CORTLAND BANCORP INC - 10-Q Quarterly Report

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes x No o

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


Item 1.	Financial Statements (Unaudited)

	Cortland Bancorp and Subsidiaries:

	Consolidated Balance Sheets — September 30, 2003 and December 31, 2002	2

	Consolidated Statements of Income — Nine months ended September 30, 2003 and 2002	3

	Consolidated Statement of Shareholders’ Equity — Nine months ended September 30, 2003	4

	Consolidated Statements of Cash Flows — Nine months ended September 30, 2003 and 2002	5

	Notes to Consolidated Financial Statements September 30, 2003	6-17

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	18-24

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	25-26

Item 4.	Controls and Procedures	27

	PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	28

Item 2.	Changes in Securities and Use of Proceeds	28

Item 3.	Defaults Upon Senior Securities	28

Item 4.	Submission of Matters to a Vote of Security Holders	28

Item 5.	Other Information	28

Item 6.	Exhibits and Reports on Form 8-K	28-29

Signatures		30

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(Amounts in thousands, except share data)


				SEPTEMBER 30,			DECEMBER 31,
				2003			2002

ASSETS
Cash and due from banks				$	10,861		$	12,571
Federal funds sold					5,600			20,000

		Total cash and cash equivalents			16,461			32,571
Investment securities available for sale (Note 2)					115,582			115,795
Investment securities held to maturity (approximate market value of $100,728 in 2003 and $85,957 in 2002) (Note 2)					99,135			84,108
Total loans (Note 4)					189,878			191,477
		Less allowance for loan losses (Note 4)			(2,976	)		(3,134	)

		Net loans			186,902			188,343

Premises and equipment					5,029			5,277
Other assets					14,495			11,504

			Total assets	$	437,604		$	437,598

LIABILITIES
Noninterest-bearing deposits				$	56,180		$	55,745
Interest-bearing deposits (Note 6)					280,647			280,013

	Total deposits				336,827			335,758

Federal Home Loan Bank advances and other borrowings					45,530			46,669
Other liabilities					3,644			3,132

			Total liabilities		386,001			385,559

Commitments and contingent liabilities (Notes 8 & 16)
SHAREHOLDERS’ EQUITY
Common stock — $5.00 stated value — authorized 20,000,000 shares; issued 4,123,437 shares in 2003 and in 2002 (Note 1)					20,617			20,617
Additional paid-in capital (Note 1)					13,502			13,323
Retained earnings					19,325			17,810
Accumulated other comprehensive income (loss) (Note 1)					2,436			3,165
Treasury shares at cost, 171,158 in 2003 and 131,544 in 2002					(4,277	)		(2,876	)

			Total shareholders’ equity (Notes 15 and 17)		51,603			52,039

			Total liabilities and shareholders’ equity	$	437,604		$	437,598

See accompanying notes to consolidated financial statements
of Cortland Bancorp and Subsidiaries

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(Amounts in thousands, except per share data)


					THREE				NINE
					MONTHS ENDED				MONTHS ENDED
					SEPTEMBER 30,				SEPTEMBER 30,

					2003		2002		2003		2002

INTEREST INCOME
	Interest and fees on loans				$	3,217	$	3,832	$	9,916	$	11,780
	Interest and dividends on investment securities:
		Taxable interest income				777		865		2,214		2,510
		Nontaxable interest income				589		620		1,856		1,841
		Dividends				31		41		96		130
	Interest on mortgage-backed securities					939		1,319		3,047		4,087
	Interest on trading account securities					34				58
	Other interest income					15		58		111		158

			Total interest income			5,602		6,735		17,298		20,506

INTEREST EXPENSE
	Deposits					1,424		1,847		4,394		5,851
	Borrowed funds					593		614		1,761		1,859

			Total interest expense			2,017		2,461		6,155		7,710

				Net interest income		3,585		4,274		11,143		12,796
				Provision for loan losses		60		160		160		335

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES						3,525		4,114		10,983		12,461

OTHER INCOME
	Fees for other customer services					414		369		1,108		1,021
	Investment securities gains — net					203		40		687		214
	Trading securities gains — net					48				173
	Gain on sale of loans — net					147		70		449		144
	Other non-interest income					138		367		384		685

				Total other income		950		846		2,801		2,064

OTHER EXPENSES
	Salaries and employee benefits					1,625		1,618		4,906		4,843
	Net occupancy and equipment expense					503		526		1,485		1,563
	State and local taxes					133		130		398		389
	Office supplies					83		88		253		274
	Marketing expense					30		47		124		133
	Other operating expenses					461		428		1,423		1,346

				Total other expenses		2,835		2,837		8,589		8,548

INCOME BEFORE FEDERAL INCOME TAXES						1,640		2,123		5,195		5,977
Federal income taxes						323		491		1,051		1,364

NET INCOME					$	1,317	$	1,632	$	4,144	$	4,613

BASIC EARNINGS PER COMMON SHARE (NOTE 6)					$	0.33	$	0.40	$	1.04	$	1.14

DILUTED EARNINGS PER COMMON SHARE (NOTE 6)					$	0.33	$	0.40	$	1.04	$	1.14

See accompanying notes to consolidated financial statements
of Cortland Bancorp and Subsidiaries

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)


