PBHC · Read the filing

ITEM 1A: RISK FACTORS

Not required of a smaller reporting company.

ITEM 1B: UNRESOLVED STAFF COMMENTS

None.

- 28 -

ITEM 2: PROPERTIES

The Company has seven offices located in Oswego County, three offices in Onondaga County and one limited purpose office in Oneida County. Management believes that the Bank’s facilities are adequate for the business conducted. The following table sets forth certain information concerning the main office and each branch office of the Bank at December 31, 2020. The aggregate net book value of the Bank's premises and equipment was $22.3 million at December 31, 2020. For additional information regarding the Bank's properties, see Notes 8 and 18 to the consolidated financial statements.

Location Opening Date Owned/Leased

Main Office 1874 Owned

214 West First Street

Plaza Branch 1989 Owned (1)

Mexico Branch 1978 Owned

Oswego East Branch 1994 Owned

34 East Bridge Street

Lacona Branch 2002 Owned

Fulton Branch 2003 Owned (2)

5 West First Street South

Central Square Branch 2005 Owned

Central Square, New York 13036

Cicero Branch 2011 Owned

Pike Block Branch 2014 Leased (3)

109 West Fayette Street

Clay Branch 2018 Leased (4)

Utica Loan Production Office 2017 Leased (5)

258 Genesee Street

(3) The premises are leased with an annual rent of $90,000.

(4) The premises are leased with an annual rent of $71,000.

(5) The premises are leased with an annual rent of $16,000.

- 29 -

ITEM 3: LEGAL PROCEEDINGS

There are various claims and lawsuits to which the Company is periodically involved that are incidental to the Company's business, most notably foreclosures. In the opinion of management, such claims and lawsuits in the aggregate are not expected to have a material adverse impact on the Company's consolidated financial condition and results of operations at December 31, 2020.

ITEM 4: MINE SAFETY DISCLOSURE

Not applicable.

PART II

ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

The Company’s common stock trades on the NASDAQ Capital Market under the symbol “PBHC.”

There were 340 shareholders of record (excluding the number of persons or entities holding stock in street name through various brokerage firms) as of March 24, 2021.

The Company did not repurchase any shares of its common stock during the fourth quarter of 2020.

Equity Compensation Plan Information

The following table provides information as of December 31, 2020 with respect to shares of common stock that may be issued under the Company’s existing equity compensation plans.

Equity compensation plans approved by security holders 320,083 $ 10.89 -

Equity compensation plans not approved by stockholders N/A N/A N/A

Dividends and Dividend History

The Company (and its predecessor) has historically paid regular quarterly cash dividends on its common stock. The board of directors presently intends to continue the payment of regular quarterly cash dividends, subject to the need for those funds for debt service and other purposes. Payment of dividends on the common stock is subject to determination and declaration by the board of directors and will depend upon a number of factors, including capital requirements, regulatory limitations on the payment of dividends, Pathfinder Bank and its subsidiaries’ results of operations and financial condition, tax considerations, and general economic conditions. More details are included within the section titled Regulation and Supervision.

- 30 -

ITEM 6: 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, and the "Management's Discussion and Analysis of Financial Condition and Results of Operations" included elsewhere in this Annual Report on Form 10-K.

For the years ended December 31,

Year End

For the Year

Net income (loss) attributable to noncontrolling interest 96 10 (22 ) (68 ) 26

Convertible preferred stock dividends 291 208 - - -

Warrant dividends 30 23 - - -

Undistributed earnings allocated to participating securities 1,224 467 - - -

Per Share

Performance Ratios

Shareholders' Equity to total assets at end of year 7.94 8.27 6.88 7.01 7.73

- 31 -

For the years ended December 31,

Asset Quality Ratios

Regulatory Capital Ratios (Bank Only)

Number of:

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

NON-GAAP FINANCIAL INFORMATION

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

- 32 -

For the years ended December 31,

Per Share

Book value per common share

Total common equity

Tangible book value per common share

Performance Ratios

Efficiency ratio

Less : Loss on marketable equity securities (629 ) 81 (62 ) - -

Dividend payout ratio

Return on average common equity

- 33 -

For the years ended December 31,

Regulatory Capital Ratios (Bank Only)

Total capital (to risk-weighted assets)

Unrealized Gain on available-for-sale securities - - - - -

Tier 1 capital (to risk-weighted assets)

Tier 1 capital (to adjusted assets)

Tier 1 Common Equity (to risk-weighted assets)

- 34 -

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 to stock form of organization (the “Conversion”). In connection with the Conversion, the Company sold 2,636,053 shares of common stock to depositors at $10.00 per share. Shareholders of Pathfinder Bancorp, Inc., a federal corporation (“Pathfinder-Federal”), the Company’s predecessor, received 1.6472 shares of the Company’s common stock for each share of Pathfinder-Federal common stock they owned immediately prior to completion of the transaction. Following the completion of the Conversion, Pathfinder-Federal was succeeded by the Company and Pathfinder Bancorp, MHC ceased to exist. The Company had 4,531,383 and 4,709,238 shares outstanding at December 31, 2020 and December 31, 2019, respectively.

On June 1, 2016, Pathfinder Bank, a savings bank chartered by the NYSDFS, merged into Pathfinder Commercial Bank, a limited purpose commercial bank also chartered by the NYSDFS. Prior to the merger, Pathfinder Bank owned 100% of Pathfinder Commercial Bank. On that same date, NYSDFS expanded the powers that it had previously granted to Pathfinder Commercial Bank and chartered Pathfinder Commercial Bank as a fully-empowered commercial bank. Simultaneously, the entity that had operated as “Pathfinder Commercial Bank” changed its name to “Pathfinder Bank.” As a result of this charter conversion and accompanying name change, the entity now known as “Pathfinder Bank” is a commercial bank with the full range of powers granted under a commercial banking charter in New York State. The merger, which had no effect on the Company’s results of operations, converted the consolidated Bank from a savings bank to a commercial bank and was completed in order to better align the Bank’s organization certificate with its long-term strategic focus.

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 margins 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 initially 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.

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

- 35 -

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. 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 Placementprimarily to support the realization of continued growth opportunities within our marketplace and, to a lesser extent, for general corporate purposes.

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 will be 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.

Pursuant to Nasdaq rules, Castle Creek may 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 must 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 will seek shareholder approval to create a class of 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 will be 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 is payable at the same time on the Series B Preferred Stock. The Series B Preferred Stock will 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 will have no voting rights except as may be required by law. The Series B Preferred Stock will not be 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, the Exchange Cap, the creation of the non-voting common stock, and regulatory approval if Castle Creek’s ownership of Common Stock would exceed 9.9%. At December 31, 2020, Castle Creek owned approximately 9.9% of the Company’s common 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.

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 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 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. At December 31, 2020, Castle Creek elected to have an observer present at substantially all meetings of the Company’s 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’sSeries 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 is the only stockholder of the

- 36 -

Series B Preferred Stock. The Company received no cash proceeds as a result of the exchange. In addition, the Company is not paying any commission or remuneration for the solicitation of the exchange. Each share of the Series B Preferred Stock will be convertible on a one for one basis into either (i) non-voting common stock (which will also be convertible into Common Stock) subject to approval of the creation of such a class of non-voting common stock by the Company’s common stockholders or (ii) Common Stock under certain circumstances, subject to the approval of the Company’s common stockholders and regulatory approvals.

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.

We have consistently maintained our historically strong presence in consumer deposit gathering and residential mortgage lending activities. Notwithstanding the retention of these business lines, we have strategically emphasized developing our business and commercial banking franchise by offering products that are attractive to small-to medium-sized businesses in our market area. We differentiate our commercial loan solutions and related services through the maintenance of high standards of customer service, solution flexibility and convenience. Highlights of our business strategy are as follows:

Consistent with this strategy, in November 2018, the Bank acquired a property on West Onondaga Street in Syracuse, which was intended to be renovated and converted into another full-service banking location. This property was sold in the fourth quarter of 2020. The intent of the sale was to access the purchaser’s ability to utilize certain available tax

- 37 -

credits that are more beneficial to the purchaser than they would be to the Company, if the Company accessed those credits directly. It is anticipated that the benefits of the more-fully-utilized tax credits will be passed through to the Company under the terms of a future lease agreement with the property’s purchaser acting as lessor. We plan to soon begin renovation work on the acquired facility and expect to open our new Syracuse Southwest branch office by the end of 2021. We consider the Syracuse Southwest Corridor neighborhood, where this property is located, to be an under-banked area within our target marketplace and believe that this branch will qualify for various economic incentives under New York State’s Banking Development District (“BDD”) program.The BDD program is designed to encourage the establishment of bank branches in areas where there is a demonstrated need for additional banking services. The program was developed in recognition of the fact that banks play a critically important role in promoting individual wealth, community development, and revitalization. This property investment demonstrates Pathfinder Bank’s firm commitment to servicing diverse economic areas within its geographic market.

COVID-19 Response

In early January 2020, the World Health Organization issued an alert that a novel coronavirus outbreak was emanating from Wuhan, Hubei Province in China. Over the course of the next several weeks, the outbreak continued to spread to various regions of the world, prompting the World Health Organization to declare COVID-19 a global pandemic on March 11, 2020. In the United States, by the end of March 2020, the rapid spread of the COVID-19 virus invoked various Federal and New York State authorities to make emergency declarations and issue executive orders to limit the spread of the disease. Measures included restrictions on international and domestic travel, limitations on public gatherings, implementation of social distancing and sanitization protocols, school closings, orders to shelter in place and mandates to close all non-essential businesses to the public. To widely varying degrees, largely dependent upon the level of regional and national outbreaks and the resultant levels of strain on available medical resources, these very substantial mandated curtailments of social and economic activity had been relaxed globally in the third and fourth quarters of

- 38 -

2020. However, the number of reported positive cases (partly due to increased testing) in the United States have continued to be at high levels as of the date of this filing and new strains of the virus, potentially more contagious and more virulent have been reported in many parts of the world, including in the United States. Further, there still are virtually no localities within the United States that have completely returned to substantively normal business and social activities at the time of this filing.

