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CLDB > SEC Filings for CLDB > Form 10-Q on 15-May-2013All Recent SEC Filings

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

Form 10-Q for CORTLAND BANCORP INC


15-May-2013

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 quarterly 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; 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 (CSB) 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.

Analysis of Assets and Liabilities for the First Three Months

Earning assets are comprised of investment securities, loans and deposits at financial institutions, including the Federal Reserve Bank. Earning assets were $512.1 million at March 31, 2013, an increase of 8.7% from the March 31, 2012 balance of $471.0 million, and a decrease of 4.4% from the December 31, 2012 balance of $535.7 million. The decrease from December 31 was the net result of the following: an increase in deposits at the Federal Reserve of $13.7 million, a decrease in investment securities of $8.6 million, $20.7 million of 60-day loans redeemed prior to March 31, 2013, and a $8.1 million decrease in loans held for sale as a result of CSB Mortgage Company activity. Total assets of $546.5 million at March 31, 2013 reflect an increase of 7.5% from the one year ago asset total of $508.5 million and a decrease of 6.1% from December 31, 2012 asset total of $582.2 million.

Total cash and cash equivalents increased by $1.7 million from year-end and increased by $16.3 million from the balance at March 31, 2012.

At March 31, 2013, the investment securities portfolio was $176.0 million, compared to $184.6 million at December 31, 2012, a decrease of $8.6 million, or 4.7%. Investment securities decreased $6.7 million compared to March 31, 2012, a decrease of 3.7%. Investment securities represented 34.4% of earning assets at March 31, 2013, compared to 38.8% at March 31, 2012 and 34.5% at December 31, 2012. The decrease from one year ago is partially due to the sale of $3.5 million in trust preferred securities in September 2012. As the Company manages its balance sheet for loan growth, asset mix, liquidity and 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 at March 31, 2013, down from 44.7 % a year ago and up from 38.7% of year-end levels.

The investment securities available-for-sale portfolio had net unrealized losses of $2.0 million at March 31, 2013, a decrease of $910,000 compared to net unrealized losses of $2.9 million at March 31, 2012, and a decrease of $605,000 compared to net unrealized losses of $2.6 million at December 31, 2012.
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, $171,000 in 2012 and none recorded in the first quarter of 2013. 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.

Loans held for sale decreased to $16.6 million at March 31, 2013 compared to $24.8 million at December 31, 2012 and an increase from $6.8 million at March 31, 2012. The variance is in line with expected results from the newly formed wholesale banking unit, which originated over $100 million of mortgage loans during the quarter ended March 31, 2013.

Total loans at March 31, 2013 were $297.5 million compared to $277.4 million a year ago, a 7.2% increase, and $317.3 million at December 31, 2012, a 6.2% decrease. The Company continues its objective of shifting its asset mix into in-market commercial loans with the intent of improving net interest margin.

Total loans net of the allowance for losses increased by $19.4 million during the twelve month period from March 31, 2012 to March 31, 2013, and decreased by $19.9 million from December 31, 2012. Total gross loans as a percentage of earning assets stood at 58.1% as of March 31, 2013, 58.9% at March 31, 2012 and 59.2% as of December 31, 2012. The total loan-to-deposit ratio was 67.5% at March 31, 2013, 67.8% at March 31, 2012 and 66.5% at December 31, 2012. The decrease in loans from year-end was, as stated previously, due in part to 60-day term commercial loans for a total of $20.7 million that closed in December 2012 and were fully secured by segregated deposit accounts with the Bank. The loans matured in the first quarter of 2013.

At March 31, 2013, the loan loss allowance of $3.9 million represented approximately1.31% of outstanding loans, and at March 31, 2012 the loan loss allowance of $3.1 million represented approximately 1.13% of outstanding loans.
The loan loss allowance at December 31, 2012 of $3.8 million represented approximately 1.21% of outstanding loans, or 1.29% excluding the 60-day term loans to which none of the allowance is allocated.

During the first three months, loan charge-offs were $176,000 in 2013 compared to $214,000 for the same period in 2012, while the recovery of previously charged-off loans amounted to $42,000 in 2013 and $25,000 in 2012. The net charge-offs represent 0.17% of average loans for 2013 and 0.27% for the same period in 2012. 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.

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. Loans accounted for on a non-accrual basis remained relatively stable from $3.0 million at December 31, 2012 and $2.6 million at March 31, 2012 to $2.8 million at the recent quarter ended March 31, 2013. Non-accrual loans at March 31, 2013 and March 31, 2012 represent 0.93% of the loan portfolio compared to 0.94% at December 31, 2012. The allowance for loan losses covers 140.27% of nonaccrual loans at March 31, 2013.