											ACCUMULATED						TOTAL
						ADDITIONAL					OTHER						SHARE-
				COMMON		PAID-IN		RETAINED			COMPREHENSIVE			TREASURY			HOLDERS'
				STOCK		CAPITAL		EARNINGS			INCOME			STOCK			EQUITY

BALANCE AT JANUARY 1, 2003				$	20,617	$	13,323	$	17,810		$	3,165			($2,876	)	$	52,039
Comprehensive income:
	Net income								4,144									4,144
	Other comprehensive income, net of tax:
			Unrealized gains or (losses) on available- for-sale securities, net of reclassification adjustment									(729	)					(729	)

Total comprehensive income																		3,415

Common stock transactions:
		Shares sold
		Treasury shares reissued					179								875			1,054
		Treasury shares purchased													(2,276	)		(2,276	)
		Cash dividends declared							(2,629	)								(2,629	)

BALANCE AT SEPTEMBER 30, 2003				$	20,617	$	13,502	$	19,325		$	2,436			($4,277	)	$	51,603

DISCLOSURE OF RECLASSIFICATION FOR AVAILABLE FOR SALE SECURITY GAINS AND LOSSES:
Net unrealized holding gains or (losses) on available-for-sale securities arising during the period, net of tax												($276	)
Less: Reclassification adjustment for net gains realized in net income, net of tax												453

Net unrealized gains or (losses) on available- for-sale securities, net of tax												($729	)

See accompanying notes to consolidated financial statements
of Cortland Bancorp and Subsidiaries

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Amounts in thousands)


		FOR THE
		NINE MONTHS ENDED
		SEPTEMBER 30,

		2003			2002

NET CASH FLOWS FROM OPERATING ACTIVITIES		$	5,179		$	5,703
CASH FLOWS FROM INVESTING ACTIVITIES
	Purchases of securities held to maturity		(51,359	)		(43,153	)
	Purchases of securities available for sale		(43,760	)		(22,783	)
	Proceeds from sales of securities available for sale		6,911			1,305
	Proceeds from call, maturity and principal payments on securities		71,773			57,718
	Net (increase) decrease in loans made to customers*		(638	)		7,101
	Proceeds from disposition of other real estate		21			167
	Purchase of premises and equipment		(316	)		(370	)

	Net cash flows from investing activities		(17,368	)		(15	)

CASH FLOWS FROM FINANCING ACTIVITIES
	Net increase (decrease) in deposit accounts		1,069			(702	)
	Net decrease in borrowings		(1,139	)		(1,755	)
	Dividends paid		(2,629	)		(2,583	)
	Purchase of treasury stock		(2,276	)		(1,907	)
	Treasury shares reissued		1,054			936

	Net cash flows from financing activities		(3,921	)		(6,011	)

	NET CHANGE IN CASH AND CASH EQUIVALENTS		(16,110	)		(323	)

CASH AND CASH EQUIVALENTS
	Beginning of period		32,571			26,720

	End of period	$	16,461		$	26,397

SUPPLEMENTAL DISCLOSURES
	Interest paid	$	6,127		$	7,782
	Income taxes paid	$	1,070		$	1,375
	Loans held for sale	$	103		$	1,412

*Excludes the change in loans held for sale, which is included in the net cash flows from operating activities. Loans held for sale at December 31, 2002 were $2,022.

See accompanying notes to consolidated financial statements
of Cortland Bancorp and Subsidiaries
5

The accompanying unaudited consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the nine months ended September 30, 2003 are not necessarily indicative of the results that may be expected for the year ending December 31, 2003. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, 2002.

Certain items contained in the 2002 financial statements have been reclassified to conform to the presentation for 2003. Such reclassifications had no effect on the net results of operations.

Securities classified as held to maturity are those that management has the positive intent and ability to hold to maturity. Securities held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts, with such amortization or accretion included in interest income.

Securities classified as available for sale are those that could be sold for liquidity, investment management, or similar reasons even though management has no present intentions to do so. Securities available for sale are carried at fair value using the specific identification method. Changes in the unrealized gains and losses on available for sale securities are recorded net of tax effect as a component of comprehensive income.

Trading securities are principally held with the intention of selling in the near term. Trading securities are carried at fair value with changes in fair value reported in the Consolidated Statements of Income.

Realized gains or losses on dispositions are based on net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. The table below sets forth the proceeds, gains and losses realized on securities sold or called for the period ended:

Securities available for sale, carried at fair value, totaled $115,582 at September 30, 2003 and $115,795 at December 31, 2002 representing 53.8% and 57.9%, respectively, of all investment securities. These levels provide an adequate level of liquidity in management’s opinion.

Investment securities with a carrying value of approximately $48,405 at September 30, 2003 and $38,126 at December 31, 2002 were pledged to secure deposits and for other purposes.