As a result of the initial and continuing outbreak, and governmental responses thereto, the spread of the coronavirus has caused us to modify our business practices, including employee travel, employee work locations, and cancellation of physical participation in meetings, events and conferences. The Company has many employees working remotely and has significantly reduced physical customer contact with employees and other customers. Initially, branch activities were limited to drive-thru transactions whenever possible, teleconferencing and in-branch “appointments only” services. The Bank’s branches are now fully accessible to the public but remain in strict compliance with all applicable social distancing and sanitization guidelines. Since the start of the pandemic, transactional volume has also increased through the Bank’s telephone, mobile and internet banking channels. We will take further actions, focused on safety, as may be required by government authorities or that we determine to be in the best interests of our employees, customers and business partners.

Concerns about the spread of the disease and its anticipated negative impact on economic activity, severely disrupted both domestic and international financial markets prompting the world’s central banks to inject significant amounts of monetary stimulus into their respective economies. In the United States, the Federal Reserve System’s Federal Open Market Committee, swiftly cut the target Federal Funds rate to a range of 0% to 0.25%, where it remains as of the date of this filing. The reductions in the Fed funds target rate included a 50 basis point reduction in the target federal funds rate on March 3, 2020 and an additional 100 basis point reduction on March 15, 2020. In addition, the Federal Reserve initiated various market support programs to ease the stress on financial markets. This significant reduction in short-term interest rates has reduced, and will continue to reduce, the Bank’s cost of funds and interest earning-asset yields. The long-term effects of the current interest rate environment, resulting from government and central bank responses to the pandemic, on the Bank’s net interest margins cannot be predicted with certainty at this time.

The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), signed into law on March 27, 2020, provided financial assistance in various forms to both businesses and consumers, including the establishment and funding of the Paycheck Protection Program (“PPP”). In addition, the CARES Act also created many directives affecting the operations of financial services providers, such as the Company, including a forbearance program for federally-backed mortgage loans and protections for borrowers from negative credit reporting due to loan accommodations related to the national emergency. The banking regulatory agencies have likewise issued guidance encouraging financial institutions to work prudently with borrowers who are, or may be, unable to meet their contractual payment obligations because of the effects of COVID-19. The Company has worked to assist its business and consumer customers affected by COVID-19.

On December 27, 2020, following passage by the United States Congress, President Donald J. Trump signed into law the Consolidated Appropriations Act, 2021 which included the Coronavirus Response and Relief Supplemental Appropriations Act (“CRRSAA”). The intent of this legislation was to provide another round of Economic Impact Payments to eligible individuals and families, renew the PPP to support small businesses and their employees, ensure needed access to unemployment benefits for Americans who have lost their jobs due to COVID-19, and provide additional funding for schools, vaccine distribution, and other important sectors of the economy. While CRRSSA is expected to benefit the economic recovery and be supportive of the Company’s business activities, the effect of this legislation on the operations of the Company cannot be determined with certainty at this time.

The Bank participated in the PPP funded by the U.S. Treasury Department and administered by the U.S. SBA pursuant to the CARES Act and subsequent legislation. PPP loans have an interest rate of 1.0% and a two-year or five-year loan term to maturity. The SBA guarantees 100% of the PPP loans made to eligible borrowers. The entire principal amount of the borrower’s PPP loan, including any accrued interest, is eligible to be reduced by the loan forgiveness amount under the PPP so long as employee and compensation levels of the business are maintained and the loan proceeds are used for qualifying expenses. Through December 31, 2020, the Bank has received approval from the SBA for 699 loans totaling approximately $75.3 million through this program. The program was extended at least through the first quarter of 2021. The Bank is participating in the second round of PPP. The Bank is now also assisting borrowers with the loan forgiveness phase of the process. As of this filing, the Company has submitted 312 loans totaling approximately $33.7 million to the SBA for forgiveness.

Borrowers that were delinquent in their payments to the Bank, prior to requesting a COVID-19 related financial hardship payment deferral were reviewed on a case by case basis for troubled debt restructure classification and non-performing loan status. In the instances where the Company granted a payment deferral to a delinquent borrower because of COVID-19, the borrower’s delinquency status was frozen as of February 29, 2020, and their loans will continue to be reported as delinquent during the deferment period based on their delinquency status as of that date. The long-term collectability of deferred loan payments will depend on many factors, including the future progression of the pandemic, potential medical breakthroughs in therapeutic treatments and/or vaccines, the pace of vaccine distributions, further economic stimulus from government authorities, the rate at which governmental restrictions on business activities are relaxed and the adequacy and sustainability of other sources of repayment such as loan collateral. Consistent with industry regulatory guidance, borrowers that were granted COVID-19 related deferrals but were otherwise current on loan

- 39 -

payments will continue to have their loans reported as current loans during the agreed upon deferral period(s), accrue interest and not be accounted for as troubled debt restructurings.

Through December 31, 2020, the Bank granted payment deferral requests for an initial period of 90 days on 618 loans representing approximately $137.4 million of existing loan balances. Upon the receipt of borrower requests, additional 90 day deferral periods were generally granted. Of these granted deferrals, 303 loans, totaling $24.0 million, were residential mortgage or consumer loans. At December 31, 2020, 265 residential and consumer loans, totaling $21.3 million, have been returned to non-deferral status. Of these granted deferrals, 315 loans, totaling $113.3 million, were commercial real estate or other commercial and industrial loans. At December 31, 2020, 291 commercial real estate or other commercial and industrial loans, totaling $98.9 million, have been returned to non-deferral status. Therefore, at December 31, 2020, 38 residential mortgage and consumer loans, totaling $2.7 million and 24 commercial real estate and other commercial and industrial loans, totaling $14.4 million remained in deferral status. These loans still in deferral status therefore totaled $17.1 million and represented 2.1% of all loans outstanding at December 31, 2020. After consultations with certain of these commercial loan borrowers, 11 loans, representing $8.3 million, have been granted an additional 90 day deferral period beyond 180 days as of December 31, 2020. These loans are included in the $17.1 million in loans still in deferred status at December 31, 2020. On an extremely limited basis, additional deferral periods will potentially be granted subject to further analysis and discussion with specific borrowers. To the extent that such modifications meet the criteria previously described they have not been classified as troubled debt restructurings nor classified as nonperforming at December 31, 2020. Loans not granted additional deferral periods have been, and will continue to be, categorized as nonaccrual loans if the borrowers fail to make the first scheduled payment following the end of the deferral period.

APPLICATION OF CRITICAL ACCOUNTING POLICIES

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 loan losses, deferred income tax assets and liabilities, pension obligations, the evaluation of investment securities for other than temporary impairment, 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 Loan Losses. The allowance for loan losses represents management's estimate of probable loan losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment on the use of estimates related to the amount and timing of expected future cash flows on impaired 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 impaired 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, for all loans subject to a troubled debt restructuring agreement. In addition, an accruing substandard loan could be identified as being impaired. The measurement of impaired 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 for impairment based on the fair value of the collateral, less costs to sell.At December 31, 2020, the Bank’s position in impaired loans consisted of 52 loans totaling $22.8 million. Of these loans, 15 loans, totaling $1.3 million, were valued using the present value of future cash flows method; and 37 loans, totaling $21.5 million, were valued based on a collateral analysis.For all other loans, the Company uses the general allocation methodology that establishes an allowance to estimate the probable incurred loss for each risk-rating category. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan losses and a discussion of the factors driving changes in the amount of the allowance for loan losses is included in this report.

- 40 -

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 of a change in tax rates is recognized in income tax expense in the period that includes the enactment date. If current available evidence about the future raises doubt about the likelihood of a deferred tax asset being realized, a valuation allowance is established. The judgment about the level of future taxable income, including that which is considered capital, is inherently subjective and is reviewed on a continual basis as regulatory and business factors change. Effective in January 2018, the Company adopted a modification methodology that was at the time newly made available under the New York State tax code, affecting how the Company’s state income tax liability is computed. Under this adopted methodology, management determined in the first quarter of 2019, it was unlikely that the Company would pay income taxes to New York State in future periods and therefore in the quarter ended March 31, 2019, the Company established, through a charge to earnings, a valuation allowance in the amount of $136,000 in order to reserve against deferred tax assets related to New York State income taxes. This valuation allowance against the value of those deferred tax assets was established to reduce the net deferred tax asset related to New York State income taxes to $0. Management is continuously monitoring its future tax consequences to determine if the Company’s deferred taxes are properly stated. In the first quarter of 2020, consistent with policy, management reviewed all facts and circumstances related to its deferred taxes and determined that based on the expected filings of future New York State tax returns, the valuation allowance created in 2019 was no longer needed. Therefore management elected to eliminate its New York State net deferred tax asset valuation allowance during the quarter ended March 31, 2020.

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 Investment Securities for Other-Than-Temporary-Impairment (“OTTI”). The Company carries all of its available-for-sale investments at fair value with any unrealized gains or losses reported net of tax as an adjustment to shareholders' equity and included in accumulated other comprehensive income (loss), except for the credit-related portion of debt security impairment losses and OTTI of equity securities which are charged to earnings. The Company's ability to fully realize the value of its investments in various securities, including corporate debt securities, is dependent on the underlying creditworthiness of the issuing organization. In evaluating the debt security (both available-for-sale and held-to-maturity) portfolio for other-than-temporary impairment losses, management considers (1) if we intend to sell the security before recovery of its amortized cost; (2) if it is “more likely than not” we will be required to sell the security before recovery of its amortized cost basis; or (3) if the present value of expected cash flows is not sufficient to recover the entire amortized cost basis. When the fair value of a held-to-maturity or available-for-sale security is less than its amortized cost basis, an assessment is made as to whether OTTI is present. The Company considers numerous factors when determining whether a potential OTTI exists and the period over which the debt security is expected to recover. The principal factors considered are (1) the length of time and the extent to which the fair value has been less than the amortized cost basis, (2) the financial condition of the issuer and (guarantor, if any) and adverse conditions specifically related to the security, industry or geographic area, (3) failure of the issuer of the security to make scheduled interest or principal payments, (4) any changes to the rating of the security by a rating agency, and (5) the presence of credit enhancements, if any, including the guarantee of the federal government or any of its agencies.

