's investment portfolio at December 31:

Available-for-Sale Held-to-Maturity

Investment Securities:

Common stock - financial services industry 206 206 206 - - -

The following table sets forth the scheduled maturities, amortized cost, fair values and average yields for the Company's investment securities at December 31, 2023. Average yield is calculated on the amortized cost to maturity. Adjustable rate mortgage-backed securities are included in the period in which interest rates are next scheduled to be reset.

AVAILABLE FOR SALE

More Than One More Than Five

One Year or Less to Five Years to Ten Years

Annualized Annualized Annualized

Amortized Weighted Amortized Weighted Amortized Weighted

(Dollars in thousands) Cost Avg Yield Cost Avg Yield Cost Avg Yield

Debt investment securities:

Mortgage-backed securities:

Other non-maturity investments:

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More Than Ten Years Total Investment Securities

Annualized Annualized

Amortized Weighted Amortized Fair Weighted

(Dollars in thousands) Cost Avg Yield Cost Value Avg Yield

Debt investment securities:

Mortgage-backed securities:

Other non-maturity investments:

HELD-TO-MATURITY

More Than One More Than Five

One Year or Less to Five Years to Ten Years

Annualized Annualized Annualized

Amortized Weighted Amortized Weighted Amortized Weighted

(Dollars in thousands) Cost Avg Yield Cost Avg Yield Cost Avg Yield

Debt investment securities:

US Treasury, agencies and GSEs $ - 0.00 % $ - 0.00 % $ 1,497 3.18 %

Mortgage-backed securities:

More Than Ten Years Total Investment Securities

Annualized Annualized

Amortized Weighted Amortized Fair Weighted

(Dollars in thousands) Cost Avg Yield Cost Value Avg Yield

Debt investment securities:

Mortgage-backed securities:

The yield information disclosed above does not give effect to changes in fair value that are reflected in accumulated other comprehensive loss in consolidated shareholders’ equity.

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Loans Receivable

Average loans receivable represented 68.1%of the Company’s average interest earning assets in 2023 and account for the greatest portion of total interest income. At December 31, 2023, the Company had the largest portion of its loan portfolio in commercial loanproducts that represented 58.4%of total loans. These products include credits extended to businesses and political subdivisions within its marketplace that are typically secured by commercial real estate, equipment, inventories, and accounts receivable. The residential mortgage loans product segment represents 28.8% of total loans at December 31, 2023. The consumer loan products represented 12.8%of total loans at December 31, 2023. The Company has seen the proportion of commercial loan products to total loans increase in recent years and it will continue to emphasize these types of loans. Notwithstanding this emphasis, the Company also anticipates a continued commitment to financing the purchase or improvement of residential real estate in its market area.

The following table sets forth the composition of our loan portfolio, including net deferred costs, in dollar amount and as a percentage of loans.

December 31,

The following table shows the amount of loans outstanding, including net deferred costs, as of December 31, 2023 which, based on remaining scheduled repayments of principal, are due in the periods indicated. Demand loans having no stated schedule of repayments, no stated maturity, and overdrafts are reported as one year or less. Adjustable and floating rate loans are included in the period on which interest rates are next scheduled to adjust, rather than the period in which they contractually mature. Fixed rate loans are included in the period in which the final contractual repayment is due.

Real estate:

The following table sets forth fixed- and adjustable-rate loans at December 31, 2023 that are contractually due after December 31, 2024:

(In thousands) Due AfterOne Year

Interest rates:

Total loans receivable, including net deferred costs, decreased $547,000, to $897.2 million at December 31, 2023 when compared to $897.8 million at December 31, 2022, due to decreases in consumer loans and residential mortgage loans of $13.1 million and $3.8 million, respectively. These decreases in outstanding loan balances were partially offset by increases in commercial real estate loans, commercial and tax exempt loans, and home equity and junior liens of $13.8 million, $1.7 million, and $882,000, respectively. Although the Company maintained its previously established credit standards, the outstanding balances of commercial real estate and commercial loans increased as the Bank continued to benefit from the expanding relationship-derived business activity within the markets that the Bank serves. The decrease in residential mortgage loans was primarily the result of decreases in the percentage of originated loans allocated for addition to the Bank's portfolio as rates generally increased throughout 2023. The Company does not originate sub-prime, Alt-A, negative amortizing or other higher risk structured residential mortgages.

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Nonperforming Loans and Assets

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

December 31

Nonaccrual loans:

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

Management monitors its loan portfolios closely and has incorporated our current estimate of the ultimate collectability of all loans into the reported allowance for credit losses at December 31, 2023. The ratio of the allowance for credit losses to year end loans was 1.78% and 1.71% at December 31, 2023 and December 31, 2022, respectively.

Total nonperforming assets increased $8.1 million, or 88.2%, between December 31, 2022 and December 31, 2023, driven by increases of $6.6 million, $957,000, and $658,000 in nonperforming commercial and commercial real estate loans, consumer loans, and residential real estate loans, respectively, partially offset by a decrease of $70,000 in foreclosed real estate. The increase in nonperforming commercial and commercial real estate loans in 2023 was primarily due to one loan relationship in the in the amount of $7.8 million that was placed on non-accrual status. The $957,000 increase in nonperforming consumer loans was primarily due to increases in purchased loans that are 90 days or greater past due.

Management believes that the value of the collateral properties underlying the loans is sufficient to preclude any significant losses related to these loans. Management continues to monitor and react to national and local economic trends as well as general portfolio conditions which may impact the quality of the portfolio, and considers these environmental factors in support of the allowance for credit loss reserve. Management believes that the current level of the allowance for credit losses, at $16.0 million at December 31, 2023, adequately addresses the current level of risk within the loan portfolio, particularly considering the types and levels of collateralization supporting the substantial majority of the portfolio. The Company maintains strict loan underwriting standards and carefully monitors the performance of the loan portfolio. See Note 1: Summary of Significant Accounting Policies contained in the financial statements herein.

Foreclosed Real Estate (“FRE”) balances decreased to $151,000 at December 31, 2023, compared to $221,000 from the prior year end.

