CORTLAND BANCORP INC - 10-Q Quarterly Report

United States
Securities and Exchange Commission

Washington, D. C. 20549

FORM 10-Q


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

		For the quarterly period ended: September 30, 2004

		or

[ ]		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

Cortland Bancorp

(Exact name of registrant as specified in its charter)


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

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

(330) 637-8040
(Registrant’s telephone number, including area code)

N/A
(Former name, former address and former fiscal year, if changed since last 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 [ ]

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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


TITLE OF CLASS	SHARES OUTSTANDING
Common Stock, No Par Value	at November 2, 2004	4,036,294 Shares

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS (UNAUDITED)

(Amounts in thousands, except share data)


	SEPTEMBER 30			DECEMBER 31			SEPTEMBER 30
	2004			2003			2003
ASSETS
Cash and due from banks	$	9,183		$	9,747		$	10,861
Federal funds sold		5,100						5,600

Total cash and cash equivalents		14,283			9,747			16,461
Investment securities available for sale (Note 3)		121,218			125,841			115,582
Investment securities held to maturity (approximate market value of $101,396 in 2004 , $98,451 in December 2003 and $100,728 in September 2003) (Note 3)		99,500			96,934			99,135
Total loans (Note 4)		194,936			189,262			189,878
Less allowance for loan losses (Note 4)		(2,608	)		(2,408	)		(2,976	)

Net loans		192,328			186,854			186,902

Premises and equipment		4,474			4,872			5,029
Other assets		14,531			14,144			14,495

Total assets	$	446,334		$	438,392		$	437,604

LIABILITIES
Noninterest-bearing deposits	$	54,058		$	57,632		$	56,180
Interest-bearing deposits		291,831			279,924			280,647

Total deposits		345,889			337,556			336,827

Federal Home Loan Bank advances and other borrowings		44,740			47,886			45,530
Other liabilities		5,473			3,069			3,644

Total liabilities		396,102			388,511			386,001

SHAREHOLDERS’ EQUITY
Common stock — $5.00 stated value — authorized 20,000,000 shares; issued 4,246,747 shares in both September 2004 and December 2003 and 4,123,437 in September 2003 (Note 1)		21,234			21,234			20,617
Additional paid-in capital (Note 1)		16,549			16,469			13,502
Retained earnings		16,282			15,401			19,325
Accumulated other comprehensive income (loss) (Note 1)		1,669			2,203			2,436
Treasury shares at cost, 210,453 in 2004, 212,838 in December 2003 and 171,158 in September 2003		(5,502	)		(5,426	)		(4,277	)

Total shareholders’ equity		50,232			49,881			51,603

Total liabilities and shareholders’ equity	$	446,334		$	438,392		$	437,604

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

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,
	2004			2003		2004			2003
INTEREST INCOME
Interest and fees on loans	$	3,103		$	3,217	$	9,278		$	9,916
Interest and dividends on investment securities:
Taxable interest income		921			777		2,573			2,214
Nontaxable interest income		663			589		1,925			1,856
Dividends		31			31		96			96
Interest on mortgage-backed securities		914			939		2,722			3,047
Interest on trading account securities					34					58
Other interest income		17			15		34			111

Total interest income		5,649			5,602		16,628			17,298

INTEREST EXPENSE
Deposits		1,469			1,424		4,302			4,394
Borrowed funds		555			593		1,662			1,761

Total interest expense		2,024			2,017		5,964			6,155

Net interest income		3,625			3,585		10,664			11,143
Provision for loan losses		175			60		275			160

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		3,450			3,525		10,389			10,983

OTHER INCOME
Fees for other customer services		628			414		1,720			1,108
Investment securities gains — net		366			203		674			687
Trading securities gains — net					48					173
Gain on sale of loans — net		18			147		41			449
Other real estate losses		(3	)				(171	)
Other non-interest income		134			138		437			384

Total other income		1,143			950		2,701			2,801

OTHER EXPENSES
Salaries and employee benefits		1,697			1,625		5,007			4,906
Net occupancy and equiptment expense		460			503		1,403			1,485
State and local taxes		136			133		431			398
Office supplies		76			83		263			253
Marketing expense		26			30		130			124
Other operating expenses		591			461		1,628			1,423