Evaluation of Goodwill. Management performs an annual evaluation of the Company’s goodwill for possible impairment. Based on the results of the 2020 evaluation, management has determined that the carrying value of goodwill is not impaired as of December 31, 2020. 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 impaired 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.

- 41 -

RECENT EVENTS

On December 21, 2020, the Company announced that its Board of Directors had declared a cash dividend of $0.06 per common and preferred share, and a cash dividend of $0.06 per notional share for the issued Warrant. The dividend was payable on February 5, 2021 to shareholders of record on January 15, 2021.

EXECUTIVE SUMMARY AND RESULTS OF OPERATIONS

The Company reported net income of $7.0 million for 2020, an increase of $2.7 million, or 62.5%, as compared to net income of $4.3 million for 2019. Net income increased during 2020, as compared to the previous year, due to an increase in net interest income before the provision for loan losses of $3.4 million, an increase in noninterest income of $1.6 million, and a decrease in noninterest expense of $650,000. These increases were partially offset by an increase in the provision for loan losses of $2.7 million and an increase in income tax expense of $130,000. Basic and diluted earnings per share in 2020 were both $1.17 per share, as compared to $0.80 per share in 2019. Return on average assets increased 17 basis points to 0.60% in 2020 from 0.43% in 2019. Return on average equity increased 209 basis points to 7.43% in 2020 as compared to 5.34% in 2019. The increase in return on average assets in 2020, as compared to the previous year, was primarily due to the increase net income outpacing average asset growth. Average assets increased in 2020 by $161.3 million, or 16.0%, as the Company grew its total assets from $1.1 billion at December 31, 2019 to $1.2 billion at December 31, 2020. The increase in return on average equity in 2020, as compared to the previous year, was primarily due to the increase in net income outpacing the growth in equity.

Net interest income, before provision for loan losses, increased $3.4 million, or 12.1%, to $31.6 million in 2020 on average interest earning assets of $1.1 billion as compared to net interest income before provision for loan losses of $28.2 million in 2019 on average interest earning assets of $947.9 million. Interest and dividend income increased $749,000 in 2020 to $42.5 million, as compared to interest and dividend income of $41.8 million in 2019. The aggregate increase in the average balance of interest-earning assets of $151.1 million was partially offset by a decrease of 53 basis points in the overall average yield earned on those assets. The $749,000 increase in interest income was further enhanced by a decrease in interest expense of $2.7 million due to a decrease in the average rate paid on interest-bearing liabilities of 48 basis points in 2020 as compared to 2019, partially offset by an increase in those average interest-bearing liabilities of $100.8 million.

The Company recorded a provision for loan losses of $4.7 million in 2020 as compared to $2.0 million in the prior year. The $2.7 million year-over-year increase in provision for loan losses was primarily due to economic uncertainty and the resultant potential for increased credit losses in future periods, as a result of the COVID-19 pandemic. Additionally, the provision reflected an increase in outstanding loan balances, excluding PPP loans, of $56.8 million, or 8.2%, in 2020 as compared to 2019, as well as an increase in the non-performing loans to period end loans as a result of the addition of three commercial loan relationships. Net loan balances increased 5.2% from December 31, 2019 to December 31, 2020. The Company recorded $599,000 in net charge-offs in 2020 as compared to $603,000 in net charge-offs in 2019. The ratio of net charge-offs to average loans decreased to 0.08% in 2020 from 0.09% in 2019.

Noninterest income was $6.5 million in 2020, an increase of $1.6 million, or 31.9%, from $4.9 million in 2019. This increase was primarily the result of a $1.1 million increase in net gains on the sales of loans and foreclosed real estate, and a $747,000 increase in net gains on sales and redemptions of investment securities. The increased gain on the sales of loans and foreclosed real estate was primarily the result of the sale of $35.9 million in seasoned, conforming residential mortgage loans that was completed in January 2020 and resulted in the recognition of a gain of $659,000. The increase in the net gains on sales of loans in 2020 was also the result of increased originations of 1-4 family residential mortgages sold into the secondary market. The increase in the number of residential originations in 2020 was primarily due to significant declines in mortgage loan interest rates in 2020 as compared to the previous year. The investment securities sales were part of the Company’s portfolio optimization and liquidity management strategies and were sold in order to improve the expected future total returns within the investment portfolio, particularly in light of potentially increased prepayment activity, related to the sharp decline in general interest rates, and/or potential credit downgrade concerns following the onset of the COVID-19 pandemic. Also contributing to the increase in noninterest income was loan servicing fees, debit card interchange fees, and insurance agency revenue, which increased $150,000, $114,000, and $111,000, respectively. The net increase in these categories of noninterest income were in part due to the Company’s increased strategic focus on improving recurring noninterest income. However, overall increases in noninterest income were significantly muted in the second and third quarters of 2020 by reduced customer activity levels and the Bank’s increased levels of fee waivers and forbearances in response to the local economic effects of the COVID-19 pandemic. These net increases in noninterest income were partially offset by a $710,000 increase in net losses on equity securities, as discussed below.

- 42 -

a result, during the second quarter of 2020, the Company recorded a net gain on sales and redemptions of investment securities of $115,000 and a gain on equity securities of $438,000. The Company retained its shares of the acquiring bank, valued at $682,000 at December 31, 2020, and has the ability to hold the investment indefinitely. In the fourth quarter of 2020, the Company received a cash dividend of $7,000 from the acquiring bank and recognized a net gain of $48,000 resulting from the quarter-over-quarter change in the market value of this investment.

In addition, the Company held a fixed-income, non-exchange traded investment, previously categorized as available-for-sale, which was managed since its acquisition in 2017 by an external party. The investment was previously reported at its stated net asset value, which was $2.1 million at March 31, 2020. The investment, was substantially restructured and subsequently listed on June 17, 2020 as a publicly-traded common stock on the New York Stock Exchange. Due to what management believes were technical factors related to the listing itself, and the almost universal pricing pressure on publicly-traded assets of this type in the current uncertain economic environment, the closing stock price at June 30, 2020 was significantly below the historical amortized cost of the investment on that date. Therefore, the restructuring and listing events caused the Company to recognize an unrealized loss in the second quarter of $1.2 million, which was measured by the difference between the newly-issued stock’s closing price at June 30, 2020 and its net asset value at March 31, 2020. The Company’s management believes that the investment is fundamentally sound, will sustainably generate significant dividend income in the future and that the Company has the ability to hold the security indefinitely. In the fourth quarter of 2020, the Company received a cash dividend of $39,000 from the issuer of this stock investment and recognized a net gain of $121,000 resulting from the quarter-over-quarter change in the market value of this investment.

Noninterest expense decreased $650,000, or 2.5%, to $25.1 million in 2020 from $25.7 million in 2019. The year-over-year decrease in noninterest expense was principally driven by a $421,000 reduction in community service activities expenses, a $295,000 decrease in other expenses, a $287,000 decrease in foreclosed real estate expenses, and a $192,000 decrease in personnel expenses. These decreases were partially offset by increases in building and occupancy costs and the FDIC assessment of $339,000 and $278,000, respectively. The decrease in community service activates was primarily due to the significant restrictions placed on many business activities as a result of the pandemic and an associated decrease in community-sponsored events and activities by the Bank. The decrease in other expenses was due to decreases in travel and training expense and meals and entertainment expense. These expenses were substantially curtailed during the year as a result of the significant restrictions placed on many business activities as a result of the pandemic. Foreclosed real estate expenses decreased $287,000 as a result of a foreclosed property that the Bank paid taxes on in 2019. This foreclosed property was sold in February 2019. The decrease in personnel expenses in 2020, as compared to 2019, was primarily due to a decrease in employee benefits. The decrease in employee benefits for the year ended December 31, 2020, as compared to 2019, was primarily due to decreases in pension, employee medical, and other employee benefits expenses. Pension expense decreased primarily due to the higher market value of pension assets held in trust at January 1, 2020 as compared to the same date in 2019. The higher market values for pension assets resulted from market value appreciation of those assets in 2019. Medical expenses declined primarily due to reduced employee utilization of elective medical services and increased cost sharing of certain medical costs with employees in 2020, as compared to the previous year. The decrease in other employee benefits expenses related to reduced levels of certain training, employee recognition and other employee-related activities due primarily to restrictions on such activities resulting from the pandemic.

Total assets were $1.2 billion at December 31, 2020 as compared to $1.1 billion at December 31, 2019. The increase in total assets of $133.6 million, or 12.2%, was the result of the increase in investment securities of $66.2 million, the increase in loans, principally commercial loans, of $44.0 million, and the $23.3 million increase in cash and cash equivalents. All other assets increased by a net $4.1 million. The increase in total assets in 2020 was funded largely by a $114.0 million increase in deposits, specifically an $80.6 million increase in customer deposits, and a $33.4 million increase in brokered deposits.

Net loan charge-offs to average loans were 0.08% for 2020, as compared to 0.09% for 2019.Nonperforming loans to total loans were 2.58% at December 31, 2020, up 191 basis points compared to 0.67% at December 31, 2019. The allowance for loan losses to non-performing loans at December 31, 2020 was 59.89%, compared with 165.25% at December 31, 2019. Nonperforming loans to total loans increased from December 31, 2019 primarily due to the addition of three commercial loan relationships, comprised of five individual loans, with aggregate outstanding loan balances of $14.5 million, which were placed in nonaccrual in 2020. These relationships, include secured loans (secured by third-party pledges, other governmental grants and/or business assets), unsecured loans, and loans collateralized by commercial real estate.