The Company generally places a loan on nonaccrual status and ceases accruing interest when loan payment performance is deemed unsatisfactory and the loan is past due 90 days or more. There are no loans that are past due 90 days or more and still accruing interest. The Company considers a loan specifically-identified when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan. Had the loans in nonaccrual status performed in accordance with their original terms, additional interest income of $989,000and $476,000 would have been recorded for the years ended December 31, 2023 and December 31, 2022, respectively.

The measurement of specifically-identified loans is based upon the fair value of the collateral or the present value of future cash flows discounted at the historical effective interest rate for specifically-identified loans when the receipt of contractual principal and interest is probable. At December 31, 2023 and December 31, 2022, the Company had $22.6 million and $20.2 million in loans, which were deemed to be specifically-identified, having specific reserves of $3.7 million and $4.8 million, respectively. The $2.4 million year-over-year increase in specifically-identified loans was principally due to increases of $4.4 million, $2.0 million, and $177,000 in specifically-identified commercial real estate, other commercial and industrial, and residential mortgages, respectively, offset by decreases of $4.1 million and $8,000 in commercial lines of credit and home equity and junior liens, respectively.

The threshold for specifically-identified commercial real estate or commercial loans remains at $100,000 and for residential mortgage loans remains at $300,000 at December 31, 2023. The thresholds described above do not apply to loans that have been classified as modified due to borrowers experiencing financial difficulties, which are individually evaluated at the time that the restructuring is affected.

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.

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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 increased $6.3 million to $43.1 million at December 31, 2023, compared to $38.6 million at December 31, 2022. These loans have been internally classified as special mention, substandard, or doubtful, yet are not currently considered specifically-identified. The increase in potential problem loans was primarily due to a $7.8 million increase in potential problem commercial real estate loans and a $2.1 million increase in potential problem consumer loans. These increases were partially offset by a decrease of $3.3 million in potential problem commercial and industrial loans. The increase in potential problem commercial real estate loans in 2023 was a result of one loan relationship for $7.1 million, and one residential real estate loan relationship in the amount of $1.4 million.

Total potential problem loans, including specifically-identified loans, were $43.1 million at December 31, 2023, and were comprised of special mention, substandard and doubtful loans of $20.7 million, $20.3 million and $2.1 million, respectively. Total potential problem loans, including impaired loans, were $38.6 million at December 31, 2022, and were comprised of special mention, substandard and doubtful loans of $20.0 million, $17.0 million and $2.1 million, respectively.

The Company measures delinquency based on the amount of past due loans as a percentage of total loans. The ratio of delinquent loans to total loans increased to 3.79% at December 31, 2023 as compared to 3.21% at December 31, 2022. This increase was due to an increase of $3.8 million in past due commercial loans, a $1.9 million increase in past due consumer loans, and a $2.3 million increase in past due residential loans.At December 31, 2023, there were $34.0 million in loans past due including $13.6 million, $3.2 million and $17.2 million in loans 30-59 days, 60-89 days, and 90 days and over past due, respectively. At December 31, 2022, there were $28.9 million in loans past due including $13.0 million, $4.3 million and $8.7 million in loans 30-59 days, 60-89 days, and 90 days and over past due, respectively.

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.

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.

Allowance for Credit Losses

The allowance for credit losses (ACL) is established through provision for credit losses and reduced by loan charge-offs net of recoveries. The allowance for credit losses represents the amount available for probable credit losses in the Company’s loan portfolio as estimated by management.

The Company establishes a specific allocation for all commercial loans identified as being specifically-identified with a balance in excess of $100,000 that are also on nonaccrual or have been risk rated under the Company’s risk rating system as substandard, doubtful, or loss. The measurement of specifically-identified loans is based upon either the present value of future cash flows discounted at the historical effective interest rate or the fair value of the collateral, less costs to sell for collateral dependent loans. At December 31, 2023, the Bank’s position in specifically-identified loans consisted of 69 loans totaling $22.5 million. Of these loans, 17 loans, totaling $1.6 million, were valued using the present value of future cash flows method; and 52 loans, totaling $20.9 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 probable lifetime loss for each risk-rating category. The Company uses the fair value of collateral, less costs to sell to measure impairment on commercial and commercial real estate loans. Residential real estate loans in excess of $300,000 will also be included in this individual loan review. Residential real estate loans less than this amount will be included in specifically-identified loans if it is part of the total related credit to a previously identified commercial loan. The Company also establishes a specific allowance, regardless of the size of the loan, for all loans modified due to borrowers experiencing financial difficulties.

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At December 31, 2022 the Company calculated its ALLL utilizing the Incurred Loss Model ("ILM") methodology, as required under GAAP on that date. On January 1, 2023, the Company adopted the Current Expected Credit Loss ("CECL") model methodology in accordance with GAAP requirements that became effective on that date. At December 31, 2022 the Company had a total allowance for loan and lease losses ("ALLL") of $15.3 million, of which $4.8 million was related to impaired loans and $10.5 million was related to loans analyzed collectively on an aggregate pool basis. On January 1, 2023 the Company recorded a one-time CECL transition adjustment (recorded as an adjustment, net of taxes, to retained earnings) of $1.9 million that reversed the $10.5 million in the December 31, 2022 ALLL, that was related to pooled loans, evaluated collectively in the aggregate, as previously calculated under the phased-out ILM methodology, and replaced it with the ACL, as calculated under CECL, in the amount of $12.4 million. The $12.4 million CECL ACL at January 1, 2023 was composed of $8.4 million in reserves calculated using quantitative methodologies based on historical loss experience and $4.0 million based on qualitative factors, as determined by management. The $4.8 million in ALLL related to impaired loans at December 31, 2022 was not affected by the transition to the CECL methodology at January 1, 2023.

