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CLDB > SEC Filings for CLDB > Form 10-K on 29-Mar-2013All Recent SEC Filings

Show all filings for CORTLAND BANCORP INC | Request a Trial to NEW EDGAR Online Pro



Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following schedules show average balances of interest-earning and non interest-earning assets and liabilities, and shareholders' equity for the years indicated. Also shown are the related amounts of interest earned or paid and the related average yields or interest rates paid for the years indicated. The averages are based on daily balances.

                                                                                                 (Fully taxable equivalent basis in thousands of dollars)
                                                                           2012                                            2011                                            2010
                                                           Average        Interest                         Average        Interest                         Average        Interest
                                                           Balance         Earned        Yield or          Balance         Earned        Yield or          Balance         Earned        Yield or
                                                         Outstanding       or Paid         Rate          Outstanding       or Paid         Rate          Outstanding       or Paid         Rate
Interest-earning assets:
Interest-earning deposits and other earning assets      $      10,369     $      31           0.29 %    $      12,738     $      51           0.40 %    $      24,898     $      92           0.36 %
Investment securities (Note 1, 2, 3, 4):
U.S. Treasury and other U.S. Government agencies and
corporations                                                   14,609           346           2.37 %           27,590           808           2.93 %           34,610         1,228           3.55 %
U.S. Government mortgage-backed pass through
certificates                                                  108,881         2,414           2.22 %          101,347         3,141           3.10 %           98,657         3,824           3.88 %
States of the U.S. and political subdivisions -
taxable                                                           663            21           3.17 %               -             -            0.00 %               -             -            0.00 %
States of the U.S. and political subdivisions -
nontaxable                                                     39,697         2,118           5.34 %           36,534         2,118           5.80 %           34,687         2,250           6.49 %
Other securities                                               19,664           532           2.70 %           21,401           424           1.98 %           23,592           505           2.14 %

TOTAL INVESTMENT SECURITIES                                   183,514         5,431           2.96 %          186,872         6,491           3.47 %          191,546         7,807           4.08 %
Loans (Note 1, 2, 3, 4)                                       301,034        16,306           5.42 %          261,080        15,314           5.87 %          237,624        14,765           6.21 %

TOTAL INTEREST-EARNING ASSETS                                 494,917     $  21,768           4.40 %          460,690     $  21,856           4.74 %          454,068     $  22,664           4.99 %

Noninterest-earning assets:
Cash and due from banks                                         7,862                                           7,175                                           6,570
Premises and equipment                                          6,524                                           6,612                                           6,918
Other                                                          18,772                                          19,251                                          19,032

TOTAL ASSETS                                            $     528,075                                   $     493,728                                   $     486,588

Interest-bearing liabilities:
Interest-bearing demand deposits                        $      83,129     $     151           0.18 %    $      73,809     $     176           0.24 %    $      69,295     $     256           0.37 %
Savings                                                       107,147           106           0.10 %           94,160           141           0.15 %           89,049           212           0.24 %
Time                                                          156,527         2,441           1.56 %          161,280         2,976           1.85 %          158,578         3,611           2.28 %

TOTAL INTEREST-BEARING DEPOSITS                               346,803         2,698           0.78 %          329,249         3,293           1.00 %          316,922         4,079           1.29 %
Securities sold under agreement to repurchase                   4,559             5           0.11 %            5,236             5           0.10 %            6,924            10           0.14 %
Subordinated debt                                               5,155           100           1.94 %            5,155            92           1.79 %            5,155            93           1.81 %
Other borrowings under one year                                 6,575            79           1.20 %            6,458            95           1.47 %           17,134           847           4.94 %
Other borrowings one year and over                             32,920         1,189           3.61 %           32,040         1,247           3.89 %           34,259         1,338           3.91 %

TOTAL BORROWINGS                                               49,209         1,373           2.79 %           48,889         1,439           2.94 %           63,472         2,288           3.60 %

TOTAL INTEREST-BEARING LIABILITIES                            396,012     $   4,071           1.03 %          378,138     $   4,732           1.25 %          380,394     $   6,367           1.67 %

Non interest-bearing liabilities:
Demand deposits                                                77,534                                          66,312                                          61,320
Other liabilities                                               5,931                                           4,689                                           5,394
Shareholders' equity                                           48,598                                          44,589                                          39,480

TOTAL LIABILITIES AND SHAREHOLDERS EQUITY               $     528,075                                   $     493,728                                   $     486,588

Net interest income                                                       $  17,697                                       $  17,124                                       $  16,297

Net interest rate spread (Note 5)                                                             3.37 %                                          3.49 %                                          3.32 %

Net interest margin (Note 6)                                                                  3.58 %                                          3.72 %                                          3.59 %

Note 1 - Includes both taxable and tax exempt securities and loans.