Pursuant to the CARES Act and subsequent legislation, financial institutions have the option to temporarily suspend certain requirements under U.S. generally accepted accounting principles related to troubled debt restructurings for a limited period of time to account for the effects of COVID-19. This provision allows a financial institution the option to not apply the guidance on accounting for troubled debt restructurings to loan modifications, such as extensions or deferrals, related to COVID-19 made between March 1, 2020 and the earlier of (i) January 1, 2022 or (ii) 60 days after the end of the COVID-19 national emergency. The relief can only be applied to modifications for borrowers that were not more than 30 days past due as of December 31, 2019. The Bank elected to adopt these provisions of the CARES Act.

- 43 -

Management is monitoring these entities closely and has incorporated our current estimate of the ultimate collectability of these loans into the reported allowance for loan losses at December 31, 2020. Overall the allowance for loan losses to year end loans increased from1.11% at December 31, 2019 to 1.55% at December 31, 2020. This increase reflected management’s estimate of the probable losses inherent in the current loan portfolio.

Total past due loans measured as a percent of total loans, decreased from 2.09% at December 31, 2019 to 1.85% at December 31, 2020, primarily due to a decrease of $813,000 in past due commercial loans and a $386,000 decrease in past due residential loans, partially offset by a $220,000 increase in past due consumer loans. The level of nonperforming loans increased in aggregate by $16.1 million led by an increase of $15.0 million in nonperforming commercial loans, a $995,000 increase in nonperforming residential loans, and a $116,000 increase in nonperforming consumer loans. Commensurate with the increase in nonperforming loans to year end loans, the ratio of nonperforming assets to total assets increased to 1.74% at December 31, 2020 from 0.49% at December 31, 2019.

The Company’s shareholders’ equity increased $7.0 million, or 7.8%, to $97.5 million at December 31, 2020 from $90.4 million at December 31, 2019. This increase was primarily due to a $5.4 million increase in retained earnings, a $735,000 increase in comprehensive income, a $662,000 increase in additional paid in capital and a $180,000 increase in ESOP shares earned. Comprehensive income increased primarily as the result of losses on derivatives and hedging activities, partially offset by the unrealized gains on available for sale securities during 2020. The increase in retained earnings resulted from $7.0 million in net income recorded in 2020. Partially offsetting this increase in retained earnings were $1.1 million for cash dividends declared on our common stock, $291,000 for cash dividends declared on our preferred stock, and $30,000 for cash dividends declared on our issued warrant.

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 loan losses, increased $3.4 million, or 12.1%, to $31.6 million in 2020 as compared to $28.2 million in the previous year. Our net interest margin for the year ended December 31, 2020 decreased to 2.88% from 2.98% for the comparable prior year. The increase in net interest income was primarily due to a $749,000, or 1.8%, increase in interest and dividend income in 2020 to $42.5 million primarily as a result of the $151.1 million, or 15.9%, increase in the average balance of interest earning assets (due primarily to loan growth), partially offset by the 53 basis point decrease in the average yield earned on those assets. This increase in interest income was enhanced by a decrease in interest expense of $2.7 million, or 19.7%, during 2020, as compared to the previous year. The decrease in interest expense was primarily due to a decrease in the average rate paid on interest-bearing liabilities of 48 basis points in 2020 as compared to 2019, partially offset by an increase in those average interest-bearing liabilities of $100.8 million.

- 44 -

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 years ended December 31,

Average Average Average

Average Yield / Average Yield / Average Yield /

Interest-earning assets:

Fed funds sold and

Noninterest-earning assets:

Net unrealized losses on available-for-sale securities (447 ) (1,215 ) (4,018 )

Interest-bearing liabilities:

Noninterest-bearing liabilities:

Ratio of average interest-earning assets

- 45 -

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 (5 ) (3 ) - - -

Savings and club accounts 14 (15 ) (1 ) - 13 13

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 $749,000, or 1.8%, to $42.5 million in 2020 as compared to $41.8 million in 2019 due principally to the $151.1 million, or 15.9%, increase in average interest-earning assets. The increase in average interest-earning assets was primarily due to the increase in the average balances of loans, which increased $105.4 million, or 15.2%, in 2020, as compared to the previous year. The increase in the average balance of loans reflected the Company’s continued success in its expansion within the greater Syracuse market and the Company’s participation in the PPP loan program. The average yield earned on loans decreased 48 basis points to 4.44% in 2020 from 4.92% in 2019 as maturing higher rate loans were replaced by loans at current lower market rates, which was a direct result of the interest rate environment caused by the pandemic. The average balance of PPP loans outstanding in 2020 was $48.6 million with an average yield of 3.33%. Excluding PPP loans, the average balance of loans was $748.5 million with an average yield of 4.52%.Interest on taxable investment securities decreased $393,000 in 2020, as compared with the previous year. The average yields earned on taxable investment securities decreased 46 basis points to 2.67% in 2020 as compared to 3.13% in 2019, accounting for a decrease in interest income of $1.1 million in 2020, as compared to 2019. The average balance of taxable investment securities increased $24.9 million, or 10.8%, in 2020, as compared to the previous year, accounting for an increase in 2020 interest income from taxable investment securities of $731,000 as compared to 2019.

- 46 -

Interest Expense

Changes in interest expense result from changes in the average balances of deposits and borrowings and the related average interest costs on those balances.

Interest expense decreased $2.7 million, or 19.7%, to $10.9 million in 2020, as compared to $13.5 million in the previous year. The decrease in interest expense was primarily the result of a decrease in interest paid on time deposits of $2.2 million. Decreases between 2020 and 2019 were recorded in average rates paid on time deposits of 81 basis points. The decrease in the average rates paid on those deposits reflected the general decline in market interest rates during 2020. Partially offsetting the reduction in interest expenses on deposits was an increase of $100.7 million, or 12.4%, in the average balance of interest-bearing deposits in 2020 as compared to the previous year. Further contributing to the decrease in interest expense was a $301,000 decrease in borrowings expense, which also decreased due to general decline in market interest rates during 2020. These decreases in borrowed funds expense were partially offset by a $238,000 increase in subordinated loan expense, which was the result of the Company’s completion of a private placement of the fixed-to-floating rate 2020 subordinated loan during the fourth quarter of 2020. The Company currently plans to redeem approximately $10.0 million of previously issued loans that were outstanding on December 31, 2020, during the second quarter of 2021.

Provision for Loan Losses

We establish a provision for loan losses, which is charged to operations, at a level management believes is appropriate to absorb probable incurred credit losses in the loan portfolio. In evaluating the level of the allowance for loan 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 loan losses represents management’s estimate of the amount necessary to maintain the allowance for loan losses at an adequate level.

Nonperforming loans to total loans were 2.58% at December 31, 2020, up 191 basis points compared to 0.67% at December 31, 2019. The allowance for loan losses to non-performing loans at December 31, 2020 was 59.89%, compared with 165.25% at December 31, 2019. Nonperforming loans to total loans increased from December 31, 2019 primarily due to the addition of three commercial loan relationships, comprised of five individual loans, with aggregate outstanding loan balances of $14.5 million, which were placed in nonaccrual in 2020. These relationships, include secured loans (secured by third-party pledges, other governmental grants and/or business assets), unsecured loans, and loans collateralized by commercial real estate.

- 47 -

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.

Years Ended December 31,

Service charges on deposit accounts $ 1,395 $ 1,391 $ 4 0.3 %

Earnings and gain on bank owned life insurance 460 462 (2 ) -0.4 %

Other charges, commissions and fees 917 878 39 4.4 %

Net gains on sales of loans and foreclosed real estate 1,179 64 1,115 1742.2 %

(Losses) gains on marketable equity securities (629 ) 81 (710 ) -876.5 %

Noninterest income for the year ended December 31, 2020 increased $1.6 million, or 31.9%, to $6.5 million from $4.9 million for the year ended December 31, 2019. Noninterest income before gains (losses) on the sales and redemptions of investment securities, gains (losses) on marketable equity securities, and gains on the sale of loans and foreclosed real estate increased $416,000, or 9.4%, to $4.9 million in 2020 as compared to $4.4 million in 2019. This $416,000 increase in 2020, as compared with the previous year, was primarily due to increases in loan servicing fees, debit card interchange fees, and insurance agency revenue, which increased $150,000, $114,000, and $111,000, respectively.

Net gains on the sales of loans and foreclosed real estate increased $1.1 million and net gains on the sales and redemptions of investment securities increased $747,000. The increased gain on the sales of loans and foreclosed real estate was primarily the result of the sale of $35.9 million in seasoned, conforming residential mortgage loans that was completed in January 2020 and resulted in the recognition of a gain of $659,000. The increase in the net gains on sale of loans in 2020 was also the result of increased originations of 1-4 family residential mortgages sold into the secondary market. The increase in the number of residential originations in 2020 was primarily due to significant declines in mortgage loan interest rates in 2020 as compared to the previous year. The investment securities sales were part of the Company’s portfolio optimization and liquidity management strategies and were sold in order to improve the expected future total returns within the investment portfolio, particularly in light of potentially increased prepayment activity, related to the sharp decline in general interest rates, and/or potential credit downgrade concerns following the onset of the COVID-19 pandemic.