The transition to CECL also required that new reserves be created in the amounts of $450,000 and $552,000, related to held-to-maturity investments and unfunded commitments, respectively. Including the $1.9 million CECL transition adjustment related to loans, described above, the total CECL transition adjustment was $2.9 million on January 1, 2023, which was recorded to retained earnings on that date. Beginning on January 1, 2023, the Bank has had to account for all credit loss exposures using this CECL methodology. The resulting nonrecurring adjustment from ILM to CECL, was made on January 1, 2023, increasing the ACL at December 31, 2022 by $2.2 million in determining the beginning allowance for credit losses ("ACL") for the quarter ended March 31, 2023. This transition adjustment was booked to retained earnings in the first quarter of 2023 and was therefore a subtraction from tangible book value, after tax effects of approximately $2.1 million.

The allowance for credit losses and the allowance for loan losses at December 31, 2023 and 2022 was $16.0 million and $15.3 million, respectively, or 1.78% and 1.71% of total year end loans on those dates, respectively. The Company recorded $4.2 million in net charge-offs in 2023, as compared to $370,000 in net charge-offs in 2022. The ratio of net charge-offs to average loans increased to 0.47% in 2023 from 0.04% in 2022.

For further discussion of our allowance for credit losses procedures, please see “Business-Allowance for Credit Losses” and Note 6 to the consolidated financial statements contained in this Annual Report on Form 10-K.

The following table sets forth the allocation of allowance for credit losses by loan category for the years indicated. The allocation of the allowance by category is not necessarily indicative of future losses and does not restrict the use of the allowance to absorb losses in any category.

of the Loans to of the Loans to of the Loans to of the Loans to of the Loans to

(1)

Includes loans held-for-sale at December 31 for each of the indicated years.

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The following table sets forth the allowance for credit losses for the years indicated:

Adoption of New Accounting Standards 1,886

Recoveries of loans previously charged-off:

Residential real estate 1 - - 2 2

Loans charged off:

Net charge-offs to average loans outstanding 0.48 % 0.04 % 0.10 % 0.08 % 0.09 %

Allowance for credit losses to year-end loans 1.78 % 1.71 % 1.57 % 1.55 % 1.11 %

The following table sets forth the loan net charge-off ratios for the years indicated:

Allowance for credit losses to year-end loans 1.78 % 1.71 %

Allowance for credit losses to nonperforming loans 92.73 % 169.93 %

Nonaccrual loans to total loans 1.92 % 1.00 %

Allowance for credit losses to nonaccrual loans 92.73 % 169.93 %

Net charge-offs to average loans outstanding

Commercial real estate and loans 0.44 % 0.03 %

Consumer and home equity 0.03 % 0.01 %

Residential real estate 0.01 % 0.00 %

Total charged-off 0.48 % 0.04 %

Bank Owned Life Insurance

The Company held $24.6 million and $24.0 million in bank owned life insurance at December 31, 2023 and 2022, respectively. Bank owned life insurance increased $630,000, or 2.6%, to $24.6 million at December 31, 2023, as compared to December 31, 2022. The increase was primarily due to an increase in the cash value of the policies recorded as income in 2023.

Deposits

The Company’s deposit base is drawn from eleven full-service offices in its market area. The deposit base consists of demand deposits, money management and money market deposit accounts, savings, and time deposits. Average deposits increased by $1.3 million, or 0.12%, in 2023. For the year ended December 31, 2023, 57.2% of the Company's average deposit base of $1.1 billion consisted of core deposits. Core deposits, which exclude time deposits, 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.

Total deposits of $1.12 billion at December 31, 2023 consisted in part of $242.7 million in various forms of brokered money market and certificates of deposit accounts. Brokered deposits represented 21.7% of all deposits at December 31, 2023. Total deposits of $1.13 billion at December 31, 2022 consisted in part of $248.6 million in brokered money market and certificates of deposit accounts. Brokered deposits represented 22.1% of all deposits at December 31, 2022.

At December 31, 2023, consumer and business deposits increased by $25.2 million and $21.1 million, respectively, and municipal deposits decreased by $17.0 million, when compared to December 31, 2022. The year over year decrease in municipal deposits was primarily the result of the withdrawal of approximately $25.0 million (approximately 58% of the entity's total deposits with the Bank) in the third quarter of 2023 by a single large municipal depositor. Noninterest-bearing deposits, which are primarily demand deposits, were $170.2 million at year end, compared with $183.7 million on December 31, 2022. The increase in consumer and business deposits

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during the year ended December 31, 2023, reflected the Bank’s increased market penetration among both non-business and business customers.

The following table sets forth our deposit balances by category, and as a percentage of total deposits for the periods indicated :

December 31,

The Company has deposits that exceed the FDIC insurance limit of $250,000 of $403.2 million at December 31, 2023 and $501.2 million at December 31, 2022. At December 31, 2023, time deposit accounts in excess of $250,000 totaled $95.3 million, or 20.1% of time deposits and 8.5% of total deposits. At December 31, 2022, these deposits totaled $71.7 million, or 18.6% of time deposits and 6.4% of total deposits.

The following table indicates the amount of the Company’s time deposit accounts in excess of $250,000 by time remaining until maturity as of December 31, 2023:

(In thousands)

Remaining Maturity:

Three months or less $ 28,083

Three through six months 30,763

Six through twelve months 25,903

All municipal deposits, regardless of amount, are effectively insured, either through specific collateralization with securities held in third-party escrow or reciprocal deposit programs, as required under New York State law. Therefore, municipal deposits are not considered to be subject to the same risks of large unannounced withdrawals as consumer and business accounts for the reason of FDIC insurance coverage limitations. However, in 2023, the Bank's ability to garner municipal deposit balances came under increasing competitive pressure, primarily due to the rising interest rate environment and the entrance of new competitors within New York State. Management expects these trends to continue in the foreseeable future.

Deposit Activity

During 2023, the Bank experienced significant increases in its cost of deposits. This increase was due to the significant increases in interest rates experienced during the 2023 and the lagged effect of the significant increases in interest rates in 2022. The Bank also experienced substantially increased competition from directly marketed U.S. Treasury securities and various forms of money market funds, both of which were in position to be more immediately responsive to the rising rate environment than banks in general. In addition, new competitors, including fintech entities, and financial institutions, including credit unions, within the Bank’s local market were highly competitive for the Bank’s deposits. The Bank anticipates continued competitive pressure on its deposit rates for the foreseeable future.

