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CLDB > SEC Filings for CLDB > Form 10-Q on 13-Nov-2012All Recent SEC Filings

Show all filings for CORTLAND BANCORP INC

Form 10-Q for CORTLAND BANCORP INC


13-Nov-2012

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Financial Review

The following is management's discussion and analysis of the financial condition and results of operations of Cortland Bancorp (the "Company"). The discussion should be read in conjunction with the Consolidated Financial Statements and related notes and summary financial information included elsewhere in this annual report.

Note Regarding Forward-looking Statements

The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking statements. In addition to historical information, certain information included in this discussion and other material filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) may contain forward-looking statements that involve risks and uncertainties. The words "believes," "expects," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends," or similar terminology identify forward-looking statements. These statements reflect management's beliefs and assumptions, and are based on information currently available to management.

Economic circumstances, the Company's operations and actual results could differ significantly from those discussed in any forward-looking statements. Some of the factors that could cause or contribute to such differences are changes in the economy and interest rates either nationally or in the Company's market area, including the impact of the impairment of securities; changes in customer preferences and consumer behavior; increased competitive pressures or changes in either the nature or composition of competitors; changes in the legal and regulatory environment; changes in factors influencing liquidity, such as expectations regarding the rate of inflation or deflation, currency exchange rates, and other factors influencing market volatility; and unforeseen risks associated with other global economic, political and financial factors.

While actual results may differ significantly from the results discussed in the forward-looking statements, the Company undertakes no obligation to update publicly any forward-looking statement for any reason, even if new information becomes available.

Analysis of Assets and Liabilities for the First Nine Months

Earning assets are comprised of investment securities, loans and deposits at financial institutions, including the Federal Reserve Bank. Earning assets were $513.4 million at September 30, 2012, an increase of 11.1% from the September 30, 2011 balance of $462.0 million, and an increase of 6.5% from the December 31, 2011 balance of $482.1 million. The increase from December 31 was the net result of the following: an increase in deposits at the Federal Reserve of $23.3 million, a decrease in investment securities of $10.9 million, $19.5 million of 60-day loans redeemed prior to September 30, 2012, an increase of $24.2 million in commercial real estate loans and a $15.1 million increase in loans held for sale as a result of CSB Mortgage Company increased activity. Total cash and cash equivalents increased by $24.7 million from year-end and increased by $24.0 million from the balance at September 30, 2011. $13.0 million of the increase was used to settle securities in October 2012 that were purchased in September 2012.

At September 30, 2012, the investment securities portfolio was $175.0 million compared to $188.7 million at September 30, 2011, a decrease of $13.7 million, or 7.3%. Investment securities decreased $10.9 million compared to December 31, 2011, a decrease of 5.9%. Investment securities represented 34.1% of earning assets at September 30, 2012, compared to 40.9% at September 30, 2011 and 38.6% at December 31, 2011. The decrease is partially due to the sale of $3.5 million in trust preferred securities. As the Company manages its balance sheet for loan growth, asset mix, liquidity and for current interest rates and interest rate forecasts, the investment portfolio is a primary source of liquidity. The investment portfolio represented 39.9% of each deposit dollar, down from 46.9% a year ago and down from 44.0% of year-end levels.

The investment securities available-for-sale portfolio had net unrealized losses of $1.8 million at September 30, 2012, a decrease of $3.2 million compared to net unrealized losses of $5.0 million at September 30, 2011, and a decrease of $2.2 million compared to net unrealized losses of $4.0 million at December 31, 2011. Contributing to the volatility in net unrealized losses over the past twelve months are changes in interest rates and an inactive market for certain securities as discussed in Note 9 to the financial statements. A partial sale of these securities has lessened unrealized losses.


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The Company's investment portfolio contains trust preferred securities, which have resulted in valuation charges against income of $13.7 million in 2009, $2.7 million in 2010, $202,000 in 2011 and $171,000 in the nine months of 2012. The Company continues to value these securities consistent with valuation techniques prescribed under accounting standards. The market for these securities and similar securities, which had been relatively active through 2003, became illiquid during the financial crisis of 2008 and is still currently not active. Since 2008, the Company has modeled and analyzed the cash flow characteristics and has concluded that a major portion of these devalued securities were not recoverable. In 2012, a portion of these securities were sold. The charge for this "other than temporary" impairment for the first nine months of 2012 was $171,000 versus $202,000 in the nine months of 2011.