Note 2 - The amounts are presented on a fully taxable equivalent basis using the
statutory tax rate of 34%, and have been adjusted to reflect the effect of disallowed interest expense related to carrying tax-exempt assets. The tax equivalent income adjustment for loans and investments is $46,000 and $707,000 for 2012, $50,000 and $696,000 for 2011 and $59,000 and $733,000 for 2010, respectively.

Note 3 - Average balance outstanding includes the average amount outstanding of
all non-accrual investment securities and loans. Investment securities consist of average total principal adjusted for amortization of premium and accretion of discount and include both taxable and tax-exempt securities. Loans consist of average total loans, including loans held for sale, less average unearned income.

Note 4 - Interest earned on loans includes net loan fees of $336,000 in 2012,
$295,000 in 2011 and $264,000 in 2010.

Note 5 - Net interest rate spread represents the difference between the yield on
earning assets and the rate paid on interest-bearing liabilities.

Note 6 - Net interest margin is calculated by dividing the net interest income by
total interest-earning assets.

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The following is management's discussion and analysis of the financial condition and results of operations of 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.


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 materials filed or to be filed by the Company with the SEC (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; political actions, including failure of the United States Congress to raise the federal debt ceiling or the imposition of changes in the federal budget; 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; changes in assumptions underlying the establishment of reserves for possible loan losses, reserves for repurchase of mortgage loans sold and other estimates; changes in operations of CSB Mortgage Company as a result of the activity in the residential real estate market; and 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.


The discussion and analysis of the Company's financial condition and results of operation are based upon the Consolidated Financial Statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the Company's consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Certain accounting policies involve significant judgments and assumptions by management which has a material impact on the carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The judgments and assumptions used by management are based on historical experience and other factors, which are believed to be reasonable under the circumstances.

Management believes the following are critical accounting policies that require the most significant judgments and estimates used in the preparation of the Company's consolidated financial statements.

Accounting for the Allowance for Loan Losses

The determination of the allowance for loan losses and the resulting amount of the provision for loan losses charged to operations reflects management's current judgment about the credit quality of the loan portfolio and takes into consideration changes in lending policies and procedures, changes in economic and business conditions, changes in the nature and volume of the portfolio and, in the terms of loans, changes in the experience, ability and depth of lending management, changes in the volume and severity of past due, non-accrual and adversely classified or graded loans, changes in the quality of the loan review system, changes in the value of underlying collateral for collateral-dependent loans, the existence and effect of any concentrations of credit and the effect of competition, legal and regulatory requirements and other external factors. The nature of the process by which we determine the appropriate allowance for loan losses requires the exercise of considerable judgment. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the performance of the loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. The allowance is increased by the provision for loan losses and decreased by charge-offs when management believes the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. A weakening of the economy or other factors that adversely affect asset quality could result in an increase in the number of delinquencies, bankruptcies or defaults and a higher level of non-performing assets, net charge offs, and provision for loan losses in future periods.

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The Company's allowance for loan losses methodology consists of three elements:
(i) specific valuation allowances based on probable losses on specific loans;
(ii) valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends; and (iii) general valuation allowances based on general economic conditions and other qualitative risk factors both internal and external to the Company. These elements support the basis for determining allocations between the various loan categories and the overall adequacy of our allowance to provide for probable losses inherent in the loan portfolio.

With these methodologies, a general allowance is established for each loan type based on historical losses for each loan type in the portfolio. Additionally, management allocates a specific allowance for "Impaired Credits," which is based on current information and events, it is probable the Company will not collect all amounts due according to the original contractual terms of the loan agreement. The level of the general allowance is established to provide coverage for management's estimate of the credit risk in the loan portfolio by various loan segments not covered by the specific allowance. Additional information regarding allowance for credit losses can be found in Item 8, Note 3 to the Consolidated Financial Statements and in this Management's Discussion and Analysis.