The amortized cost and estimated market value of debt securities at September 30, 2003, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The amortized cost and estimated fair value of investment securities available for sale and investment securities held to maturity as of September 30, 2003, are as follows:


				GROSS		GROSS		ESTIMATED
		AMORTIZED		UNREALIZED		UNREALIZED		FAIR
Investment securities available for sale		COST		GAINS		LOSSES		VALUE

U.S. Treasury Securities		$	4,910	$	411	$		$	5,321
U.S. Government agencies and corporations			24,304		817		16		25,105
Obligations of states and political subdivisions			18,587		881		16		19,452
Mortgage-backed and related securities			52,275		1,353		155		53,473
Corporate securities			8,702		300		20		8,982

	Total debt securities		108,778		3,762		207		112,333
Marketable equity securities			28		131				159
Other securities			3,090						3,090

	Total available for sale	$	111,896	$	3,893	$	207	$	115,582


				GROSS		GROSS		ESTIMATED
		AMORTIZED		UNREALIZED		UNREALIZED		FAIR
Investment securities held to maturity		COST		GAINS		LOSSES		VALUE

U.S. Treasury Securities		$	157	$	7	$		$	164
U.S. Government agencies and corporations			27,274		394		36		27,632
Obligations of states and political subdivisions			32,439		1,483		80		33,842
Mortgage-backed and related securities			39,265		123		298		39,090

	Total held to maturity	$	99,135	$	2,007	$	414	$	100,728

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following provides a summary of the amortized cost and estimated fair value of investment securities available for sale and investment securities held to maturity as of December 31, 2002:


				GROSS		GROSS		ESTIMATED
		AMORTIZED		UNREALIZED		UNREALIZED		FAIR
Investment securities available for sale		COST		GAINS		LOSSES		VALUE

U.S. Treasury Securities		$	5,093	$	592	$		$	5,685
U.S. Government agencies and corporations			25,585		1,150		1		26,734
Obligations of states and political subdivisions			22,032		723		17		22,738
Mortgage-backed and related securities			55,261		2,256		26		57,491

	Total debt securities		107,971		4,721		44		112,648
Marketable equity securities			28		113				141
Other securities			3,006						3,006

	Total available for sale	$	111,005	$	4,834	$	44	$	115,795


				GROSS		GROSS		ESTIMATED
		AMORTIZED		UNREALIZED		UNREALIZED		FAIR
Investment securities held to maturity		COST		GAINS		LOSSES		VALUE

U.S. Government agencies and corporations		$	22,190	$	645	$		$	22,835
Obligations of states and political subdivisions			31,517		1,078		81		32,514
Mortgage-backed and related securities			30,401		237		30		30,608

	Total held to maturity	$	84,108	$	1,960	$	111	$	85,957

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The Company currently does not enter into derivative financial instruments including futures, forwards, interest rate risk swaps, option contracts, or other financial instruments with similar characteristics. The Company also does not participate in any partnerships or other special purpose entities that might give rise to off-balance sheet liabilities.

The Company is 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, standby letters of credit, and financial guarantees. Such instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

In the event of nonperformance by the other party, the Company’s exposure to credit loss on these financial instruments is represented by the contract or notional amount of the instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for instruments recorded on the balance sheet. The amount and nature of collateral obtained, if any, is based on management’s credit evaluation.

Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Generally these financial arrangements have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

The Company, through its subsidiary bank, grants residential, consumer and commercial loans, and also offers a variety of saving plans to customers located primarily in Northeast Ohio and Western Pennsylvania. The following represents the composition of the loan portfolio:

There are $103 in mortgage loans held for sale included in 1-4 family residential mortgages as of September 30, 2003, and $2,022 at December 31, 2002. These loans are carried, in the aggregate, at the lower of cost or estimated market value based on secondary market prices.

The following table sets forth the aggregate balance of underperforming loans for each of the following categories at September 30, 2003 and December 31, 2002:

The following shows the amounts of contractual interest income and interest income actually reflected in income on loans accounted for on a nonaccrual basis and loans considered troubled debt restructuring for the nine months ended September 30, 2003 and 2002.

A loan is placed on a nonaccrual basis whenever sufficient information is received to question the collectibility of the loan or any time legal proceedings are initiated involving a loan. When a loan is placed on nonaccrual status, any interest that has been accrued and not collected on the loan is charged against earnings. Cash payments received while a loan is classified as nonaccrual are recorded as a reduction to principal or reported as interest income according to management’s judgement as to collectibility of principal.

A loan is returned to accrual status when either all of the principal and interest amounts contractually due are brought current and future payments are, in management’s opinion, collectable, or when it otherwise becomes well secured and in the process of collection. When a loan is charged-off, any interest accrued but not collected on the loan is charged against earnings.

Impaired loans are generally included in nonaccrual loans. Management does not individually evaluate certain smaller balance loans for impairment as such loans are evaluated on an aggregate basis. These loans include 1-4 family, consumer and home equity loans. Impaired loans were evaluated using the fair value of collateral as the measurement method. At September 30, 2003 the recorded investment in impaired loans was $3,107 while the related portion of the allowance for loan losses was $1,193. At December 31, 2002, there were no loans considered impaired.

Loans in the amount of $943 as of September 30, 2003, and $2,058 as of December 31, 2002, were not included in any of the above categories and were not currently considered impaired, but which can be considered to be potential problem loans.

Any loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed above do not (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

The following is an analysis of the allowance for loan losses for the nine-month periods ended September 30, 2003 and September 30, 2002:


		2003			2002

Balance at beginning of period		$	3,134		$	2,998
Loan charge-offs:
	1-4 family residential mortgages		75			57
	Commercial mortgages		—			—
	Consumer loans		108			127
	Commercial loans		270			117
	Home equity loans		—			—

			453			301

Recoveries on previous loan losses:
	1 - 4 family residential mortgages		—			—
	Commercial mortgages		40			—
	Consumer loans		88			74
	Commercial loans		7			11
	Home equity loans		—			—

			135			85

Net charge-offs			(318	)		(216	)
Provision charged to operations			160			335

Balance at end of period		$	2,976		$	3,117

Ratio of annualized net charge-offs to average loans outstanding			0.22	%		0.14	%

The increase in charge-offs in 2003 primarily reflects an impaired commercial loan credit for which a specific loss reserve had previously been established.