Loans held for sale increased to $16.0 million at September 30, 2012 compared to $947,000 at December 31, 2011 and $215,000 at September 30, 2011. The increase is in line with expected results from the newly formed wholesale banking unit, which originated over $135.0 million of mortgage loans through September 2012.

Total loans at September 30, 2012 were $293.2 million as compared to $263.5 million a year ago, an 11.3% increase, and $289.1 million at December 31, 2011, a 1.4% increase. Total assets of $554.5 million at September 30, 2012 reflect an increase of 11.4% from year ago asset totals of $497.8 million and an increase of 6.7% from December 31, 2011 asset totals of $519.8 million with loans providing the core growth. Cumulative loan growth since September 2010 exceeds 26.0%, while cumulative asset growth during the same period reflects a 15.6% increase. The Company continues its objective of shifting its asset mix into in-market commercial loans with the intent of improving net interest margin.

Loans net of the allowance for losses increased by $29.1 million during the twelve month period from September 30, 2011 to September 30, 2012, and increased by $3.5 million from December 31, 2011. Gross loans as a percentage of earning assets stood at 57.1% as of September 30, 2012, 57.0% at September 30, 2011 and 60.0% as of December 31, 2011. The loan to deposit ratio was 66.8% at September 30, 2012, 65.5% at September 30, 2011 and 68.4% at December 31, 2011. The increase in loans at year-end was due in part to 60-day term commercial loans for a total of $19.5 million that closed in December 2011 and were fully secured by segregated deposit accounts with the Bank. The loans matured in the first quarter of 2012. Additionally, commercial real estate loans increased by $24.2 million.

At September 30, 2012, the loan loss allowance of $3.6 million represented approximately 1.23% of outstanding loans, and at September 30, 2011 the loan loss allowance of $3.1 million represented approximately 1.16% of outstanding loans. The loan loss allowance at December 31, 2011 of $3.1 million represented approximately 1.06% of outstanding loans, or 1.15% excluding the 60-day term loans.

During the first nine months, loan charge-offs were $452,000 in 2012 compared to $491,000 for the same period in 2011, while the recovery of previously charged-off loans amounted to $111,000 in 2012 and $176,000 in 2011. The net charge-offs represent 0.16% of average loans for both periods. Charge-offs of specific problem loans, as well as for smaller balance homogeneous loans, are recorded periodically during the year. The number of loan accounts and the amount of charge-off associated with account balances vary from period to period as loans are deemed uncollectible by management.

Loans accounted for on a non-accrual basis increased slightly from $3.6 million at December 31, 2011 and $3.3 million at September 30, 2011 to $3.8 million at the recent quarter ended September 30, 2012. Non-accrual loans at September 30, 2012 represent a relatively insignificant 1.3% of the loan portfolio compared to 1.2% at December 31, 2011 and 1.3% at September 30, 2011. The allowance for loan losses covers 96.0% of nonaccrual loans at September 30, 2012.

Bank-owned life insurance had a cash surrender value of $13.9 million at September 30, 2012, $12.9 million at December 31, 2011 and $12.8 million at September 30, 2011. The Company purchased $694,000 in bank-owned life insurance in 2012 as part of its funding of executive post retirement benefits. Other assets increased slightly to $12.6 million at September 30, 2012 from $11.3 million at December 31, 2011 and from $12.2 million at September 30, 2011. Included in other assets is a prepaid assessment paid to the FDIC in December of 2009. This prepayment is the estimate, based on projected assessment rates and assessment base, made by the FDIC of premiums due until December 31, 2012. On a quarterly basis, this prepayment is reduced through a charge to expense until the prepayment is depleted. The balance is $1.3 million at September 30, 2012, $1.5 million at December 31, 2011 and $1.6 million at September 30, 2011. Other real estate decreased to $242,000 at September 30, 2012 compared to $437,000 at December 31, 2011 and $479,000 at September 30, 2011. Also included in other assets is deferred taxes of $2.8 million, $6.4 million and $7.0 million for the periods ended September 30, 2012, December 31, 2011 and September 30, 2011, respectively, and Federal income tax receivable of $3.3 million, $335,000 and $44,000 for the periods ended September 30, 2012, December 31, 2011 and September 30, 2011, respectively. $3.5 million of deferred taxes were