Since 2016, the Company held a passive equity investment, acquired for $534,000, in an otherwise unaffiliated financial institution. The issuer of that originally-purchased common stock was acquired in June 2020 by another financial institution (the acquiring bank). Upon the closing of the transaction, the acquisition resulted in the Company receiving total cash and stock compensation of $911,000 for its equity investment, based on the closing stock price of the acquiring institution on June 30, 2020. As a result, during the second quarter of 2020, the Company recorded a net gain on sales and redemptions of investment securities of $115,000 and a gain on equity securities of $438,000. The Company retained its shares of the acquiring bank, valued at $682,000 at December 31, 2020, and has the ability to hold the investment indefinitely. In the fourth quarter of 2020, the Company received a cash dividend of $7,000 from the acquiring bank and recognized a net gain of $48,000 resulting from the quarter-over-quarter change in the market value of this investment.

- 48 -

generate significant dividend income in the future and that the Company has the ability to hold the security indefinitely. In the fourth quarter of 2020, the Company received a cash dividend of $39,000 from the issuer of this stock investment and recognized a net gain of $121,000 resulting from the quarter-over-quarter change in the market value of this investment.

Noninterest Expense

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

Years Ended December 31,

Noninterest expenses for 2020 decreased $650,000, or 2.5%, to $25.1 million from $25.7 million for the prior year. The year-over-year decrease in noninterest expense was principally driven by a $421,000 reduction in community service activities expenses, a $295,000 decrease in other expenses, a $287,000 decrease in foreclosed real estate expenses, and a $192,000 decrease in personnel expenses. These decreases were partially offset by increases in building and occupancy costs and the FDIC assessment of $339,000 and $278,000, respectively.

Community service activities decreased $421,000, or 67.9%, in 2020 primarily due to the significant restrictions placed on many business activities as a result of the pandemic and an associated decrease in community-sponsored events and activities by the Bank.

Other expenses decreased $295,000, or 13.7%, due to decreases in travel and training expense and meals and entertainment expense. These expenses were substantially curtailed during the year as a result of the significant restrictions placed on many business activities as a result of the pandemic.

Foreclosed real estate expenses decreased $287,000 as a result of a foreclosed property that the Bank paid taxes on in 2019. This foreclosed property was sold in February 2019.

The year-over-year decrease of $192,000 in personnel expenses was primarily due to a decrease in employee benefits. The decrease in employee benefits for the year ended December 31, 2020, as compared to 2019, was primarily due to decreases in pension, employee medical, and other employee benefits expenses. Pension expense decreased primarily due to the higher market value of pension assets held in trust at January 1, 2020 as compared to the same date in 2019. The higher market values for pension assets resulted from market value appreciation of those assets in 2019. Medical expenses declined primarily due to reduced employee utilization of elective medical services and increased cost sharing of certain medical costs with employees in 2020, as compared to the previous year. The decrease in other employee benefits expenses related to reduced levels of certain training, employee recognition and other employee-related activities due primarily to restrictions on such activities resulting from the pandemic.

These decreases were offset by increases in building and occupancy costs and the FDIC assessment. Building and occupancy costs increased $339,000 as a result of an increase in maintenance costs and depreciation expense of $220,000 and $117,000, respectively. These increases are consistent with the Company’s recent refurbishments of certain branch and administrative locations and the relative timing of certain maintenance activities. The FDIC assessment increased $278,000 and is consistent with the Bank’s growth in assets.

- 49 -

Income Tax Expense

The Company reported income tax expense of $1.3 million in 2020 and $1.2 million in 2019. Income tax expense increased $130,000 in 2020 as compared to the previous year. Income tax expense increased in 2020, as compared to the previous year, as a result of the increase in pretax net income of $2.9 million, partially offset by a decrease in the effective tax rate in 2020, as described below.

The Company’s effective tax rate was 15.9% in 2020, as compared to 21.4% in 2019. The Company’s effective tax rate was reduced from the federal statutory income tax rate of 21.0% by 3.8% in 2020 as a result of anticipated New York State tax refunds described below and 2.0% by the combined effects of tax exempt income received in the form of interest on tax exempt loans and investment securities, and the increase in the value of its bank owned life insurance.

The Company’s effective tax rate was reduced from the federal statutory income tax rate of 21.0% by 2.6% in 2019 by the combined effects of tax exempt income received in the form of interest on tax exempt loans and investment securities, and the increase in the value of its bank owned life insurance. All other individually immaterial items related to the calculation of the Company’s effective tax rate in aggregate increased the Company’s effective tax rate by 0.5% in 2019.

Effective in January 2018, the Company adopted a modification methodology that was at the time newly made available under the New York State tax code, affecting how the Company’s state income tax liability is computed. Under this adopted methodology, management determined in the first quarter of 2019, it was unlikely that the Company would pay income taxes to New York State in future periods and therefore in the quarter ended March 31, 2019, the Company established, through a charge to earnings, a valuation allowance in the amount of $136,000 in order to reserve against deferred tax assets related to New York State income taxes. This valuation allowance against the value of those deferred tax assets was established to reduce the net deferred tax asset related to New York State income taxes to $-0-. Management is continuously monitoring its future tax consequences to determine if the Company’s deferred taxes are properly stated. In the first quarter of 2020, consistent with policy, management reviewed all facts and circumstances related to its deferred taxes and determined that based on the expected filings of future New York State tax returns, the valuation allowance created in 2019 was no longer needed. Therefore management elected to eliminate its New York State net deferred tax asset valuation allowance during the quarter ended March 31, 2020.

In the first quarter of 2021, the Company filed amended New York State tax returns for 2015 through 2017 (the “carryback years”). The returns were amended from their original filings in order to file carryback claims utilizing New York State net operating losses generated under New York State tax law in 2018. As a result, the Company expects to receive $316,000 in tax refunds from New York State for taxes previously paid in the carryback years. This anticipated refund has been applied to the effective tax rate of the Company in 2020 in accordance with GAAP. The recognition of this anticipated tax refund in 2020 reduced the Company’s effective tax rate by 3.8% in 2020.

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, 2020 were both $1.17, as compared to basic and diluted earnings per share of $0.80 for the year ended December 31, 2019. The increase in earnings per share between these two periods was due to the increase in net income available to common shareholders between these two time periods. Further information on earnings per share can be found in Note 3 of this Form 10-K.

CHANGES IN FINANCIAL CONDITION

- 50 -

Investment Securities

The investment portfolio represented 24.2% of the Company’s average interest earning assets in 2020 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 primarily 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 over-collateralized pass-through securities as well as pass-through securities guaranteed by Fannie Mae, Freddie Mac, or Ginnie Mae. At December 31, 2020, the investment securities portfolio had approximately 2.4%of its composition in various forms of pass-through securities comprised of seasoned mortgage-backed securities whose underlying collateral was, to varying degrees (depending on the individual security’s initial and current composition), considered sub-prime, re-performing or high-risk at the securities’ issuance dates. These privately-issued mortgage-backed securities are believed to be adequately collateralized by subordinate structures and ongoing credit support mechanisms and are, therefore, well insulated from loss of principal due to credit default.

At December 31, 2020, available-for-sale investment securities increased 15.4% to $128.3 million and held-to-maturity investment securities increased 39.2% to $171.2 million. 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 - - -

- 51 -

The following table sets forth the scheduled maturities, amortized cost, fair values and average yields for the Company's investment securities at December 31, 2020. 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:

US Treasury, agencies and GSEs $ - - $ - - $ 6,428 1.38 %

State and political subdivisions - - - - - -

Mortgage-backed securities:

Residential mortgage-backed - US agency $ - - $ 269 3.30 % $ 985 2.04 %

Collateralized mortgage obligations - US agency - - 1,299 1.68 % 3,707 1.25 %

Collateralized mortgage obligations - Private label 203 4.84 % 1,753 3.38 % - -

Other non-maturity investments:

Equity securities $ 206 0.53 % $ - - $ - -

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:

US Treasury, agencies and GSEs $ - - $ 6,428 $ 6,416 0.46 %

Mortgage-backed securities:

Other non-maturity investments:

- 52 -

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 $ 1,000 1.70 % $ - - $ - -

Mortgage-backed securities:

Residential mortgage-backed - US agency $ - - $ 2,783 3.22 % $ 202 2.80 %

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:

US Treasury, agencies and GSEs $ - - $ 1,000 $ 1,002 1.70 %

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.

Loans Receivable

Average loans receivable represented 72.5% of the Company’s average interest earning assets in 2020 and account for the greatest portion of total interest income. At December 31, 2020, the Company has the largest portion of its loan portfolio in commercial loan products that represented 58.3% 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 28.5% of total loans at December 31, 2020. The consumer loan products represents 13.2% of total loans at December 31, 2020. 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.

- 53 -

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, 2020 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.

Due Under Due 1-5 Due Over

(In thousands) One Year Years Five Years Total

Real estate:

The following table sets forth fixed- and adjustable-rate loans at December 31, 2020 that are contractually due after December 31, 2021:

(In thousands) Due After One Year

Interest rates:

Total loans receivable, including net deferred costs, increased $44.0 million, or 5.6%, to $825.5 million at December 31, 2020 when compared to $781.5 million at December 31, 2019, due to growth in commercial loans of $78.8 million, partially offset by decreases in consumer loans and residential loans of $19.5 million and $13.9 million, respectively. The Company does not originate sub-prime, Alt-A, negative amortizing or other higher risk structured residential mortgages. Commercial loans increased primarily due to increases of $60.6 million in PPP loans and $32.0 million in commercial real estate loans. This was reflective of high levels of participation in the government relief program, organic loan growth and the Company’s continued success in its expansion within the greater Syracuse, New York market. The decrease in residential mortgage loans was primarily the result of the sale of $35.9 million in seasoned conforming residential mortgage loans in the first quarter of 2020, which generated a $659,000 gain. The decrease in consumer loans was primarily due to general amortization. The Company maintained its previously established credit standards, but continued to benefit from the expanding relationship-derived business activity within the markets that the Bank serves.