We offer deposit accounts to consumers, business and local municipalities having a wide range of interest rates and terms. Our deposits consist of various types of transactional accounts such as savings accounts, money market accounts, NOW, and demand accounts as well as time accounts in the form of certificates of deposits. We solicit deposits in our market areas as well as online through our website. We also participate in reciprocal deposit services for our customers through the Certificate of Deposit Account Registry Services (“CDARS”) and Insured Cash Sweep (“ICS”) networks. The Bank also has a substantial number of readily-available sources for brokered term deposits that it uses regularly as a secondary funding source.

The Bank primarily relies on competitive pricing policies, marketing and customer service to attract and retain these deposits. As noted above, the Bank also accepts deposits from deposit brokers. At December 31, 2023 our brokered deposits, including CDARS, totaled $242.7 million, or 21.7% of total deposits with an average rate of 3.91%, including the effects of interest rate hedging activities and a weighted average maturity of 22 months. At December 31, 2022 our brokered deposits, including CDARS, totaled $248.6 million, or

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22.1% of total deposits with an average rate of 2.57%, including the effects of interest rate hedging activities and a weighted average maturity of 21 months. Our reliance on brokered deposits may increase the cost of funds, particularly in a rising interest rate environment.

The following table sets forth our brokered deposit balances and rates at December 31, 2023:

(Dollars in thousands) Balance Average Rate

Maturity Year:

Included in the brokered deposit balances, detailed above, are $46.3 million in deposits that can be called at the Bank's discretion, should that become economically advantageous in the future.

In addition to the term brokered deposits detailed above, the Bank had $40.0 million in overnight brokered funds, derived from a pool of individual depositors, at December 31, 2023. The interest rate paid for these funds is indexed to the overnight Fed funds effective rate plus 0.15%. These aggregate deposits are comprised of multiple individual deposits with balances small enough to be fully insured by the FDIC and the individual depositors with the aggregate pool can be readily substituted when withdrawals are made. These deposits are therefore considered to be highly stable in the aggregate. The Bank can exit this funding arrangement, in whole or in part, with 60 days prior notice to the issuing counterparty.

Excluding brokered deposits, all other deposits, collectively referred to as nonbrokered deposits, totaled $877.4 million, or 78.3% of total deposits with an average rate of 2.4% at December 31, 2023. Nonbrokered deposits, totaled $876.8 million, or 77.9% of total deposits with an average rate of 1.0% at December 31, 2022. Our core deposits, which herein are defined as transactional and savings accounts, that do not include certificates of deposit, were $607.2 million, or 69.2% of nonbrokered deposits, and $699.6 million, or 78.8% of nonbrokered deposits, at December 31, 2023 and December 31, 2022, respectively.

The following table sets forth our nonbrokered deposit activities in the periods indicated:

Years Ended December 31,

The Company’s management estimates that $45.0 million, or 48.4%, of the $93.0 million of the increase in the Bank’s certificates of deposit in 2023 were the result of transfers from the bank’s existing core deposit balances at December 31, 2022.

The following table sets forth our certificate of deposit balances and rates at December 31, 2023:

(Dollars in thousands) Balance Average Rate

Maturity Year:

Deposit Concentrations

The Bank has a broadly diversified customer base for its consumer, business and municipal deposits. However, due to the nature of the Bank’s deposit gathering activities, particularly for certain business and municipal deposit accounts, it also has significant concentrations of deposits gathered from a relatively small number of large balance depositors. The Bank faces substantial competition for these deposits and these depositors are generally offered higher interest rates than other depositors. Withdrawals of large balances by these customers would require the Bank to replace the withdrawn funds with other funding obtained from sources, such as FHLB advances

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or brokered deposits. These replacement funding activities would likely reduce the Bank’s overall available liquidity, as well increase its overall funding costs.

The following table sets forth certain statistics by customer type related to large balance customers within our nonbrokered deposit balances at the periods indicated:

At December 31,

Year end balances:

Percentage of year end balances:

Borrowings

Borrowings are comprised primarily of advances and overnight borrowings at the FHLBNY.

The following table represents information regarding short-term borrowings for the years ended December 31:

Average interest rate during the year 5.42 % 2.48 % 0.28 %

Average interest rate at the end of the period 4.50 % 3.86 % 1.28 %

The following table represents information regarding long-term borrowings for the years ended December 31:

Average interest rate during the year 1.54 % 0.96 % 1.34 %

Average interest rate at the end of the period 1.84 % 1.39 % 1.12 %

Subordinated Debt

The Company has a non-consolidated subsidiary trust, Pathfinder Statutory Trust II, of which the Company owns 100% of the common equity. The Trust issued $5,000,000 of 30-year floating rate Company-obligated pooled capital securities of Pathfinder Statutory Trust II (“Floating-Rate Debentures”). The Company borrowed the proceeds of the capital securities from its subsidiary by issuing floating rate junior subordinated deferrable interest debentures having substantially similar terms. The capital securities mature in 2037 and are treated as Tier 1 capital by the FDIC and the Federal Reserve. The capital securities of the trust are a pooled trust preferred fund of Preferred Term Securities VI, Ltd., with interest rates that reset quarterly, and are indexed to the 3-month the Secured Overnight Financing Rate ("SOFR") which is a broad measure of the cost of borrowing cash overnight collateralized by Treasury securities, plus1.91%. These securities have a five-year call provision. The Company guarantees all of these securities.

The Company's equity interest in the trust subsidiary is included in other assets on the Consolidated Statements of Financial Condition at December 31, 2023 and 2022. For regulatory reporting purposes, the Federal Reserve Board has indicated that the preferred securities will continue to qualify as Tier 1 Capital subject to previously specified limitations, until further notice. If regulators make a

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determination that Trust Preferred Securities can no longer be considered in regulatory capital, the securities become callable and the Company may redeem them.