For each of the periods presented above, the provision for loan losses charged to operations is based on management’s judgment after taking into consideration all known factors connected with the collectibility of the existing portfolio. Management evaluates the portfolio in light of economic conditions, changes in the nature and volume of the portfolio, industry standards and other relevant factors. Specific factors considered by management in determining the amounts charged to operations include previous loan loss experience, the status of past due interest and principal payments, the quality of financial information supplied by customers and the general economic conditions present in the lending area of the Company’s bank subsidiary.

Since 1993 the Company’s subsidiary bank has been a defendant in a class action lawsuit, Frank Slentz, et al. v. Cortland Savings and Banking Company, involving purchased interests in two campgrounds.

On September 30, 2002 the registrant received notice that The Court of Common Pleas in Trumbull County, Ohio had ordered the dismissal of all Plaintiffs’ claims in Slentz, et al (Plaintiffs) versus Cortland Savings and Banking Company (Defendant), and a related case, McDonagh, et al (Plaintiffs) versus Cortland Savings and Banking Company (Defendant), and granted registrant’s subsidiary bank, Cortland Savings and Banking Company, Summary Judgment on all counts of Plaintiffs’ Complaint in both cases.

These two class action cases originated in 1993 with filings in the Northern District of Ohio Eastern Division of the Federal Court system. In addition to their alleged Federal claims, Plaintiffs had alleged State law claims which were included as pendent causes of action. On October 20, 1997 the federal judge presiding over these cases filed a judgment entry dismissing all federal claims against the registrant’s subsidiary bank without prejudice. The judgment of the district court was appealed by Plaintiffs. On March 2, 1999 the United States Court of Appeals for the Sixth Circuit affirmed the decision of the district court to grant summary judgment in favor of the defendant bank and dismissing all of Plaintiffs’ Federal Claims. While awaiting the ruling of the Sixth Circuit Court of Appeals, the Plaintiffs asserted their alleged State law claims by filing suit in the Common Pleas Court of Trumbull County seeking damages of approximately $4.3 million.

Plaintiffs have appealed the judgment rendered by the Common Pleas Court of Trumbull County. The Company and the Plaintiffs have filed all permitted briefs with the 11th District Court of Appeals. Oral arguments were made before the Court of Appeals on October 20,2003. While it is not feasible to predict the ultimate resolution of this matter, an outcome unfavorable to the Company’s bank subsidiary could have a material effect on the Company’s quarterly and annual operating results for that period in which such a judgment might be rendered. It remains the Company’s intent to vigorously defend these actions.

The Bank is also involved in other legal actions arising in the ordinary course of business. In the opinion of management, the outcomes from these other matters, either individually or in the aggregate, are not expected to have any material effect on the Company.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands except per share data)

The following table sets forth the computation of basic earnings per common share and diluted earnings per common share.

On January 23, 2001, the Company’s Board of Directors approved a Stock Repurchase Program (the “2001 Program”), which allowed the Company to repurchase up to 187,000 shares (or approximately 4.9% of the 3,815,125 shares outstanding as of January 31, 2001) of the Company’s outstanding common stock. The program expired February 6, 2002. On January 22, 2002, the Company’s Board of Directors approved a new program (the “2002 Program”), which allowed the Company to repurchase up to 193,000 shares (or approximately 4.9% of the 3,943,151 shares outstanding as of January 31, 2002) of the Company’s outstanding common stock. This program expired on February 6, 2003. On January 28, 2003, the Company’s Board of Directors once again approved a new program (the “2003 Program”) which allows the Company to repurchase up to 196,000 shares (or approximately 4.9% of the 3,998,191 shares outstanding as of January 28, 2003) of the Company’s outstanding common stock. This program will expire not later than February 6, 2004, with results depending on market conditions. Repurchased shares are designated as treasury shares, available for general corporate purposes, including possible use in connection with the Company’s dividend reinvestment program, employee benefit plans, acquisitions or other distributions.

Repurchase amounts are effected through open market transactions or in privately negotiated agreements in accordance with applicable regulations of the Securities and Exchange Commission. Under the 2001 program based on the value of the Company’s stock on January 31, 2001, the commitment to repurchase the stock over the next year was approximately $3,179. The Company repurchased 51,321 shares under the 2001 Program.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands except per share data)

Under the 2002 Program, based on the value of the Company’s stock on January 31, 2002, the commitment to repurchase the stock over the next year was $4,053. The Company repurchased 19,745 shares between January 1 and February 6, 2003, bringing the total repurchased shares to 114,073 under the 2002 Program. The Company also reissued 20,592 shares to existing shareholders through its dividend reinvestment program in January 2003, bringing the total number of shares reissued during the 2002 Program to 52,647.

Under the 2003 Program, based on the value of the Company’s stock on January 28, 2003, the commitment to repurchase the stock over the next twelve months was $5,037. As of September 30, 2003, the Company has repurchased 58,950 shares under the 2003 Program. The Company also reissued 18,489 shares to existing shareholders through its dividend reinvestment program. Based on the price of the Company’s stock at September 30, 2003, the remaining commitment to repurchase the stock was approximately $4,180.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

(Dollars in thousands)

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 included elsewhere in this 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 Quarterly Report on Form 10-Q 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 herein, the 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; 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; 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.