- 54 -

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, nonaccrual troubled debt restructurings (“TDR”), and foreclosed real estate (“FRE”). Loans are considered a TDR when, due to a borrower’s financial difficulties, the Company makes a concession(s) to the borrower that it would not otherwise consider. These modifications may include an extension of the term of the loan, and granting a period when interest-only payments can be made, with the principal payments made over the remaining term of the loan or at maturity. TDRs are included in the above table within the categories of nonaccrual loans or accruing TDRs.

Total nonperforming loans increased $16.1 million, or 306.7%, between December 31, 2019 and December 31, 2020, driven by increases of $15.0 million, $995,000 and $116,000 in nonperforming commercial and commercial real estate loans, residential real estate loans, and consumer loans, respectively. The increase in nonperforming commercial and commercial real estate loans was primarily due to the addition of three commercial loan relationships, comprised of five individual loans, with aggregate outstanding loan balances of $14.5 million, which were placed in nonaccrual in 2020. These relationships, include secured loans (secured by third-party pledges, other governmental grants and/or business assets), unsecured loans, and loans collateralized by commercial real estate. Management is monitoring these entities closely and has incorporated our current estimate of the ultimate collectability of these loans into the reported allowance for loan losses at December 31, 2020. 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 loan loss reserve. Management believes that the current level of the allowance for loan losses, at $12.8 million at December 31, 2020, 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.

Foreclosed Real Estate (“FRE”) balances decreased by $88,000 at December 31, 2020, from the prior year end and reflected the timing of foreclosures versus sales in 2020. The number of FRE properties decreased from one to zero between these two dates.

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 impaired 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 $685,000 and $222,000 would have been recorded for the years ended December 31, 2020 and December 31, 2019, respectively.

- 55 -

The measurement of impaired 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 impaired loans when the receipt of contractual principal and interest is probable. At December 31, 2020 and December 31, 2019, the Company had $22.8 million and $7.5 million in loans, which were deemed to be impaired, having specific reserves of $2.8 million and $830,000, respectively. The $15.3 million year-over-year increase in impaired loans was principally due to increases of $8.3 million, $6.0 million, and $741,000 in impairedcommercial real estate loans,other commercial and industrial loans, and commercial lines of credit, respectively. All other loan product segments (which include residential loans and commercial lines of credit) reported modest year-over-year increases in impaired loans of $223,000 in aggregate.

The threshold for individually measuring impairment on commercial real estate or commercial loans remains at $100,000 and for residential mortgage loans remains at $300,000 at December 31, 2020. The thresholds described above do not apply to loans that have been classified as troubled debt restructurings, which are individually measured for impairment 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.

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 impaired loan reporting. Potential problem loans decreased $8.3 million to $23.2 million at December 31, 2020, compared to $31.5 million at December 31, 2019. These loans have been internally classified as special mention, substandard, or doubtful, yet are not currently considered impaired. The decrease in potential problem loans was primarily due to a $5.7 million decrease in potential problem commercial real estate loans, a $2.3 million decrease in potential problem commercial and industrial loans and a $592,000 decrease in potential problem commercial lines of credit. These decreases were partially offset by decreases in potential problem residential estate loans of $558,000. The decrease in potential problem commercial real estate loans, commercial and industrial loans and commercial lines of credit was a result of the loans that were previously potential problem loans, which were deemed to be impaired during 2020.

Total potential problem loans, including impaired loans, were $45.9 million at December 31, 2020, comprised of special mention, substandard and doubtful loans of $20.7 million, $23.7 million and $1.5 million, respectively. Total potential problem loans, including impaired loans, were $38.9 million at December 31, 2019, comprised of special mention, substandard and doubtful loans of $30.3 million, $6.8 million and $1.8 million, respectively. Substandard loans increased $17.0 million, partially offset by decreases in special mention loans and doubtful loans of $9.6 million and $339,000, respectively, at December 31, 2020 as compared to December 31, 2019. The increase in loans classified as substandard was primarily due to a $15.5 million increase in commercial loans, due to the addition of two relationships outstanding comprised of eight loans with an outstanding balance of $8.9 million. These relationships, include secured loans (secured by third-party pledges, other governmental grants and/or business assets), unsecured loans, and loans collateralized by commercial real estate.

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 decreased to 1.85% at December 31, 2020 as compared to 2.09% at December 31, 2019. The delinquency statistics presented at December 31, 2020 do not include loan payment deferrals granted under the provisions of the CARES Act. Delinquent loans decreased $979,000 year-over-year, primarily due to a decrease of $813,000 in delinquent commercial loans. At December 31, 2020, there were $15.3 million in loans past due including $3.8 million, $5.4 million and $6.1 million in loans 30-59 days, 60-89 days, and 90 days and over past due, respectively. At December 31, 2019, there were $16.3 million in loans past due including $9.7 million, $1.4 million and $5.2 million in loans 30-59 days, 60-89 days, and 90 days and over past due, respectively.

The decrease of $979,000 in total loans past due at December 31, 2020, as compared to December 31, 2019, was primarily due to a decrease of $6.0 million in loans 30-59 days past due, partially offset by a $4.0 million and $980,000 increase in loans 60-89 days past due and loans 90 days and over past due, respectively. The decrease in loans 30-59 days past due was primarily due to a decrease of $6.3 million in commercial loans. At December 31, 2020 there were 13 loans with an outstanding aggregate balance of $1.8 million that were 30-59 days past due, while at December 31, 2019, there were 18 loans with an outstanding aggregate balance of $8.2 million. The increase in loans 60-89 days past due was primarily due to an increase of $4.1 million in commercial loans. The increase in loans 90 days and over past due was primarily due to an increase of $1.5 million in delinquent commercial loans.

The ratio of the allowance to loan losses to year end loans at December 31, 2020 was 1.55% as compared to 1.11% at December 31, 2019.

Loans purchased outside of the Bank’s general market area are subject to substantial prepurchase due diligence. Homogenous pools of purchased loans are subject to prepurchase 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 collateral enhancements and other credit loss mitigation factors offered by the seller and the capabilities and financial stability of the servicing entities

- 56 -

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 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 loan losses is adjusted, through the provision for loan 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 loan 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 Loan Losses

The allowance for loan losses is established through provision for loan losses and reduced by loan charge-offs net of recoveries. The allowance for loan losses represents the amount available for probable credit losses in the Company’s loan portfolio as estimated by management. In its assessment of the qualitative factors used in arriving at the required allowance for loan losses, management considers changes in national and local economic trends, including the COVID-19 pandemic, the rate of the portfolios’ growth, trends in delinquencies and nonaccrual balances, changes in loan policy, and changes in management experience and staffing. These factors, coupled with the recent historical loss experience within the loan portfolio by product segment support the estimable and probable losses within the loan portfolio.

The Company establishes a specific allocation for all commercial loans identified as being impaired 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 impaired 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, 2020, the Bank’s position in impaired loans consisted of 52 loans totaling $22.8 million. Of these loans, 15 loans, totaling $1.3 million, were valued using the present value of future cash flows method; and 37 loans, totaling $21.5 million, were valued based on a collateral analysis. 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 impaired loans if it is part of the total related credit to a previously identified impaired commercial loan. The Company also establishes a specific allowance, regardless of the size of the loan, for all loans subject to a troubled debt restructuring agreement.

The allowance for loan losses at December 31, 2020 and 2019 was $12.8 million and $8.7 million, or 1.55% and 1.11% of total year end loans, respectively. The Company recorded $599,000 in net charge-offs in 2020 as compared to $603,000 in net charge-offs in 2019. The ratio of net charge-offs to average loans decreased to 0.08% in 2020 from 0.09% in 2019.

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

- 57 -

The following table sets forth the allocation of allowance for loan 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

The following table sets forth the allowance for loan losses for the years indicated and related ratios:

Recoveries of loans previously charged-off:

Commercial real estate and loans 4 1 66 15 31

Loans charged off:

Net charge-offs to average loans outstanding 0.08 % 0.09 % 0.22 % 0.16 % 0.09 %

Allowance for loan losses to year-end loans 1.55 % 1.11 % 1.18 % 1.23 % 1.27 %

Bank Owned Life Insurance

The Company held $17.9 million and $17.4 million in bank owned life insurance at December 31, 2020 and 2019, respectively. Bank owned life insurance increased $461,000, or 2.6%, to $17.9 million at December 31, 2020, as compared to December 31, 2019. The increase was primarily due to the increase in the cash value of the policies recorded as income in 2020.

Deposits

The Company’s deposit base is drawn from ten 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 $136.9 million, or 16.7%, in 2020. For the year ended December 31, 2020, 57.5% of the Company's average deposit base of $959.0 million consisted of core deposits. Core deposits, which exclude time deposits, are considered to be more stable and provide the Company with a lower cost of funds than time deposits. The Company will continue to emphasize retail and business core deposits by providing depositors with a full range of deposit product offerings and will maintain its recent focus on deposit gathering within the Syracuse market.

At December 31, 2020, business deposits, consumer deposits, and municipal deposits increased $70.1 million, $37.4 million and $6.5 million, respectively, when compared to December 31, 2019. The increase in business deposits was primarily from activities related to PPP loans. Noninterest-bearing deposits, which are primarily demand deposits, were $162.1 million at year end, compared with $107.5 million on December 31, 2019. A significant, but indeterminate amount of this increase in noninterest-bearing accounts is comprised of the unused balances in PPP loans that were deposited directly into customer accounts during the second quarter of 2020. The increase in consumer deposits during the year ended December 31, 2020 reflected increased brokered deposit acceptances and the Bank’s increased market penetration among non-business customers, particularly in northern Onondaga County. The increase in the

- 58 -

average balance of brokered deposits accepted by the Bank in 2020, as compared to 2019, resulted from management’s efforts to increase cash and cash equivalent balances, in response to the COVID-19 pandemic, during the second quarter of 2020. The increase in municipal deposits in 2020, as compared to the previous year, resulted from transitory factors among a small number of the Bank’s largest municipal depositors.