On October 14, 2020, the Company executed a private placement of $25.0 million of its 5.50% Fixed to Floating Rate non-amortizing Subordinated Debt (the “2020 Subordinated Debt”) to certain qualified institutional buyers and accredited institutional investors. The 2020 Subordinated Debt has a maturity date of October 15, 2030 and initially bear interest, payable semi-annually, at a fixed annual rate of 5.50% per annum until October 15, 2025. Commencing on that date, the interest rate applicable to the outstanding principal amount due will be reset quarterly to an interest rate per annum equal to the then current three month SOFR plus 532 basis points, payable quarterly until maturity. The Company may redeem the 2020 Subordinated Debt at par, in whole or in part, at its option, any time after October 15, 2025 (the first redemption date). The 2020 Subordinated Debt is senior in the Company’s credit repayment hierarchy only to the Company’s common equity and, and any future senior indebtedness and is intended to qualify as Tier 2 capital for regulatory capital purposes for the Company. The Company paid $783,000 in origination and legal fees as part of this transaction. These fees will be amortized over the life of the 2020 Subordinated Debt through its first redemption date using the effective interest method, giving rise to an effective cost of funds of 6.22% from the issuance date calculated under this method. Accordingly, interest expense related to this transaction of $1.6 million was recorded in both the years ended December 31, 2023 and 2022.

Shareholders' Equity

The Company’s shareholders’ equity increased $8.5 million, or 7.7%, to $119.5 million at December 31, 2023 from $111.0 million at December 31, 2022. This increase was primarily due to a $4.8 million increase in retained earnings, a $1.0 million increase in additional paid in capital, a $2.6 million decrease in comprehensive loss and an increase of $180,000 of ESOP shares earned. The increase in retained earnings resulted from $9.3 million in net income recorded in 2023. Partially offsetting these increases in retained earnings were a $2.1 million nonrecurring charge to retained earnings related to the implementation of CECL, $1.7 million for cash dividends declared on our voting common stock, $497,000 for cash dividends declared on our non-voting common stock and $45,000 for cash dividends declared on our issued warrant, and $199,000 for the cumulative effect of affiliate capital allocation. Comprehensive loss decreased primarily as the result of decreased losses on available for sale securities of $2.6 million and a $354,000 adjustment to pension and post retirement, partially offset by a $350,000 loss on derivatives and hedging activities.

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 support growth and expansion activities, while maintaining a strong capital position and exceeding regulatory standards. At December 31, 2023, the Bank exceeded all regulatory required minimum capital ratios and met the regulatory definition of a “well-capitalized” institution. See “Supervision and Regulation – Federal Regulations – Capital Requirements”

As a result of the Dodd-Frank Act, the Company’s ability to raise new capital through the use of trust preferred securities may be limited because these securities will no longer be included in Tier 1 capital. In addition, our ability to generate or originate additional revenue producing assets may be constrained in the future in order to comply with capital standards required by federal regulation. See Note 20 to the consolidated financial statements contained herein and the regulation and supervision section within Part I of this Annual Report on Form 10-K for further discussion on regulatory capital requirements.

The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of its assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Bank to maintain amounts and ratios of Total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined).

As of December 31, 2023, the Bank’s most recent notification from the Federal Deposit Insurance Corporation categorized the Bank as “well-capitalized”, under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized”, the Bank must maintain specified total risk-based, Tier 1 risk-based and Tier 1 leverage ratios. There are no conditions or events since that notification that management believes have changed the Bank’s category.

The regulations also impose 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 Action (“PCA”) standards and imposes restrictions on dividend distributions and discretionary bonuses for senior officers if the buffer is not met (See Note 20 contained within the accompanying consolidated financial statements). In order to avoid these restrictions, the capital conservation buffer effectively increases the minimum the following capital to risk-weighted assets ratios: (1) Core Capital, (2) Total Capital and (3) Common Equity. At December 31, 2023, the Bank exceeded all current regulatory required minimum capital ratios, including the capital buffer requirements.

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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 ability to borrow from the 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, or the sale of loans. Such actions could result in higher interest expense costs and/or losses on the sale of securities or loans.

For the year ended December 31, 2023, cash and cash equivalents increased by $11.9 million. The Company reported net cash flows from financing activities of $52.8 million generated principally by a $65.3 million increase in short term borrowings, offset by a decrease in brokered deposits of $5.0 million, customer deposits of $352,000, a decrease in net proceeds from long-term borrowings of $5.7 million, and an aggregate decrease in net cash of all other financing sources, including dividends paid to common shareholders, and the holder of the Warrant of $2.2 million.Additionally, $13.8 million was provided through operating activities generated principally by net income and proceeds from loan sales. These cash flows were primarily invested in: $112.8 million in purchases of investment securities in 2023, and $1.8 million net increases in loans outstanding.

Certificates of deposit due within one year of December 31, 2023 totaled $325.0 million, representing 68.7% of certificates of deposit at December 31, 2023, an increase from 56.0% at December 31, 2022. If these maturing deposits do not remain with us, we will be required to seek other sources of funds, including other certificates of deposit and borrowings. Depending on market conditions, we may be required to pay higher rates on such deposits or other borrowings than we currently pay on the certificates of deposit due on or before December 31, 2024.

The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders and making payments on its subordinated debt. The Company may repurchase shares of its common stock. The Company’s primary sources of funds are the proceeds it retained from the Private Placement, the issuance of the 2020 Subordinated Debt, interest and dividends on securities and, potentially, dividends received from the Bank. The amount of dividends that the Bank may declare and pay to the Company in any calendar year, without prior regulatory approval, cannot exceed net income for that year to date plus retained net income (as defined) for the preceding two calendar years. The Company believes that this restriction will not have an impact on the Company's ability to meet its ongoing cash obligations. At December 31, 2023 and 2022, the Company had cash and cash equivalents of $47.1 million and $35.3 million, respectively.