Investment Securities and Impairment

The classification and accounting for investment securities is discussed in detail in Item 8, Notes 1 and 2 to the Consolidated Financial Statements. Investment securities must be classified as held-to-maturity, available-for-sale, or trading. The appropriate classification is based partially on the Company's ability to hold the securities to maturity and largely on management's intentions, if any, with respect to either holding or selling the securities. The classification of investment securities is significant since it directly impacts the accounting for unrealized gains and losses on securities. Unrealized gains and losses on trading securities, if any, flow directly through earnings during the periods in which they arise, whereas available-for-sale securities are recorded as a separate component of shareholders' equity (accumulated other comprehensive income or loss) and do not affect earnings until realized. The fair values of the Company's investment securities are generally determined by reference to quoted market prices and reliable independent sources. At each reporting date, the Company assesses whether there is an "other-than-temporary" impairment to the Company's investment securities. Such impairment must be recognized in current earnings rather than in other comprehensive income (loss).

The Company reviews investment debt securities on an ongoing basis for the presence of other-than-temporary impairment (OTTI) with formal reviews performed quarterly. OTTI losses on individual investment securities were recognized during 2012 and 2011 in accordance with FASB ASC topic 320, Investments - Debt and Equity Securities. The purpose of this ASC is to provide greater clarity to investors about the credit and noncredit component of an OTTI event and to communicate more effectively when an OTTI event has occurred. This ASC amends the OTTI guidance in GAAP for debt securities, improves the presentation and disclosure of OTTI on investment securities and changes the calculation of the OTTI recognized in earnings in the financial statements. This ASC does not amend existing recognition and measurement guidance related to OTTI of equity securities.

For debt securities, ASC topic 320 requires an entity to assess whether it has the intent to sell the debt security or it is more-likely-than-not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an OTTI on the security must be recognized.

In instances in which a determination is made that a credit loss (defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more-likely-than-not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost basis (i.e., the amortized cost basis less any current-period credit loss), ASC topic 320 changes the presentation and amount of the OTTI recognized in the income statement.

In these instances, the impairment is separated into the amount of the total impairment related to the credit loss and the amount of the total impairment related to all other factors. The amount of the total OTTI related to the credit loss is recognized in earnings. The amount of the total impairment related to all other factors is recognized in other comprehensive income (loss). The total OTTI is presented in the income statement with an offset for the amount of the total OTTI that is recognized in other comprehensive income (loss). In determining the amount of impairment related to credit loss, the Company uses a third party discounted cash flow model, several inputs for which require estimation and judgment. Among these inputs are projected deferral and default rates and estimated recovery rates. Realization of events different than that projected could result in a large variance in the values of the securities.

Additional information regarding investment securities can be found in Item 8, Notes 2 and 11 to the Consolidated Financial Statements and further more in this Management's Discussion and Analysis.

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Income Taxes

The provision for income taxes is based on income reported for financial statement purposes and differs from the amount of taxes currently payable, since certain income and expense items are reported for financial statement purposes in different periods than those for tax reporting purposes. Taxes are discussed in more detail in Item 8, Note 10 to the Consolidated Financial Statements. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, the Company assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and regulatory guidance in the context of our tax position.

The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax assets and liabilities for the temporary differences between the financial reporting basis and tax basis of our assets and liabilities at enacted tax rates expected to be in effect when such amounts are realized or settled. We conduct periodic assessments of deferred tax assets to determine if it is more-likely-than-not that they will be realized. In making these assessments, we consider taxable income in prior periods, projected future taxable income, potential tax planning strategies and projected future reversals of deferred tax items. These assessments involve a certain degree of subjectivity which may change significantly depending on the related circumstances.


The Company is a bank holding company headquartered in Cortland, Ohio whose principle activity is to manage, supervise and otherwise serve as a source of strength to the Bank.

Cortland Banks, with total assets of approximately $582.2 million at December 31, 2012, is a state chartered bank engaged in commercial and retail banking services. The Bank offers a full range of financial services to its local communities with an ongoing strategic focus on commercial banking relationships.

CSB is a wholly-owned subsidiary of Cortland Banks, and functions as the originator of wholesale mortgage loans and the seller of company-wide mortgage loans in the secondary mortgage market. Historically, the mortgage banking business is both cyclical and seasonal. The cyclical nature of its business is influenced by, among other things, the levels of and trends in mortgage interest rates, national and local economic conditions and consumer confidence in the economy. Nationally, the mortgage banking industry reports the lowest levels of quarterly loan closings during the first quarter of the year, and management expects that seasonality to characterize the operations of CSB.