Total deposits of $995.9 million at December 31, 2020 consisted in part of $170.0 million in brokered money market and certificates of deposit accounts. Brokered deposits represented 17.1% of all deposits at December 31, 2020. Total deposits of $881.9 million at December 31, 2019 consisted in part of $136.5 million in brokered money market and certificates of deposit accounts. Brokered deposits represented 15.5% of all deposits at December 31, 2019.

The following table sets forth our deposit composition in dollar amount and as a percentage of total deposits.

December 31,

At December 31, 2020, time deposit accounts in excess of $100,000 totaled $200.8 million, or 50.6% of time deposits and 20.2% of total deposits. At December 31, 2019, these deposits totaled $315.3 million, or 74.8% of time deposits and 35.8% of total deposits.

The following table indicates the amount of the Company’s time deposit accounts of $100,000 or more by time remaining until maturity as of December 31, 2020:

(In thousands)

Remaining Maturity:

Three months or less $ 65,476

Three through six months 89,819

Six through twelve months 35,237

- 59 -

Borrowings

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

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

Average interest rate during the year 1.65 % 2.54 % 1.63 %

Average interest rate at the end of the period 0.26 % 1.80 % 2.15 %

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

Average interest rate during the year 2.08 % 2.46 % 2.00 %

Average interest rate at the end of the period 1.60 % 2.52 % 2.32 %

- 60 -

Subordinated Loans

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 FRB. The capital securities of the trust are a pooled trust preferred fund of Preferred Term Securities VI, Ltd., whose interest rate resets quarterly, and are indexed to the 3-month U.S. dollar-denominated (“USD”) LIBOR rate plus 1.65%. These securities have a five-year call provision. The Company paid $124,000 and $213,000 in interest expense related to this issuance in 2020 and 2019, respectively. The Company guarantees all of these securities.

Following several earlier transition date announcements in recent years, in December 2020 the United Kingdom’s Financial Conduct Authority (“FCA”), the organization responsible for regulating LIBOR, stated that it would (i) cease publishing indices at December 31, 2020 for one-week and two-month USD LIBOR after December 31, 2021, and (ii) cease publishing of all other tenors of USD LIBOR (specifically, one, three, six and 12-month tenors) after June 30, 2023. The Alternative Reference Rates Committee (the “ARRC”), formed by the FRB and the Federal Reserve Bank of New York, has been charged with developing an alternative rate that will replace USD LIBOR. The ARRC has identified the Secured Overnight Financing Rate (“SOFR”) as the rate that represents best practice for use in USD LIBOR derivatives and other financial contracts. Accordingly, SOFR currently represents the ARRC's preferred alternative to USD LIBOR. However, the replacement of USD LIBOR is a highly complex task due to the large number and aggregate magnitude of currently-outstanding USD LIBOR-based contracts, as well as the broad range of users of these indices. As a result, there are a number of significant objections to the adoption of the SOFR index that have been brought forth for consideration by a wide-range of entities. Notwithstanding the uncertainties related to the transition away from USD LIBOR, described above, U.S. banking regulators have also encouraged banks to cease entering into new contracts that use USD LIBOR as a reference rate as soon as practicable and, in any event, by December 31, 2021. Management has analyzed the Company’s aggregate exposure to instruments that are indexed to USD LIBOR (including the Company’s acquired loan participations, fixed-income investments, hedging instruments and the Floating-Rate Debentures) and concluded that the adoption of SOFR, or another similar index that may ultimately be promulgated by the ARRC, will not materially impact the Company or the results of its operations.

The Company's equity interest in the trust subsidiary is included in other assets on the Consolidated Statements of Financial Condition at December 31, 2020 and 2019. For regulatory reporting purposes, the Federal Reserve 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 determination that Trust Preferred Securities can no longer be considered in regulatory capital, the securities become callable and the Company may redeem them at its discretion.

On October 15, 2015, the Company executed a $10.0 million non-amortizing Subordinated Loan (the 2015 Subordinated Loan) with an unrelated third party that is scheduled to mature on October 1, 2025. The Company has the right to prepay the 2015 Subordinated Loan on the first day of any calendar quarter after October 15, 2020 without penalty. The annual interest rate charged to the Company will be 6.25% through the maturity date of the 2015 Subordinated Loan. The 2015 Subordinated Loan is senior in the Company’s credit repayment hierarchy only to the Company’s common equity and preferred stock and, as a result, qualifies as Tier 2 capital for all future periods when applicable. The Company paid $172,000 in origination and legal fees as part of this transaction. These fees were amortized over the life of the 2015 Subordinated Loan through its first call date using the effective interest method. The effective cost of funds related to this transaction was 6.44% calculated under this method through October 15, 2020 and is and will be 6.25% thereafter until the stated maturity date. Interest expense, related to this borrowing, of $650,000 and $650,000 was recorded in the years ended December 31, 2020 and 2019, respectively.

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 Loan (the “2020 Subordinated Loan”) to certain qualified institutional buyers and accredited institutional investors. The 2020 Subordinated Loan 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 Secured Overnight Financing Rate (SOFR) plus 532 basis points, payable quarterly until maturity. The Company may redeem the 2020 Subordinated Loan at par, in whole or in part, at its option, any time after October 15, 2025 (the first redemption date). The 2020 Subordinated Loan is senior in the Company’s credit repayment hierarchy only to the Company’s common equity and preferred stock and, and any future senior indebtedness and is intended to qualify as Tier 2 capital for regulatory capital purposes for the Company, when applicable. 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 Loan 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 of $327,000 was recorded in the year ended December 31, 2020 related to this transaction.

- 61 -

Capital

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, 2020, 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, 2020, 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 specifiied 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. 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, 2020, the Bank exceeded all current regulatory required minimum capital ratios, including the capital buffer requirements.

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

- 62 -

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, 2020, cash and cash equivalents increased by $23.3 million. The Company reported net cash flows from financing activities of $126.0 million generated principally by increased customer deposit balances of $80.6 million, an increase in net proceeds from long-term borrowings of $40.2 million, increased brokered deposit balances of $33.4 million, and by net proceeds from the 2020 Subordinated Loan of $24.2 million. This was partially offset by an aggregate decrease in net cash of $1.2 million from all other financing sources, including dividends paid to common and preferred shareholders, and the holder of the Warrant of $1.4 million.Additionally, $46.6 million was provided through operating activities generated principally by proceeds from the sale of loans. These cash flows were primarily invested in: (1) $243.7 million in purchases of investment securities in 2020, and (2) net increases in loans outstanding of $81.2 million.

Certificates of deposit due within one year of December 31, 2020 totaled $334.9 million, representing 84.3% of certificates of deposit at December 31, 2020, a decrease from 91.8% at December 31, 2019. We believe the large percentage of certificates of deposit that mature within one year reflect customers’ hesitancy to invest their funds for long periods in the current low interest rate environment. 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, 2021.

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 loans. 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 Loan, 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, 2020 and 2019, the Company had cash and cash equivalents of $43.5million and $20.2 million, respectively.

The Bank has a number of existing credit facilities available to it. At December 31, 2020, total credit available under the existing lines of credit was approximately $143.8 million at FHLBNY, the FRB, and two other correspondent banks. At December 31, 2020, the Company had $82.1 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 $61.7 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, 2020, 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, 2020, the Bank had $169.2 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.

- 63 -

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 65

Report of Independent Registered Public Accounting Firm 67

Consolidated Statements of Condition – December 31, 2020 and 2019 69

Consolidated Statements of Income – Years ended December 31, 2020 and 2019 70

Notes to Consolidated Financial Statements 75

- 64 -

MANAGEMENT’S REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Evaluation of Disclosure Controls and Procedures

Under the supervision and with the participation of our Chief Executive Officer (“CEO”) and our Chief Financial Officer (“CFO”) (the Company’s principal executive officer and principal financial officer), management conducted an evaluation (the “Evaluation”) of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Exchange Act) as of December 31, 2020. The term “disclosure controls and procedures,” under the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to our management, including its principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosure.

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

In connection with the filing of the Annual Report on Form 10-K as of December 31, 2020, our CEO and CFO concluded that the design and operation of our disclosure controls and procedures were not effective at December 31, 2020, at the reasonable assurance level, due to the material weakness described below under “Management’s Report on Internal Control over Financial Reporting.” The control deficiencies creates a reasonable possibility that a material misstatement to the consolidated financial statements would not be prevented or detected on a timely basis.

Notwithstanding the existence of the material weakness as described above, we believe that the financial statements in this annual report present fairly, in all material respects, our consolidated statements of condition, statements of operations, statements of comprehensive income (loss), statements of cash flows and statements of shareholders’ equity as of the dates, and for the periods presented, in conformity with GAAP.

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.

As noted below in the “Management’s Report on Internal Control over Financial Reporting,” as a result of the Evaluation, management identified material weaknesses in internal control processes related to transactions with Related Parties and material weaknesses in internal control related to loan processing. To be clear, these material weaknesses, as identified by the Evaluation, relate solely to the Company’s internal control over financial reporting identified below and does not affect or relate to either the Company’s compliance with laws or regulations or the Company’s operations (e.g., credit underwriting, loan issuance, loan servicing, disclosure of information to contractual counterparties, deposit management, collection/retention of funds, account management, compliance with Anti-Money Laundering policies or any other operational policies).

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

- 65 -

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, 2020, management identified two areas that, under applicable SEC accounting rules, each constituted a “material weakness” at December 31, 2020. The first material weaknesses identified ineffectiveness in the controls related to Related Party (as defined in applicable regulations) transactions that included procedural and documentary deficiencies related to underwriting risk ratings and the completeness of borrower reviews. The second identified area of material weakness at December 31, 2020 identified relates to loan authorization, disbursement and file maintenance controls. As a result of the material weakness described above, management has concluded that, as of December 31, 2020, our internal control over financial reporting was not effective.