Bank-owned life insurance had a cash surrender value of $14.1 million at March 31, 2013, $14.0 million at December 31, 2012 and $13.7 million at March 31, 2012. Other assets decreased slightly to $10.3 million at March 31, 2013 from $11.2 million at December 31, 2012 and from $11.6 million at March 31, 2012. 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, or on June 30, 2013 any remaining balance will be returned. The balance is $1.1 million at March 31, 2013, $1.2 million at December 31, 2012 and $1.4 million at March 31, 2012. Other real estate increased to $324,000 at March 31, 2013 compared to $145,000 at December 31, 2012 and decreased from $359,000 at March 31, 2012. Also included in other assets is deferred taxes of $4.4 million, $5.0 million and $6.5 million for the periods ended March 31, 2013, December 31, 2012 and March 31, 2012, respectively, and Federal income tax receivable of $1.0 million, $1.9 million and $470,000 for the periods ended March 31, 2013, December 31, 2012 and March 31, 2012, respectively.

Noninterest-bearing deposits measured $82.4 million at March 31, 2013 compared to $91.7 million at December 31, 2012 and $73.7 million at March 31, 2012. Interest-bearing deposits decreased $26.6 million to $358.6 million at March 31, 2013 from $385.2 million at December 31, 2012 and increased $23.3 million from $335.3 million at March 31, 2012. The decrease in interest-bearing deposits from year end is due mainly to segregated money market deposit accounts with the Bank which fully collateralized $20.7 million in 60-day term commercial loans that closed in December 2012. The loans matured and the deposits withdrew the first quarter of 2013.


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Federal Home Loan Bank advances and short-term borrowings stayed consistent at $45.0 million at March 31, 2013 from $46.1 million at December 31, 2012 and from $42.2 million at March 31, 2012. 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 $4.7 million at March 31, 2013 and December 31, 2012 and measured $4.4 million at March 31, 2012. The increase from March 31, 2012 is due to derivative valuations related to the mortgage banking subsidiary.
These valuations measured $634,000, $630,000 and $45,000 for the periods ended March 31, 2013, December 31, 2012 and March 31, 2012 respectively.

The Company continued to increase its capital levels in the first quarter of 2013. The Company's total shareholders' equity increased from $47.6 million at March 31, 2012 and $49.5 million on December 31, 2012 to $50.6 million at March 31, 2013, an increase of $3.0 million and $1.1 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 $19.8 million in excess of the 10% threshold for the Company to be well-capitalized.

In October 2012, the Company announced the reinstatement of a cash dividend reflecting the growing confidence supported by stable core earnings, increasing loan production, and restored capital levels. A dividend of $.03 per share was paid to shareholders of record on February 14, 2013, and another declared on April 30, 2013 for $0.03 per share.

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 the decline in the value of the Bank's trust preferred securities, the regulatory capital levels of the Bank have declined. 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 $54.1 million, well above the $13.9 million in amortized cost of these securities as of March 31, 2013, thereby significantly diluting the risk-based capital ratios by approximately 1.67% for March 31, 2013 compared to 1.58% for December 31, 2012.

Regardless of the trust preferred securities risk weighting, the Company met all capital adequacy requirements to which it was subject as of March 31, 2013 and December 31, 2012, 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           Regulatory Capital Ratio
                                  Capital Ratios as of:               Requirements:

                                  March        December                          Adequately
                                 31, 2013      31, 2012      Well Capitalized    Capitalized

Tier I capital to risk-weighted
assets                             13.96%          13.15%               6.00%          4.00%
Total risk-based capital to
risk-weighted assets               14.95%          14.10%              10.00%          8.00%
Tier I capital to average assets    9.99%           9.63%               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 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 March 31, 2013 and December 31, 2012. Management considers these excesses to be adequate with regard to the risks inherent in the balance sheet.

                                               (Amounts in thousands)
                                             March 31,     December 31,
                                                2013           2012


           Tier 1 Capital                      $ 55,837        $ 53,996
           Tier 2 Capital                         3,975           3,909

           QUALIFYING CAPITAL                  $ 59,812        $ 57,905

           Risk-Adjusted Total Assets (*)     $ 400,082       $ 410,773
           Tier 1 Risk- Based Capital Excess   $ 31,832        $ 29,350
           Total Risk- Based Capital Excess      19,804          16,828
           Total Leverage Capital Excess         27,893          25,966


(*)  Includes off-balance sheet exposures

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 $558.9 million for the three months ended March 31, 2013 and $560.6 million for the year ended December 31, 2012.