The central role of the Company’s liquidity management is to (1) ensure sufficient liquid funds to meet the normal transaction requirements of its customers, (2) take advantage of market opportunities requiring flexibility and speed, and (3) provide a cushion against unforeseen liquidity needs.

Principal sources of liquidity for the Company include assets considered relatively liquid, such as interest-bearing deposits in other banks, federal funds sold, cash and due from banks, as well as cash flows from maturities and repayments of loans, investment securities and mortgage-backed securities.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)

(Dollars in thousands)

Along with its liquid assets, the Company has other sources of liquidity available to it which help to ensure that adequate funds are available as needed. These other sources include, but are not limited to, the ability to obtain deposits through the adjustment of interest rates, the purchasing of federal funds, borrowings from the Federal Home Loan Bank of Cincinnati and access to the Federal Reserve Discount Window.

Cash and cash equivalents decreased compared to levels at year-end 2002, as the Company moved to reduce its level of Federal Funds Sold in response to additional interest rate reductions implemented by the Federal Reserve, along with statements by the Federal Reserve that it could maintain such an accommodative policy for a considerable period of time. Operating activities provided cash of $5,179 and $5,703 during the nine months ended September 30, 2003 and 2002, respectively. Refer to the Consolidated Statements of Cash Flows for a summary of the sources and uses of cash for September 30, 2003 and 2002.

The capital management function is a continuous process which consists of providing capital for both the current financial position and the anticipated future growth of the Company. Central to this process is internal equity generation, particularly through earnings retention. Internal capital generation is measured as the annualized rate of return on equity, exclusive of any appreciation or depreciation relating to available for sale securities, multiplied by the percentage of earnings retained. Internally generated capital retained by the Company measured 4.1% for the nine months ended September 30, 2003 and 5.4% for the nine months ended September 30, 2002. Overall capital (a figure which reflects earnings, dividends paid, common stock issued, treasury shares purchased, treasury shares reissued and the net change in the estimated fair value of available for sale securities) decreased at an annual rate of 1.1%. Capital ratios remained well in excess of regulatory minimums.

Risk-based standards for measuring capital adequacy require banks and bank holding companies to maintain capital based on “risk-adjusted” assets. Categories of assets with potentially higher credit risk require more capital 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.

These standards also classify capital into two tiers, referred to as Tier 1 and Tier 2. The Company’s Tier 1 capital consists of common shareholders’ equity (excluding any gain or loss on available for sale debt securities) less intangible assets and the net unrealized loss on equity securities with readily determinable fair values. Tier 2 capital is the allowance for loan and lease losses reduced for certain regulatory limitations.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
(Dollars in thousands)

Risk based capital standards require a minimum ratio of 8% of qualifying total capital to risk-adjusted total assets with at least 4% constituting Tier 1 capital. Capital qualifying as Tier 2 capital is limited to 100% 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% to 4%, subject to regulatory guidelines.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required 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 table below illustrates the Company’s risk weighted capital ratios at September 30, 2003 and December 31, 2002.

Assets, less intangibles and the net unrealized market value adjustment of investment securities available for sale, averaged $431,988 for the nine months ended September 30, 2003 and $437,149 for the year ended December 31, 2002.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
(Dollars in thousands)

During the first nine months of 2003, net interest income after provision for loan losses decreased by $1,478 compared to the first nine months of 2002. Total interest income decreased by $3,208 or 15.6%, from the level recorded in 2002. This was accompanied by a decrease in interest expense of $1,555, or 20.2%, and a $175 decrease in the provision for loan losses.

The decline in net interest income was the product of a 1.5% year-over-year decline in average earning assets and compression in the Company’s net interest margin rates as short-term interest rates hover just above zero. The Company’s net interest margin for the first nine months of 2003 measured 4.0% compared to 4.4% a year ago.

The average rate paid on interest sensitive liabilities decreased by 56 basis points year-over-year. The average balance of interest sensitive liabilities decreased by $8,298, or 2.5%. Compared to the first nine months of last year, average borrowings decreased by $2,589 while the average rate paid on borrowings remained stable at 5.2%. Average interest bearing demand deposits increased by $360, while savings and money market accounts decreased by $1,053. The average rate paid on these products decreased by 62 basis points in the aggregate. The average balance on time deposit products decreased by $5,017 as the average rate paid also decreased by 62 basis points, from 4.3% to 3.6%.

Interest and dividend income on securities registered a decrease of $1,355 or 15.8%, during the first nine months of 2003 when compared to 2002, while on a fully tax equivalent basis income on investment securities decreased by $1,330, or 14.1%. The average invested balances decreased by $3 from the levels of a year ago. The decrease in the average balance of investment securities was accompanied by a 97 basis point decline in the tax equivalent yield of the portfolio.

Interest and fees on loans decreased by $1,864, or 15.8%, for the first nine months of 2003 compared to 2002. A $10,805 decrease in the average balance of the loan portfolio, or 5.3%, was accompanied by an 83 basis point decline in the portfolio’s tax equivalent yield.