The Bank has a number of existing credit facilities available to it. At December 31, 2023, total credit available under the existing lines of credit was approximately $236.7 million at FHLBNY, the FRB, and two other correspondent banks. At December 31, 2023, the Company had $175.6 million of the available lines of credit utilized, including encumbrances supporting the outstanding letters of credit, described above, on its existing lines of credit with the remainder of $61.1 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 December 31, 2023, management reported to the Board of Directors that the Bank was in compliance with its liquidity policy guidelines.

OFF-BALANCE SHEET ARRANGEMENTS

The Bank 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 December 31, 2023, the Bank had $205.0 million in outstanding commitments to extend credit and standby letters of credit. See Note 18 within the Notes to consolidated financial statements contained herein.

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required of a smaller reporting company.

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ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Index to Consolidated Financial Statements

Pathfinder Bancorp, Inc.

Page

Management’s Report on Internal Control over Financial Reporting 56

Report of Independent Registered Public Accounting Firm 57

Consolidated Statements of Condition – December 31, 2023 and 2022 59

Consolidated Statements of Income – Years ended December 31, 2023 and 2022 60

Notes to Consolidated Financial Statements 65

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MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Overview of Internal Control

Internal control processes and procedures help entities achieve important objectives and sustain and improve performance. The COSO Framework (as defined below) enables organizations to effectively and efficiently develop systems of internal control that adapt to changing business and operating environments, mitigate risks at acceptable levels and support sound decision making and governance of organizations. The COSO Framework defines internal control as “a process, effected by an entity’s Board of Directors, management, and other personnel, designed to provide reasonable assurance regarding the achievement of objectives relating to operations, reporting and compliance.” The COSO Framework provides three categories of objectives, which allow organizations to focus on differing aspects of internal control: (a) Operations Objectives, (b) Reporting Objectives and (c) Compliance Objectives.

Management’s Report on Internal Control over Financial Reporting

Management is responsible for establishing and maintaining effective internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. Our internal control over financial reporting is designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with GAAP.

Management evaluates the effectiveness of internal control over financial reporting and tests for reliability of recorded financial information through a program of ongoing internal audits. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation. Under applicable SEC accounting related rules, a material weakness is a deficiency, or combination of deficiencies, in internal control over financial reporting such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements would not be prevented or detected on a timely basis.

Management conducted the Evaluation based on the 2013 framework established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO Framework).

As a result of the Evaluation as of December 31, 2023, management has determined that there were no material weaknesses in the Company’s internal controls over financial reporting.

This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered public accounting firm pursuant to rules of the SEC that permit the Company to provide only management’s report in this annual report.

/s/ James A. Dowd /s/ Walter F. Rusnak

James A. Dowd Walter F. Rusnak

Oswego, New York

March 22, 2024

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Report of Independent Registered Public Accounting Firm

To the Board of Directors and Shareholders of

Pathfinder Bancorp, Inc.

Oswego, New York:

Opinion on the Consolidated Financial Statements

We have audited the accompanying consolidated statements of condition of Pathfinder Bancorp, Inc. and subsidiaries (the “Company”) as of December 31, 2023 and 2022, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years in the two-year period ended December 31, 2023, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2023 and 2022, and the results of their operations and their cash flows for each of the years in the two-year period ended December 31, 2023, in conformity with accounting principles generally accepted in the United States of America.

Basis for Opinion

These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.

Change in Accounting Principle

As discussed in Note 1 to the consolidated financial statements, the Company adopted Accounting Standard Update No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments as of January 1, 2023.

Critical Audit Matters

The critical audit matters communicated below are matters arising from the current period audit of the consolidated financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the consolidated financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.

Allowance for Credit Losses

In accordance with Accounting Standards Update (the “ASU”) 2016-13, Financial Instruments —Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, the Company adopted Accounting Standards Codification (“ASC”) 326 as of January 1, 2023 as described in Notes 1 and 6 of the consolidated financial statements. See also explanatory paragraph above. The ASU requires the Company's loan portfolio, measured at amortized cost, to be presented at the net amount expected to be collected. Estimates of expected credit losses for loans are based on evaluation of the size of the portfolio, current risk characteristics, past events, current conditions, reasonable and supportable forecasts of future economic conditions and prepayment experience. The Company disclosed the impact of adoption of this standard on January 1, 2023 with a $1.9 million increase to the allowance for credit losses and a $2.1 million decrease to retained earnings for the cumulative effect adjustment recorded upon adoption. Provision expense for the year ending December 31, 2023 was $2.9 million and the allowance for credit losses as of December 31, 2023 was $15.98 million.

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The Company’s methodology for estimating the allowance for credit losses on loans includes quantitative and qualitative components of the calculation. The Company’s loan portfolio is segmented by loan types that behave similarly during economic cycles. The quantitative analysis includes using a discounted cash flow (DCF) model for determining the allowance for credit losses. Economic forecasts are used in the model to estimate the probability of default and loss given default through regression which are key inputs into the DCF model calculation. Quantitative model assumptions include, but are not limited to the discount rate, prepayment speeds, and curtailments. The quantitative model output is adjusted with qualitative adjustments. Management develops a qualitative framework that serves as the basis for determining the reasonableness of the model’s output and makes qualitative adjustments as necessary. The allowance methodology is inherently complex and requires the use of significant management judgment.

We determined that auditing the allowance for credit losses on loans was a critical audit matter because of the extent of auditor judgment applied and significant audit effort to evaluate the significant subjective and complex judgments made by management throughout the initial adoption and subsequent application processes, including segmentation, the economic forecasts used to calculate the regressions within the DCF model, the quantitative model assumptions as mentioned above, and the qualitative adjustments made using the qualitative framework.

The primary procedures performed to address this critical audit matter included the following:

•

Evaluated management’s selection and application of the DCF model, including the evaluation of the reasonableness of the segmentation, the reasonable and supportable economic forecasts, the significant model assumptions, and the relevance and reliability of data used in the model, and the validation of the DCF model outputs.

•

Evaluated management’s review of the appropriateness of the qualitative framework, the reasonableness of significant assumptions applied, the relevance and reliability of data used in the qualitative adjustments, and the mathematical accuracy of the qualitative adjustments calculation.