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.

Management’s Financial Reporting Remediation Initiatives

In order to remediate the material weakness related to transactions with Related Parties, management has commenced to initiate enhanced training programs and revise internal operating procedures designed to identify, summarize and monitor all such transactions and relationships.

In order to remediate the material weakness related to loan authorization, disbursement and file maintenance controls, management has commenced the redesign of specific processes and controls associated with each of the loan operations and will increase staffing levels where appropriate, improve training, increase the use of certain automated productivity tools, and install enhanced process oversight and functional controls to ensure that these internal controls are effective.

Management is committed to maintaining a strong internal control environment and believes this remediation effort will represent an improvement in existing controls. Management anticipates that the new controls, as implemented and when tested for a sufficient period of time, will remediate the material weakness. As we continue to evaluate and work to improve our internal control over financial reporting, we may determine to take additional measures to address control deficiencies or modify certain activities of the remediation measures described above.

Changes in Internal Control over Financial Reporting

Other than the changes described above under “Management’s Report on Internal Control over Financial Reporting,” there were no changes made in our internal controls during the year ended December 31, 2020 that materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

/s/ Thomas W. Schneider /s/ Walter F. Rusnak

Thomas W. Schneider Walter F. Rusnak

Oswego, New York

March 30, 2021

- 66 -

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, 2020 and 2019, 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, 2020, 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, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the two-year period ended December 31, 2020, 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.

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 Loan Losses

As described in Notes 1 and 6 to the consolidated financial statements, the Company’s allowance for loan losses is management’s estimate of losses inherent in the loan portfolio as of the date of the statement of condition and it is recorded as a reduction to loans. The allowance for loan losses was $12.8 million at December 31, 2020, which consists of three components (i) specific reserves based on probable losses on specific loans (“specific reserves”), and (ii) a general allowance based on historical loan loss experience, general economic conditions and other qualitative risk factors both internal and external to the Company (“general reserves”). The specific reserve component relates to loans that are classified as impaired and is established when the collateral value or discounted cash flows of the impaired loan are lower than the carrying value of the loan. The general reserve component of the allowance for loan losses covers pools of loans, by loan class, and is based on a variety of risk considerations, both quantitative and qualitative. Quantitative factors include the Company’s historical loss experience, delinquency and charge-off trends, known information about individual loans and other factors. Qualitative factors include various considerations regarding the general economic environment in the Company’s market area. The qualitative adjustment for the general reserve includes management’s consideration of changes in national and local economic trends, the rate of growth in the portfolio, trends of delinquencies and nonaccrual balances, changes in loan policy, and changes in lending management experience and related staffing.

- 67 -

The qualitative adjustment contributes significantly to the general reserve component of the allowance for loan losses. Management’s identification and analysis of these considerations and related adjustments requires significant judgment and could have a significant effect on the allowance for loan losses. We identified the estimate of the qualitative adjustments of the general reserve for the allowance for loan losses as a critical audit matter as they represent a significant portion of the total general reserve and because management’s estimate relies on a qualitative analysis to determine a quantitative adjustment which required especially subjective auditor judgment.

The primary procedures we performed to address this critical audit matter included performing substantive testing, including evaluating management’s judgments and assumptions for developing the general reserve qualitative adjustments for the allowance for loan losses, which consisted of the following:

Loans

As described in Notes 1 and 5 to the consolidated financial statements, the Company grants loans to customers with the intent and ability to hold for the foreseeable future or until maturity or pay-off. The Company’s primary lending portfolio consists of originating commercial real estate, commercial loans, and one-to-four family residential real-estate loans, but also consists of municipal loans, home equity loans, and consumer loans. The balance of loans, net of the allowance for loan losses and deferred origination costs, was $812.7 million at December 31, 2020. The Company recognizes revenue from loans through interest income, which is determined based on the underlying interest rate on the loans. The Company offers both fixed and adjustable rate loans based on the type of loan and borrower specific risk characteristics. During 2020 the Company recognized $35.1 million in interest income associated with loans.

Auditing loans resulted in complexities due to the material weaknesses in the Company’s internal control over financial reporting relating to the insufficient documentation supporting loan transactions occurring during the year. We obtained an understanding of management’s processes and evaluated the design and operating effectiveness of certain controls over the Company’s accounting for loans. We tested controls over management’s review of new and existing loans, as well as controls over the presentation of loans in the consolidated financial statements.

To test the presentation of loans and recognition of interest income during the year, we performed audit procedures that included, among others, third-party confirmations, independent loan reviews, testing the clerical accuracy of interest income recorded on individual loans, and testing the completeness and accuracy of all loan and related party disclosures. Because of the material weakness, we expanded our sample sizes selected for substantive testing and modified our testing approach for certain procedures to encompass a highly statistical method of sampling in order to provide greater assurance over the fair presentation of the consolidated financial statement amounts. We performed additional testing over the completeness and accuracy of loan data, and evaluated whether management’s accounting, presentation, and disclosure of loans in the consolidated financial statements followed US Generally Accepted Accounting Principles.

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

/s/ BONADIO & CO., LLP

Bonadio & Co., LLP

Pittsford, New York

- 68 -

Pathfinder Bancorp, Inc.

Consolidated Statements of Condition

December 31, December 31,

(In thousands, except share and per share data) 2020 2019

ASSETS:

Marketable equity securities, at fair value 1,850 534

Federal Home Loan Bank stock, at cost 4,390 4,834

Operating lease right-of-use assets 2,240 2,386

Foreclosed real estate - 88

LIABILITIES AND SHAREHOLDERS' EQUITY:

Deposits:

Accrued interest payable 193 396

Shareholders' equity:

Accumulated other comprehensive loss (2,236 ) (2,971 )

Total Pathfinder Bancorp, Inc. shareholders' equity 97,456 90,434

Noncontrolling interest 266 235

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

- 69 -

Pathfinder Bancorp, Inc.

Consolidated Statements of Income

For the years ended

(In thousands, except per share data) December 31, 2020 December 31, 2019

Interest and dividend income:

Debt securities:

Federal funds sold and interest earning deposits 79 304

Interest expense:

Interest on short-term borrowings 148 377

Interest on long-term borrowings 1,503 1,575

Interest on subordinated loans 1,101 863

Net interest income after provision for loan losses 26,936 26,264

Noninterest income:

Service charges on deposit accounts 1,395 1,391

Earnings and gain on bank owned life insurance 460 462

Net gains on sales and redemptions of investment securities 1,076 329

(Losses) gains on marketable equity securities (629 ) 81

Net gains on sales of loans and foreclosed real estate 1,179 64

Debit card interchange fees 771 657

Insurance agency revenue 955 844

Other charges, commissions & fees 917 878

Noninterest expense:

Professional and other services 1,210 1,325

Insurance agency expense 743 816

Community service activities 199 620

Foreclosed real estate expenses 50 337

Net income attributable to noncontrolling interest 96 10

Net income attributable to Pathfinder Bancorp, Inc. $ 6,950 $ 4,276

Convertible preferred stock dividends 291 208

Warrant dividends 30 23

Undistributed earnings allocated to participating securities 1,224 467

Net income available to common shareholders $ 5,405 $ 3,578

Earnings per common share - basic $ 1.17 $ 0.80

Earnings per common share - diluted $ 1.17 $ 0.80

Dividends per common share $ 0.24 $ 0.24

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

- 70 -

Pathfinder Bancorp, Inc.

Consolidated Statements of Comprehensive Income

Years ended

Other Comprehensive Income

Retirement Plans:

Retirement plan net losses recognized in plan expenses 234 335

Plan gains not recognized in plan expenses 610 255

Net unrealized gain on retirement plans 844 590

Unrealized holding gains on available-for-sale securities

Unrealized holding gains arising during the period 2,352 3,869

Reclassification adjustment for net gains included in net income (926 ) (329 )

Net unrealized gains on available-for-sale securities 1,426 3,540

Derivatives and hedging activities:

Unrealized holding losses arising during the period (1,308 ) -

Net unrealized losses on derivatives and hedging activities (1,308 ) -

Other comprehensive income, before tax 995 4,157

Other comprehensive income, net of tax 735 3,071

Comprehensive income, attributable to noncontrolling interest $ 96 $ 10

Comprehensive income attributable to Pathfinder Bancorp, Inc. $ 7,685 $ 7,347

Tax Effect Allocated to Each Component of Other Comprehensive Income

Retirement plan net losses recognized in plan expenses $ (61 ) $ (88 )

Plan gains not recognized in plan expenses (159 ) (67 )

Unrealized holding gains arising during the period (615 ) (1,010 )

Reclassification adjustment for net gains included in net income 242 86

Unrealized losses on derivatives and hedging arising during the period 342 -

Income tax effect related to other comprehensive income $ (260 ) $ (1,086 )

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

- 71 -

Pathfinder Bancorp, Inc. PBHC US Equity

PBHC · 10-K · period ended 2020-12-31

ITEM 1A: RISK FACTORS

ITEM 1B: UNRESOLVED STAFF COMMENTS

ITEM 2: PROPERTIES

ITEM 3: LEGAL PROCEEDINGS

ITEM 4: MINE SAFETY DISCLOSURE

ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

ITEM 6: SELECTED FINANCIAL DATA

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

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Pathfinder Bancorp, Inc. PBHC US Equity☆

PBHC · 10-K · period ended 2020-12-31

ITEM 1A: RISK FACTORS

ITEM 1B: UNRESOLVED STAFF COMMENTS

ITEM 2: PROPERTIES

ITEM 3: LEGAL PROCEEDINGS

ITEM 4: MINE SAFETY DISCLOSURE

ITEM 5: MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

ITEM 6: SELECTED FINANCIAL DATA

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

ITEM 7A: QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

ITEM 8: FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

Pathfinder Bancorp, Inc. PBHC US Equity