Interest on trading account securities measured $58 at September 30, 2003. Trading account securities had an average balance of $1,366 and a yield of 5.7% in the first nine months of 2003. There was no trading account activity in the first nine months of 2002. Other interest income decreased by $47 from the same period a year ago. The average balance of Federal Funds sold and other money market funds increased by $525. The yield on federal funds decreased by 55 basis points compared to 2002.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
(Dollars in thousands)

Other income from all sources increased by $737 from the same period a year ago. Gains on 1-4 residential mortgage loans sold in the secondary mortgage market increased by $305 from the same period a year ago. Gains on securities called and net gains on the sale of available for sale investment securities increased by $473 from year ago levels. Gains on trading account securities in 2003 were $173 with no activity recorded in 2002. Fees for other customer services increased by $87. Other sources of non-recurring non-interest income decreased by $301 from the same period a year ago, primarily reflecting receipt of one-time franchise tax refunds in 2002.

Reflecting the residual effects of the recent economic recession, loan charge-offs during the first nine months were $453 in 2003 in contrast to $301 in 2002, while the recovery of previously charged-off loans amounted to $135 in 2003 compared to $85 in 2002. The increase in charge-offs during 2003 primarily reflects an impaired commercial loan credit for which a specific loss reserve had previously been established. A provision for loan loss of $160 has been charged to operations in 2003, compared to the $335 charged in 2002. Non-accrual loans at September 30, 2003 represented 1.6% of the loan portfolio compared to 0.7% at December 31, 2002 and 1.0% a year ago. At September 30, 2003, the loan loss allowance of $2,976 represented 1.6% of outstanding loans.

Total other expenses in the first nine months were $8,589 in 2003 compared to $8,548 in 2002, an increase of only $41, or 0.5%. Full time equivalent employment during the first nine months averaged 167 employees in 2003, a 0.6% decrease from the 168 employed in the same period of 2002. Salaries and benefits increased by $63, or 1.3%, compared to the similar period a year ago, primarily due to the increased cost of benefits.

For the first nine months of 2003, state and local taxes increased by $9, or 2.3%. Occupancy and equipment expense decreased by $78, or 5.0%. All other expense categories increased by 2.7%, or $47 as a group.

Income before income tax expense amounted to $5,195 for the first nine months of 2003 compared to $5,977 for the similar period of 2002. The effective tax rate for the first nine months was 20.2% in 2003 compared to 22.8% in 2002, resulting in income tax expense of $1,051 and $1,364 respectively. Net income for the first nine months registered $4,144 in 2003 compared to $4,613 in 2002, representing per share amounts of $1.04 in 2003 and $1.14 in 2002.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
(Dollars in thousands)

During the third quarter of 2003 net interest income after provision for loan losses decreased by $589 as compared to third quarter 2002. Year-over-year average earning assets decreased by 1.5% while average interest-bearing liabilities decreased by 2.1%. Average loans decreased by 4.7%, while average investments increased by 3.9%.

The composite tax equivalent yield on earning assets decreased by 102 basis points from the same quarter a year ago. The tax equivalent yield of the investment portfolio and the trading account measured 5.0%, a 123 basis point decrease from the same quarter a year ago, while the loan portfolio yielded 6.8%, down 93 basis points from last year’s rate. Meanwhile, the rate paid on interest-bearing liabilities decreased 48 basis points compared to a year ago. The net effect of these changes was that the tax equivalent net interest margin decreased to 3.8%, a decrease of 63 basis points from that achieved during last year’s third quarter.

Loans net of the allowance for losses decreased by $8,919 during the 12-month period from September 30, 2002 to September 30, 2003. Gross loans as a percentage of earning assets stood at 46.3% as of September 30, 2003 as compared to 47.9% on September 30, 2002. The loan to deposit ratio at the end of the first nine months of 2003 was 56.4% compared to 59.0% at the end of the same period a year ago. The investment portfolio represented 63.8% of each deposit dollar, up from 60.1% a year ago.

Loan charge-offs during the third quarter were $148 in 2003 and $91 in 2002, while the recovery of previously charged-off loans amounted to $73 during the third quarter of 2003 compared to $35 in the same period of 2002.

Other income for the quarter increased by $104 or 12.3% compared to the same period a year ago. The net gain on 1-4 residential mortgage loans sold during the quarter amounted to $147 compared to $70 a year ago. There was a $203 gain on investment securities transactions in the third quarter of 2003 compared to the $40 gain realized in 2002. Fees from other customer services increased by $45. There was a $48 gain on trading securities with no activity recorded in 2002. Other sources of non-recurring non-interest income decreased by $229 from the same period a year ago, primarily due to a $241 franchise tax refund received in the third quarter of 2002.

Total other expenses in the third quarter were $2,835 in 2003 and $2,837 in 2002, a decrease of $2. Employee salaries and benefits increased by $7 or 0.4%. Occupancy and equipment expense showed a $23 decrease, or 4.4%. Other expenses as a group increased by $14, or 2.0%, compared to the same period last year.

Income before tax for the quarter decreased by 22.8% to $1,640 in 2003 from the $2,123 recorded in 2002. Net income for the quarter of $1,317 represented a 19.3% decrease from the $1,632 earned a year ago. Earnings per share amounted to $0.33 and $0.40 for the third quarter of 2003 and 2002, respectively.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
(Dollars in thousands)

On March 13, 2000, the Board of Governors of the Federal Reserve System approved the Company’s application to become a financial holding company. As a financial holding company, the Company may engage in activities that are financial in nature or incidental to a financial activity, as authorized by the Gramm-Leach-Bliley Act of 1999 (The Financial Services Reform Act). Under the Financial Services Reform Act, the Company may continue to claim the benefits of financial holding company status as long as each depository institution that it controls remains well capitalized and well managed.