Regulations require that investments designated as available-for-sale are marked-to-market with corresponding entries to the deferred tax account 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.

For the current quarter, the provision for loan losses was $200,000, substantially exceeding the net charge-offs for the quarter of $134,000. For the same quarter last year, the provision was $270,000, also exceeding net charge-offs for the quarter of $189,000. 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


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

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 referenced as part of management's discussion and analysis of financial condition and results of operations.

Core earnings, which exclude the OTTI charge and certain other non-recurring items, decreased for the three months ended March 31, 2013 as compared to the three months ended March 31, 2012. Core earnings for the first three months of 2013 were $876,000, or $0.19 per share, compared to $1.1 million, or $0.24 per share for the first three months of 2012.

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

(Amounts in thousands, except per share amounts)

                                                            THREE MONTHS ENDED
                                                                 March 31,

                                                            2013         2012

   GAAP earnings                                             $ 830      $ 1,159
   Impairment losses on investment securities (net of tax)      -           113
   Expenses related to reorganization-net                       46           -
   Net impact of historic tax credit investment                 -          (190)

   Core earnings                                             $ 876      $ 1,082

   Core earnings per share                                  $ 0.19       $ 0.24

Analysis of Net Interest Income - Three months ended March 31, 2013 and 2012

                                                           (Amounts in thousands)
                                         March 31, 2013                             March 31, 2012

                              Average                                    Average
                              Balance      Interest     Average Rate     Balance      Interest     Average Rate

INTEREST-EARNING ASSETS
Interest-earning deposits            $                                          $
and other earning assets      11,006           $ 6             0.19%      4,847           $ 5             0.38%
Investment securities(1)(2)  185,126         1,130             2.45%    187,235         1,505             3.22%
Loans(1)(2)(3)               331,514         4,069             4.94%    286,715         3,979             5.56%

Total interest-earning               $                                          $
assets                       527,646       $ 5,205             3.97%    478,797       $ 5,489             4.59%

INTEREST-BEARING LIABILITIES
Interest-bearing demand and          $                                          $
money market deposits         96,972          $ 51             0.22%     82,365          $ 34             0.16%
Savings                      121,437            23             0.08%    100,057            25             0.10%
Time                         148,433           509             1.39%    157,560           661             1.68%

Total interest-bearing
deposits                     366,842           583             0.64%    339,982           720             0.85%
Other borrowings              47,727           305             2.59%     43,625           318             2.93%
Subordinated debt              5,155            23             1.75%      5,155            26             1.97%

Total interest-bearing               $                                          $
liabilities                  419,724         $ 911             0.88%    388,762       $ 1,064             1.10%

Net interest income                        $ 4,294                                    $ 4,425

Net interest rate spread(4)                                    3.09%                                      3.49%

Net interest margin(5)                                         3.27%                                      3.67%

(1) Includes both taxable and tax exempt securities and loans.

(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 $10,000 and $150,000 for 2013 and $12,000 and $172,000 for 2012, respectively.

(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 deferred fees and costs.

(4) Net interest rate spread represents the difference between the yield on earning assets and the rate paid on interest-bearing liabilities.

(5) Net interest margin is calculated by dividing the net interest income by total interest-earning assets.


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Net interest income, the principal source of the Company's earnings, is the amount by which interest and fees generated by interest-earning assets, primarily loans and investment securities, exceeds the interest cost of deposits and borrowed funds. On a fully taxable equivalent basis, net interest income measured $4.3 million at March 31, 2013 and $4.4 million at March 31, 2012.
During the recent reporting period the net interest margin registered 3.27% at March 31, 2013 and 3.67% at March 31, 2012.

The decrease in interest income, on a fully taxable equivalent basis, of $284,000 is the product of a 62 basis point decrease in interest rates earned offset somewhat by a 10.2% year-over-year increase in average earning assets. The decrease in interest expense of $153,000 was a product of a 22 basis point decrease in rates paid and a 8.0% increase in interest-bearing liabilities. The net result was a 3.0% decrease in net interest income on a fully taxable equivalent basis, and a 40 basis point decrease in the Company's net interest margin on a slightly larger asset base with a different mix.

On a fully taxable equivalent basis, income on investment securities decreased by $375,000, or 24.9%. The average invested balances in securities decreased by $2.1 million, or 1.1%, from the levels of a year ago. The decrease in the average balance of investment securities was accompanied by a 77 basis point decrease in the tax equivalent yield of the portfolio. The Company will continue attempting to redeploy liquidity into loans. Any reinvestment into the securities portfolio will serve to decrease the yield due to the current low rate environment.

On a fully taxable equivalent basis, income on loans increased by $90,000, or . . .

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