•

Evaluated the reasonableness of management’s judgments related to the selection of the segmentation, DCF model, the reasonable and supportable economic forecasts, the significant model assumptions, and the relevance and reliability of the data used in the DCF model.

•

Tested the mathematical accuracy and application of the DCF model to validate the DCF model outputs.

•

Evaluated the reasonableness of qualitative adjustments, including evaluating the appropriateness of the qualitative framework, the assumptions and judgments applied in the determination of the qualitative adjustments, the relevance and reliability of data used in the qualitative adjustments, and the mathematical accuracy of the qualitative adjustments calculation.

•

Performed a sensitivity analysis on the components of the calculation.

We have served as the Company’s auditor since 2011.

/s/ BONADIO & CO., LLP

Bonadio & Co., LLP

Syracuse, New York

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Pathfinder Bancorp, Inc.

Consolidated Statements of Condition

December 31, December 31,

(In thousands, except share and per share data) 2023 2022

ASSETS:

Marketable equity securities, at fair value 3,206 1,862

Federal Home Loan Bank stock, at cost 8,748 5,982

Loans held-for-sale - 19

Operating lease right-of-use assets 1,526 2,098

Finance lease right-of-use assets 4,073 4,213

Intangible assets, net 85 101

LIABILITIES AND SHAREHOLDERS' EQUITY:

Deposits:

Shareholders' equity:

Accumulated other comprehensive loss (9,605 ) (12,172 )

Total Pathfinder Bancorp, Inc. shareholders' equity 119,495 110,997

Noncontrolling interest 761 585

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

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Pathfinder Bancorp, Inc.

Consolidated Statements of Income

For the year ended

(In thousands, except per share data) December 31, 2023 December 31, 2022

Interest and dividend income:

Debt securities:

Federal funds sold and interest earning deposits 295 149

Interest expense:

Interest on short-term borrowings 2,688 310

Interest on long-term borrowings 850 564

Interest on subordinated debt 1,941 1,749

Provision for credit losses:

Held-to-maturity securities (98 ) -

Unfunded commitments 37 -

Total provision for credit losses 2,930 2,754

Net interest income after provision for credit losses 35,989 38,649

Noninterest income:

Service charges on deposit accounts 1,249 1,126

Earnings and gain on bank owned life insurance 630 589

Gains (losses) on sales and redemptions of investment securities 62 (169 )

Net realized (losses) gains on marketable equity securities (255 ) 352

Gains on sales of loans and foreclosed real estate 181 137

Gains (losses) on sale of premises and equipment - (250 )

Debit card interchange fees 616 867

Other charges, commissions & fees 1,096 1,771

Noninterest expense:

Professional and other services 2,019 1,528

Community service activities 200 267

Foreclosed real estate expenses 111 78

Income before provision for income taxes 11,784 15,689

Net income attributable to noncontrolling interest 129 101

Net income attributable to Pathfinder Bancorp Inc. $ 9,293 $ 12,932

Voting Earnings per common share - basic and diluted $ 1.51 $ 2.13

Series A Non-Voting Earnings per common share- basic and diluted $ 1.51 $ 2.13

Dividends per common share (Voting and Series A Non-Voting) $ 0.36 $ 0.36

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

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Pathfinder Bancorp, Inc.

Consolidated Statements of Comprehensive Income

For the years ended

Other Comprehensive Income (Loss)

Retirement Plans:

Retirement plan net gains recognized in plan expenses 222 2

Plan gains (losses) not recognized in plan expenses 257 (1,380 )

Net unrealized gains (losses) on retirement plans 479 (1,378 )

Available-for-sale securities:

Unrealized holding gains (losses) arising during the period 1,538 (14,448 )

Reclassification adjustment for net losses included in net income 1,932 160

Net unrealized gains (losses) on available-for-sale securities 3,470 (14,288 )

Derivatives and hedging activities:

Unrealized holding (losses) gains arising during the period (474 ) 906

Net unrealized (losses) gains on derivatives and hedging activities (474 ) 906

Other comprehensive income (loss), before tax 3,475 (14,762 )

Other comprehensive income (loss), net of tax 2,567 (10,904 )

Comprehensive income, attributable to noncontrolling interest $ 129 $ 101

Comprehensive income attributable to Pathfinder Bancorp, Inc. $ 11,860 $ 2,028

Tax Effect Allocated to Each Component of Other Comprehensive (Loss) Income

Retirement plan net gains recognized in plan expenses $ (58 ) $ -

Plan (gains) losses not recognized in plan expenses (67 ) 363

Reclassification adjustment for net losses included in net income (505 ) (42 )

Income tax effect related to other comprehensive income $ (908 ) $ 3,858

(1)

The accretion of the unrealized holding losses in accumulated other comprehensive loss at the date of transfer at September 30, 2013 partially offsets the amortization of the difference between the par value and the fair value of the investment securities at the date of transfer, and is an adjustment of yield.

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

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Pathfinder Bancorp, Inc.

Consolidated Statements of Changes in Shareholders' Equity

Other comprehensive income, net of tax - - - - 2,567 - - 2,567

Stock based compensation - - 92 - - - - 92

Stock options exercised - - 623 - - - - 623

Common stock dividends declared ($0.36 per share) - - - (1,680 ) - - - (1,680 )

Warrant dividends declared ($0.36 per share) - - - (45 ) - - - (45 )

Cumulative effect of affiliate capital allocation - - 108 (199 ) - - 91 -

Distributions from affiliates - - - - - - (44 ) (44 )

Other comprehensive loss, net of tax - - - - (10,904 ) - - (10,904 )

Stock based compensation - - 156 - - - - 156

Stock options exercised 1 - 417 - - - - 418

Common stock dividends declared ($0.36 per share) - - - (1,646 ) - - - (1,646 )

Warrant dividends declared ($0.36 per share) - - - (45 ) - - - (45 )

Cumulative effect of affiliate capital allocation - - 194 (368 ) - - 174 -

Distributions from affiliates - - - - - - (36 ) (36 )

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

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Pathfinder Bancorp, Inc.