The Company is required to provide notice to the Board of Governors of the Federal Reserve System when it becomes aware that any depository institution controlled by the Company ceases to be well capitalized or well managed. Furthermore, current regulation specifies that prior to initiating or engaging in any new activities that are authorized for financial holding companies, the Company’s insured depository institutions must be rated “satisfactory” or better under the Community Reinvestment Act (CRA). The Company’s bank subsidiary is rated “satisfactory” for CRA purposes, remains well capitalized and, in management’s opinion, is well managed.

In June 1998, FASB issued Statement of Financial Accounting Standards (SFAS) No. 133, “Accounting for Derivative Instruments and Hedging Activities.” The FASB issued further guidance on the application of SFAS No. 133 to loan commitments under the Derivatives Implementation Group (DIG) Statement 133 Implementation Issue C13, “Scope Exceptions: When a Loan Commitment is Included in the Scope of Statement 133.” Then, in April 2003, FASB issued SFAS NO. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This Statement clears the guidance issued in implementation Issue C13 and adds the following to Statement 133, “loan commitments that relate to the origination of mortgage loans held for sale shall be accounted for as derivatives by the issuer of the loan commitment.” This guidance is effective for fiscal quarters that began prior to June 15, 2003. The adoption of this guidance does not have a current impact on the Company’s financial statements.

The Company files an annual report on Form 10K, quarterly reports on Form 10Q, current reports on Form 8K and amendments to those reports with the Securities and Exchange Commission (SEC) pursuant to Section 13 (a) or (15)d of the Exchange Act. The Company’s Internet address is www.cortland-banks.com. The Company makes available through this address, free of charge, the reports filed, as soon as reasonably practicable after such material is electronically filed, or furnished to, the SEC. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
(Dollars in thousands)

Management considers interest rate risk to be the Company’s principal source of market risk. Since December 31, 2002, short-term interest rates, as measured by U.S. Treasury securities with maturities of one year or less, have decreased by 17 to 33 basis points, reflecting concerns about economic weakness and deflation. Intermediate interest rates, as measured by U.S. Treasury securities with maturities of two to five years, ranged from a decrease of 11 basis points to an increase of 7 basis points. Long-term interest rates as measured by U.S. Treasury securities with maturities of ten to twenty years increased by 8 to 13 basis points.

Over the past twelve months, the Federal Reserve has decreased its target rate for overnight federal funds by 75 basis points. Through the quarter ended September 30, 2003, the yield curve has steepened as the difference between the yield on the ten-year Treasury and the three-month Treasury has increased to 301 basis points from 261 basis points at December 31, 2002. Interest rates continue to peak in the long-end of the Treasury curve.

The net effect of these changes in the level of interest rates and the shape of the yield curve has had mixed effects on the Company’s risk position. When these changes are incorporated into the Company’s risk analysis, simulated results for an unchanged rate environment indicate a $1,022 decrease in the net interest income for the twelve month horizon subsequent to September 30, 2003 compared to the simulated results for a similar twelve month horizon subsequent to December 31, 2002, primarily reflecting the continued decline in yields on federal funds sold, loans, investments and limited opportunity to reprice non maturity deposit products as short term interest rates remain just above zero, with the targeted Federal Funds rate of 1% remaining at a 45-year low. Meanwhile, the protracted current environment of low interest rates has resulted in an acceleration of mortgage prepayments and increased competitive pressures to renegotiate the interest rates of existing loan customers prior to their scheduled repricing date, all of which has had an adverse impact on the Company’s net interest income.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK (CONTINUED)
(Dollars in thousands)

The following table indicates the Company’s current estimate of interest rate sensitivity based on the composition of the balance sheet at September 30, 2003 and December 31, 2002. For purposes of this analysis, short term interest rates as measured by the federal funds rate and the prime lending rate are assumed to increase (decrease) gradually over the subsequent twelve month period, reaching a level 300 basis points higher (lower) than the rates in effect at September 30, 2003 and December 31, 2002. Under both the rising rate scenario and the falling rate scenario, the yield curve is assumed to exhibit a parallel shift. The analysis assumes no growth in assets and liabilities and no change in asset or liability mix over the subsequent twelve month period.


	Net Interest Income				$Change in NII						% Change in NII

Changes in	Sept.30,		Dec. 31,		Sept.30,			Dec. 31,			Sept.30,			Dec. 31,
Interest Rates	2004		2003		2004			2003			2004			2003

Graduated increase of +300 basis points		15,219		16,111		(275	)		(405	)		(1.8	)%		(2.5	)%
Short term rates unchanged		15,494		16,516
Graduated decrease of - -300 basis points		15,077		16,117		(417	)		(399	)		(2.7	)%		(2.4	)%

The Company’s sensitivity to a decreasing rate environment increased, reflecting a greater decline in the Company’s expected net interest income. Sensitivity to the rising rate environment declined with a smaller decline in net interest income expected. Overall, the Company’s sensitivity to a change in interest rates remains balanced, with simulated net interest income declining by 1.8% in the case of rising rates and 2.7% in the case of falling rates.