Residential mortgage loans closed by the Bank and CSB are underwritten in accordance with guidelines established by government-sponsored entities.

The Bank's results of operations depend primarily on net interest income, which, in part, is a direct result of the market interest rate environment. Net interest income is the difference between the interest income earned on interest-earning assets and the interest paid on interest-bearing liabilities. Net interest income is affected by the shape of the market yield curve, the repricing of interest-earning assets and interest-bearing liabilities and the prepayment rate of mortgage-related assets. Results of operations may be affected significantly by general and local economic conditions, particularly those with respect to changes in market interest rates, credit quality, governmental policies and actions of regulatory authority.


Net income for 2012 was $2.9 million, or $0.64 per share, representing a decrease of $0.26 from the $0.90 per share in 2011.

Amid more rigorous regulatory standards and an uncertain economy, the Company continues to follow its core strategic direction. Operating results reflect its commitment to growing loans and deposits in the markets in which it operates and in producing consistent positive earnings.

The Company's financial results for 2012 were affected by these notable specific factors:

Core earnings for the year, which exclude non-recurring items such as impairment loss and gain on securities sales, were $2.8 million compared to $4.0 million for 2011, a decrease of 29.2%, mainly attributed to an increase in provision for loan losses.

The Company's recognition of pre-tax OTTI losses on investment securities fell in 2012 to $171,000 versus $202,000 in 2011.

Net interest margin for the full year 2012 was 3.58%, or 14 basis points lower than the 3.72% in 2011. The Company continues to optimally manage its balance sheet in this historically low interest rate environment.

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Despite less than favorable economic conditions over the past several years, the Company has been able to grow its loan portfolio without experiencing any substantive deterioration in credit quality. Nonaccrual loans declined to $3.0 million at December 31, 2012, or 0.94% of loans, versus $3.6 million, or 1.23% of loans at December 31, 2011 and the Company's allowance for loan losses covers 128.7% of nonaccrual loans at December 31, 2012. Annual net loan charge-offs were 0.78% of average loans in 2012 and 0.24% for 2011. The allowance for loan loss to total loans ratio was 1.21% at December 31, 2012 versus 1.06% a year ago.

In 2012, the provision for loan losses was $3.0 million with charge-offs of $2.3 million, while 2011 was $1.2 million with charge-offs of $639,000. A $1.9 million charge-off on one commercial loan caused the increased provision in 2012. Loans considered as potential problem loans decreased from $8.9 million at December 31, 2011 to $2.7 million at December 31, 2012.

Total loans at December 31, 2012 were $317.3 million, compared to $289.1 million a year ago, a 9.7% increase. Total assets of $582.2 million at December 31, 2012 reflect an increase of 12.0% from year ago asset totals of $519.8 million with loans providing the core growth. Cumulative loan growth since December 2010 is 19.6%, while cumulative asset growth during the same period reflects a 16.4% increase.

The Company continued to increase its capital levels during 2012. With capital as the ultimate cushion to absorb any unforeseen negative consequences of the struggling economy, capital levels for banks across the industry have been under the watchful eye of the regulators. The Company's total shareholders' equity increased from $45.7 million at December 31, 2011 to $49.5 million at December 31, 2012, an increase of $3.8 million, or 8.2%. The Company continues to remain well capitalized under all regulatory measures. The Company's regulatory capital ratios exceed the statutory well-capitalized thresholds by a comfortable margin. In the current regulatory environment, regulatory oversight bodies expect banks to maintain ratios above the statutory levels as a margin of safety. The calculated ratios are as follows for the year ended December 31, 2012: a Tier 1 leverage ratio of 10.24% (compared to a "well-capitalized" threshold of 5.0%); a Tier 1 risk-based capital ratio of 13.15% (compared to a "well-capitalized" threshold of 6.00%); and a total risk-based capital ratio of 14.10% (compared to a "well-capitalized" threshold of 10.00%). The Company's total risk-based capital is $16.8 million in excess of the 10% well-capitalized threshold.

In the midst of earnings pressures brought on by the economic downturn, interest rate compression and investment impairment issues, the Company devoted substantial attention in 2011 and 2012 to profit improvement measures, balance sheet restructuring and a reorganization of its management structure. The Company's management team continues to focus on measures designed to enhance capital and to provide for adequate liquidity for lending and business . . .

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