Consolidated Statements of Cash Flows

For the years ended December 31,

OPERATING ACTIVITIES

Net income attributable to Pathfinder Bancorp, Inc. $ 9,293 $ 12,932

Adjustments to reconcile net income to net cash flows from operating activities:

Deferred income tax expense (367 ) 139

Originations of loans held-for-sale (5,550 ) (7,404 )

Realized (gains) losses on sales, redemptions and calls of:

Real estate acquired through foreclosure 35 -

Available-for-sale investment securities (80 ) 160

Held-to-maturity investment securities 19 9

Premise and Equipment - (130 )

Marketable securities 255 (352 )

Impairment of asset - 380

Amortization of mortgage servicing rights (38 ) (11 )

Amortization of deferred loan fees and costs (268 ) 385

Amortization of operating leases (35 ) (372 )

Amortization of deferred financing from subordinated debt 181 170

Earnings on bank owned life insurance (630 ) (589 )

Net amortization of premiums and discounts on investment securities 1,785 2,002

Amortization of intangible assets 16 16

Stock based compensation and ESOP expense 462 626

Net change in accrued interest receivable (1,118 ) (1,648 )

Net change in other assets and liabilities 1,576 3,701

Net cash flows from operating activities 15,432 21,733

INVESTING ACTIVITIES

Purchase of investment securities available-for-sale (99,086 ) (52,375 )

Purchase of investment securities held-to-maturity (13,682 ) (62,566 )

Purchase of Federal Home Loan Bank stock (19,738 ) (15,896 )

Proceeds from redemption of Federal Home Loan Bank stock 16,972 14,103

Purchase of marketable securities (1,598 ) (1,628 )

Proceeds from sales, redemptions and calls of:

Available-for-sale investment securities 17,396 8,358

Held-to-maturity investment securities 288 2,206

Real estate acquired through foreclosure 320 -

Marketable securities - 714

Purchase of premises and equipment (1,966 ) (1,898 )

Insurance proceeds from fixed assets - 66

Disposal of premises and equipment - (3,311 )

Proceeds from sale of premises and equipment - 991

Net cash outflows from investing activities (54,788 ) (131,160 )

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FINANCING ACTIVITIES

Net change in brokered deposits (5,011 ) 90,826

Payments on long-term borrowings (12,019 ) (18,227 )

Proceeds from long-term borrowings 6,274 9,293

Proceeds from exercise of stock options 623 418

Cash dividends paid to common voting shareholders (1,690 ) (1,568 )

Cash dividends paid to common non-voting shareholders (497 ) (469 )

Cash dividends paid on warrants (45 ) (43 )

Change in noncontrolling interest, net 176 239

Net cash inflows from financing activities 52,806 107,560

Change in cash and cash equivalents 13,450 (1,867 )

Cash and cash equivalents at beginning of year 35,282 37,149

Cash and cash equivalents at end of year $ 48,732 $ 35,282

CASH PAID DURING THE YEAR FOR:

NON-CASH INVESTING ACTIVITY

Real estate acquired in exchange for loans 333 252

Transfer from net premises for held for sale investments - 3,042

RESTRICTED CASH

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

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NOTE 1: Summary of Significant Accounting Policies

Nature of Operations

The accompanying consolidated financial statements include the accounts of Pathfinder Bancorp, Inc. (the “Company”) and its wholly owned subsidiary, Pathfinder Bank (the “Bank”). The Company is a Maryland corporation headquartered in Oswego, New York. On October 16, 2014, the Company completed its conversion from the mutual holding company structure and the related public offering and is now a stock holding company that is fully owned by the public. As a result of the conversion, the mutual holding company and former mid-tier holding company were merged into Pathfinder Bancorp, Inc. The primary business of the Company is its investment in Pathfinder Bank (the "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 owns, through its subsidiary PRMC, 51% of the membership interest in FitzGibbons Agency, LLC (“FitzGibbons”), 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 noncontrolling interests within the consolidated financial statements.

The Company has seven branch offices located in Oswego County, four branch offices in Onondaga County and one limited purpose office in Oneida County. The Company is primarily engaged in the business of attracting deposits from the general public in the Company’s market area, and investing such deposits, together with other sources of funds, in loans secured by commercial real estate, business assets, one-to-four family residential real estate and investment securities.

Use of Estimates in the Preparation of Consolidated Financial Statements

The preparation of consolidated financial statements in accordance with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Management has identified the allowance for credit losses, deferred income taxes, pension obligations, the annual evaluation of the Company’s goodwill for possible impairment and 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 Company is subject to the regulations of various governmental agencies. The Company also undergoes periodic examinations by the regulatory agencies which may subject it to further changes with respect to asset valuations, amounts of required loss allowances, and operating restrictions resulting from the regulators' judgments based on information available to them at the time of their examinations.

Significant Group Concentrations of Credit Risk

Most of the Company’s activities are with customers located primarily in Oswego and Onondaga counties of New York State. A large portion of the Company’s portfolio is centered in residential and commercial real estate. The Company closely monitors real estate collateral values and requires additional reviews of commercial real estate appraisals by a qualified third party for commercial real estate loans in excess of $400,000.All residential loan appraisals are reviewed by an individual or third party who is independent of the loan origination or approval process and was not involved in the approval of appraisers or selection of the appraiser for the transaction, and has no direct or indirect interest, financial or otherwise in the property or the transaction. Note 4 discusses the types of securities that the Company invests in. Note 5 discusses the types of lending that the Company engages in.

Advertising

The Company generally follows the policy of charging the costs of advertising to expense as incurred. Expenditures for new marketing and advertising material designs and/or media content, related to specifically-identifiable marketing campaigns are capitalized and expensed over the estimated life of the campaign. Such periods of time are generally 12-24 months in duration and do not exceed 36 months.

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Noncontrolling Interest

Noncontrolling interest represents the portion of ownership and profit or loss that is attributable to the minority owners of FitzGibbons.