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

reclassified to a Federal income tax receivable due to the sale of trust preferred securities with impairment previously recorded. Noninterest-bearing deposits measured $82.3 million at September 30, 2012 up from $70.7 million at December 31, 2011 and $68.8 million at September 30, 2011. Interest-bearing deposits increased $4.6 million to $356.6 million at September 30, 2012 from $352.0 million at December 31, 2011 and increased $23.3 million from $333.3 million at September 30, 2011. The increase in interest bearing deposits from year end is net of segregated deposit accounts with the Bank which fully collateralized $19.5 million in 60-day term commercial loans that closed in December 2011. The loans matured and the deposits withdrew the first quarter of 2012.

Federal Home Loan Bank advances and short term borrowings stayed consistent at $41.7 million at September 30, 2012 from $42.3 million at December 31, 2011 and from $42.4 million at September 30, 2011. Future maturities of long term notes are expected to be paid off. Management continues to use short-term borrowings to bridge its cash flow needs.

Other liabilities measured $18.2 million at September 30, 2012 compared to $3.9 at December 31, 2011 and $3.8 million at September 30, 2011. The increase is due to $13.0 million in securities purchases traded in September 2012, but settled in October 2012.

The Company's total shareholders' equity increased from $45.7 million on December 31, 2011 and $44.3 million at September 30, 2011 to $50.6 million at September 30, 2012, an increase of $4.9 million and $6.3 million, respectively. The Company's capital continues to meet the requirements for the Company to be deemed well capitalized under all regulatory measures. The Company's total risk-based capital is $18.6 million in excess of the 10% threshold for the Company to be well-capitalized.

Capital Resources

Regulatory standards for measuring capital adequacy require banks and bank holding companies to maintain capital based on "risk-adjusted" assets so that categories of assets with potentially higher credit risk require more capital backing than assets with lower risk. In addition, banks and bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as standby letters of credit and interest rate swaps.

The risk-based standards classify capital into two tiers. Tier 1 capital consists of common shareholders' equity, noncumulative and cumulative perpetual preferred stock, qualifying trust preferred securities and minority interests less intangibles, disallowed deferred tax assets and the unrealized market value adjustment of investment securities available-for-sale. Tier 2 capital consists of a limited amount of the allowance for loan and lease losses, perpetual preferred stock (not included in Tier 1), hybrid capital instruments, term subordinated debt, and intermediate-term preferred stock.

In April 2009, the FFIEC issued additional instructions for reporting of direct credit substitutions that have been downgraded below investment grade. Included in the definition of a direct credit substitute are mezzanine and subordinated tranches of trust preferred securities and non-agency collateralized mortgage obligations. Adopting these instructions results in an increase in total risk-weighted assets with an attendant decrease in the risk-based capital and Tier 1 risk-based capital ratios.

As a result of investment downgrades by the rating agencies, all of the 12 trust preferred securities were rated as "highly speculative grade" debt securities. As a consequence, the Bank is required to maintain higher levels of regulatory risk-based capital for these securities due to the greater perceived risk of default by the underlying bank and insurance company issuers. Specifically, regulatory guidance requires the Bank to apply a higher "risk weighting formula" for these securities to calculate its regulatory capital ratios. The result of that calculation increases the Bank's risk-weighted assets for these securities to $57.5 million, well above the $13.9 million in amortized cost of these securities as of September 30, 2012, thereby significantly diluting the risk-based capital ratios by approximately 1.7% for September 30, 2012 and 2.2% for December 31, 2011.

Regardless of the trust preferred securities risk weighting, the Company met all capital adequacy requirements to which it was subject as of September 30, 2012 and December 31, 2011, as supported by the data in the following table. As of those dates, the Company met the capital requirements to be deemed "well capitalized" under regulatory prompt corrective action provisions.


           ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

                      CONDITION AND RESULTS OF OPERATIONS



                                         Actual Regulatory Capital Ratios                 Regulatory Capital Ratio
                                                      as of:                                    Requirements:
                                      September 30,             December 31,             Well               Adequately
                                          2012                      2011              Capitalized           Capitalized
Tier I capital to risk-weighted
assets                                         13.72 %                   13.37 %              6.00 %                4.00 %
Total risk-based capital to
risk-weighted assets                           14.64 %                   14.18 %             10.00 %                8.00 %
Tier I capital to average assets               10.66 %                   10.47 %              5.00 %                4.00 %

Risk based capital standards require a minimum ratio of 8.00% of qualifying total capital to risk-adjusted total assets with at least 4.00% constituting Tier 1 capital. Capital qualifying as Tier 2 capital is limited to 100.00% of Tier 1 capital. All banks and bank holding companies are also required to maintain a minimum leverage capital ratio (Tier 1 capital to total average assets) in the range of 3.00% to 4.00%, subject to regulatory guidelines. The Company's capital ratios remain above regulatory minimums for "well capitalized" financial institutions.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires banking regulatory agencies to revise risk-based capital standards to ensure that they adequately account for the following additional risks: interest rate, concentration of credit, and non-traditional activities. Accordingly, regulators will subjectively consider an institution's exposure to declines in the economic value of its capital due to changes in interest rates in evaluating capital adequacy. The following table illustrates the Company's components of risk weighted capital ratios and the excess over amounts considered well-capitalized at September 30, 2012 and December 31, 2011. Management considers these excesses to be adequate with regard to the risks inherent in the balance sheet.

                                                 (Amounts in thousands)
                                            September 30,        December 31,
                                                2012                 2011
       Tier 1 Capital                      $        55,104      $       51,739
       Tier 2 Capital                                3,700               3,142

       QUALIFYING CAPITAL                  $        58,804      $       54,881

       Risk-Adjusted Total Assets (*)      $       401,599      $      387,091

       Tier 1 Risk- Based Capital Excess   $        31,008      $       28,514
       Total Risk- Based Capital Excess             18,644              16,172
       Total Leverage Capital Excess                29,249              27,028

(*) Includes off-balance sheet exposures

Average total assets for leverage capital purposes is calculated as average assets less disallowed deferred tax assets and the net unrealized market value adjustment of investment securities available for sale, which averaged $517.1 million for the nine months ended September 30, 2012 and $494.2 million for the year ended December 31, 2011.

Accounting guidelines require that investments designated as available-for-sale are marked-to-market with corresponding entries to the deferred taxes and shareholders' equity. Regulatory agencies, however, exclude these adjustments in computing risk-based capital, as their inclusion would tend to increase the volatility of this important measure of capital adequacy.

Executive Summary - Income and Expenses

Net income of $1.3 million, or $0.28 per share, was recorded for the third quarter of 2012 compared to $1.1 million, or $0.24 per share, for the third quarter of 2011. Net income for the nine months ended September 30, 2012 was $3.4 million versus $3.2 million for the same period in 2011.

Respective to the quarterly operating results, highlights of operations are as follows:

Spurred by the commercial loan growth, net interest income increased by $7,000 in 2012 versus 2011 as the Company continues to optimally manage its balance sheet in this historically low interest rate environment.


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The Company continues to excel in managing risks in the loan portfolio as asset quality measures are among the best for banks with similar asset totals. Net loan charge-offs were 0.03% of average loans in 2012 and 0.18% for 2011. The allowance for loan loss (ALLL) to total loans ratio was 1.23% at September 30, 2012 versus 1.16% a year ago.

Mortgage banking gains reached $1.0 million in the quarter versus $25,000 in the same quarter of 2011. These gains, which are reported as non-interest income, are exceeding expectations from the wholesale mortgage unit which was formed late last year specifically as a result of strategic initiatives aimed at improving overall profitability. The wholesale mortgage unit, CSB Mortgage Company partners with mortgage brokers in contiguous states to originate mortgage loans. The loans are sold to investors in the secondary market generating a profit margin.

The improvement in earnings is highlighted by a 19.8% year over year growth rate in the commercial loan portfolio and a composite loan portfolio growth rate of 11.3%.

Net interest income, which provides the core earnings base for the Company, has remained stable with the prior year at $4.1 million in the third quarter of 2012 and 2011. The Company has benefited in this low interest rate environment from increasing balances in the loan portfolio yielding 5.33% during the quarter in lieu of allocating funds into the investment portfolio earning 2.80%. Also, as liabilities continue to mature and reprice at lower rates, the net interest income is expected to improve. Even with deposit rates creeping lower to reflect market trends, the Company has been able to both retain and grow deposits and has recorded a 9.1% increase in balances over the past year.