The level of interest rate risk indicated remains within limits that management considers acceptable. However, given that interest rate movements can be sudden and unanticipated, and are increasingly influenced by global events and circumstances beyond the purview of the Federal Reserve, no assurance can be made that interest rate movements will not impact key assumptions and relationships in a manner not presently anticipated.

With the participation of management, including the Company’s principal executive officer and principal financial officer, the effectiveness of disclosure controls and procedures (as defined in Rules 13a-15 and 15d-15 of the Securities Exchange Act of 1934 (the “Exchange Act”)) has been evaluated as of the end of the period covered by this report. Based upon that evaluation, the Company’s principal executive officer and principal financial officer have concluded that such disclosure controls and procedures are effective as of the end of the period covered by this report to ensure that material information relating to the Company and its consolidated subsidiaries is made known to them, particularly during the period for which our periodic reports, including this report, are being prepared.

In addition, there were no significant changes during the period covered by this report in the Company’s internal control over financial reporting (as defined in Rules 13a-15 and 15d-15 of the Exchange Act) that have materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

32.

Certifications of Chief Executive Officer and Chief Financial Officer required under Section 906 of Sarbanes-Oxley Act of 2002 (Filed herewith)

Form 8-K was filed with the United States Securities and Exchange Commission, dated August 5, 2003. The 8-K applied to Item 9 — Regulation FD Disclosure, per the 8-K instructions, and announced second quarter and year-to-date results for the periods ended June 30, 2003.

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


x		Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

		For the quarterly period ended: September 30, 2003

		or

o		Transition Report Pursuant to Section 13 or 15(d) of the Securities Act of 1934

		For the transition from to

	Commission file number: 0-13814


Ohio State or other jurisdiction of Incorporation or organization	34-1451118 (I.R.S. Employer Identification No.)

194 West Main Street, Cortland, Ohio (Address of principal executive offices)	44410 (Zip code)


		NINE MONTHS				THREE MONTHS
		September 30,				September 30,

		2003		2002		2003		2002

Proceeds on securities sold		$	6,911	$	1,305	$	1,448	$	1,305
	Gross realized gains		570		130		203		130
	Gross realized losses		0		114		0		114

Proceeds on securities called		$	8,890	$	14,730	$	0	$	3,710
	Gross realized gains		117		198		0		24
	Gross realized losses		0		0		0		0


	AMORTIZED		ESTIMATED
Investment securities available for sale	COST		FAIR VALUE

Due in one year or less	$	1,504	$	1,514
Due after one year through five years		7,921		8,424
Due after five years through ten years		19,770		20,388
Due after ten years		27,308		28,534

		56,503		58,860
Mortgage-backed securities		52,275		53,473

	$	108,778	$	112,333


		AMORTIZED		ESTIMATED
Investment securities held to maturity		COST		FAIR VALUE

Due in one year or less		$	1,810	$	1,814
Due after one year through five years			187		196
Due after five years through ten years			15,135		15,395
Due after ten years			42,738		44,233

			59,870		61,638
	Mortgage-backed securities		39,265		39,090

		$	99,135	$	100,728

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TITLE OF CLASS Common Stock, No Par Value		SHARES OUTSTANDING at November 7, 2003 3,926,653 Shares


	ITEM 1. FINANCIAL STATEMENTS (UNAUDITED)
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 4. CONTROLS AND PROCEDURES
PART II — OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 2. Changes in Securities
	Item 3. Defaults upon Senior Securities
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Reports on Form 8-K
	SIGNATURES
EX-31.1 302 CERTIFICATION - CEO
EX-31.2 302 CERTIFICATION - CFO
EX-32 906 CERTIFICATIONS FOR CEO AND CFO


			CONTRACT OR
			NOTIONAL AMOUNT

			September 30,		December 31,
			2003		2002

Financial instruments whose contract amount represents credit risk:
	Commitments to extend credit:
		Fixed rate	$	912	$	859
		Variable		29,730		36,890
	Standby letters of credit			807		615


	THREE MONTHS ENDED				NINE MONTHS ENDED

	September 30,		September 30,
	2003		2002		2003		2002

Net Income	$	1,317	$	1,632	$	4,144	$	4,613
Weighted average common shares outstanding*		3,974,842		4,015,758		3,983,675		4,035,050
Basic earnings per share*	$	0.33	$	0.40	$	1.04	$	1.14
Diluted earnings per share*	$	0.33	$	0.40	$	1.04	$	1.14



	Cortland Bancorp (Registrant)


DATED: November 7, 2003	/s/ Lawrence A. Fantauzzi

	Lawrence A. Fantauzzi Secretary/Treasurer (Chief Financial Officer)


DATED: November 7, 2003	/s/ Rodger W. Platt

	Rodger W. Platt Chairman and President (Chief Executive Officer)


		September 30,			December 31,
		2003			2002

Tier 1 Capital		$	48,913		$	48,593
Tier 2 Capital			2,939			2,822

TOTAL QUALIFYING CAPITAL		$	51,852		$	51,415

Risk Adjusted Total Assets(*)		$	230,285		$	221,332

	Tier 1 Risk-Based Capital Ratio		21.24	%		21.95	%
	Total Risk-Based Capital Ratio		22.52	%		23.23	%
	Tier 1 Risk-Based Capital to Average Assets (Leverage Capital Ratio)		11.32	%		11.12	%