The Company, to date, has not experienced notable deterioration in credit quality despite less than favorable economic conditions over the past several years. Nonaccrual loans of $3.8 million at September 30, 2012, or 1.28% of loans, were relatively stable from $3.6 million at December 31, 2011. The Company's allowance for loan losses covers 96.0% of nonaccrual loans at September 30, 2012.

Non-interest income for the quarter increased by $842,000 from a year ago. This is driven by mortgage banking gains in 2012 of $1.0 million versus gains in 2011 of $25,000. Non-interest expenses increased 16.9% from the same quarter a year ago, reflecting the additional personnel and other expenses to operate the mortgage banking operation. The Company incurred over $250,000 in non-interest expenses in 2011 and to date in 2012 representing costs associated with the start-up of the mortgage banking unit including the employment expenses of managerial personnel, administrative staff and seasoned mortgage loan originators. As the mortgage unit operations continue to transition from a start-up unit to a growing business unit, CSB Mortgage Company has already made a positive contribution to the first nine months of 2012 on just over $135 million of originations.

For the current quarter, the provision for loan losses was $300,000, substantially exceeding the net charge-offs for the quarter of $21,000. For the same quarter last year, the provision was $324,000, also exceeding net charge-offs for the quarter of $119,000. Provision expense levels are in recognition of loan growth and a changing composition of the loan portfolio as the Company takes aim at managing its balance sheet with a commercially oriented focus.

Certain Non-GAAP Measures

Certain financial information has been determined by methods other than Generally Accepted Accounting Principles (GAAP). Specifically, certain financial measures are based on core earnings rather than net income. Core earnings exclude income, expense, gains and losses that either are not reflective of ongoing operations or that are not expected to reoccur with any regularity or reoccur with a high degree of uncertainty and volatility. Such information may be useful to both investors and management, and can aid them in understanding the Company's current performance trends and financial condition. Core earnings are a supplemental tool for analysis and not a substitute for GAAP net income. Reconciliation from GAAP net income to the non-GAAP measure of core earnings is shown as part of management's discussion and analysis of financial results of operations.

Core earnings (earnings before other-than-temporary-impairment charge and certain other non-recurring items) increased for the nine months ended September 30, 2012 as compared to the comparable 2011 period. Core earnings for the first nine months of 2012 were $3.3 million, or $0.72 per share, compared to $3.2 million, or $0.70 per share for the first nine months of 2011. Core earnings for the quarter ended September 30, 2012 were $1.3 million, or $0.28 per share, compared to $1.0 million, or $0.23 per share.


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The following is reconciliation between core earnings and earnings under GAAP.

(Amounts in thousands, except per share amounts)

                                                       THREE MONTHS ENDED           NINE MONTHS ENDED
                                                         September 30,                September 30,
                                                       2012           2011          2012          2011
GAAP earnings                                       $     1,266      $ 1,054      $   3,377      $ 3,244
Impairment losses on investment securities (net
of tax)                                                      -            -             113          134
Investment gains not in the ordinary course of
business (net of tax)*                                       -            (9 )          (20 )       (220 )
Net impact of historic tax credit investment                 -            -            (190 )         -

Core earnings                                       $     1,266      $ 1,045      $   3,280      $ 3,158

Core earnings per share                             $      0.28      $  0.23      $    0.72      $  0.70

* Gains in 2012 and 2011 are due to the settlement on General Motors Corporation bonds.


           ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

                      CONDITION AND RESULTS OF OPERATIONS



Analysis of Net Interest Income -Nine months ended September 30, 2012 and 2011



                                                                    (Amounts in thousands)
                                                September 30, 2012                         September 30, 2011
                                        Average                     Average        Average                     Average
                                        Balance      Interest        Rate          Balance      Interest        Rate
INTEREST-EARNING ASSETS
Interest-earning deposits and other
earning assets                         $   7,322     $      16          0.29 %    $  14,856     $      45          0.39 %
Investment securities(1)(2)              182,576         4,203          3.07 %      184,877         4,967          3.59 %
Loans(1)(2)(3)                           293,935        12,025          5.45 %      259,344        11,486          5.93 %
. . .
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