Total other expenses		2,986			2,835		8,862			8,589

INCOME BEFORE FEDERAL INCOME TAXES		1,607			1,640		4,228			5,195
Federal income taxes		292			323		690			1,051

NET INCOME	$	1,315		$	1,317	$	3,538		$	4,144

BASIC EARNINGS PER COMMON SHARE (NOTE 6)	$	0.33		$	0.32	$	0.88		$	1.01

DILUTED EARNINGS PER COMMON SHARE (NOTE 6)	$	0.33		$	0.32	$	0.88		$	1.01

CASH DIVIDENDS DECLARED PER SHARE (NOTE 6)	$	0.22		$	0.21	$	0.66		$	0.64

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

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(Amounts in thousands)


								ACCUMULATED						TOTAL
			ADDITIONAL					OTHER						SHARE-
	COMMON		PAID-IN		RETAINED			COMPREHENSIVE			TREASURY			HOLDERS’
	STOCK		CAPITAL		EARNINGS			INCOME			STOCK			EQUITY
NINE MONTHS ENDED SEPTEMBER 30, 2003:
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	)
Special dividend

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

NINE MONTHS ENDED SEPTEMBER 30, 2004:
BALANCE AT JANUARY 1, 2004	$	21,234	$	16,469	$	15,401		$	2,203			($5,426	)	$	49,881
Comprehensive income:
Net income						3,538									3,538
Other comprehensive income, net of tax:
Unrealized gains or (losses) on available- for-sale securities, net of reclassification adjustment									(534	)					(534	)

Total comprehensive income															3,004

Common stock transactions:
Shares sold
Treasury shares reissued				80								956			1,036
Treasury shares purchased												(1,032	)		(1,032	)
Cash dividends declared						(2,657	)								(2,657	)

BALANCE AT SEPTEMBER 30, 2004	$	21,234	$	16,549	$	16,282		$	1,669			($5,502	)	$	50,232


	SEPTEMBER 30,
	2004			2003
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		($90	)		($276	)
Less: Reclassification adjustment for net gains realized in net income, net of tax		444			453

Net unrealized gains (losses) on available- for-sale securities, net of tax		($534	)		($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,
	2004			2003
NET CASH FLOWS FROM OPERATING ACTIVITIES	$	6,406		$	5,179
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities held to maturity		(33,018	)		(51,359	)
Purchases of securities available for sale		(47,725	)		(43,760	)
Proceeds from sales of securities available for sale		18,675			6,911
Proceeds from call, maturity and principal payments on securities		62,777			71,773
Net increase in loans		(5,852	)		(638	)
Proceeds from disposition of other real estate		815			21
Purchase of premises and equipment		(76	)		(316	)

Net cash flows from investing activities		(4,404	)		(17,368	)

CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in deposit accounts		8,333			1,069
Net decrease in borrowings		(3,146	)		(1,139	)
Dividends paid		(2,657	)		(2,629	)
Purchase of treasury shares		(1,032	)		(2,276	)
Treasury shares reissued		1,036			1,054

Net cash flows from financing activities		2,534			(3,921	)

NET CHANGE IN CASH AND CASH EQUIVALENTS		4,536			(16,110	)
CASH AND CASH EQUIVALENTS
Beginning of period		9,747			32,571

End of period	$	14,283		$	16,461

SUPPLEMENTAL DISCLOSURES
Interest paid	$	6,018		$	6,127
Income taxes paid	$	750		$	1,070

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

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED AVERAGE BALANCE SHEETS,
YIELDS AND RATES (UNAUDITED)

(Fully taxable equvalent basis in thousands of dollars)


	YEAR TO DATE AS OF
	September 30, 2004							December 31, 2003							September 30, 2003
	Average				Average			Average				Average			Average				Average
	Balance (1)		Interest		Rate			Balance (1)		Interest		Rate			Balance (1)		Interest		Rate
ASSETS
Federal funds sold and other money market funds	$	4,099	$	34		1.1	%	$	10,338	$	118		1.1	%	$	12,940		111		1.2	%
Investment securities (1)(2)		215,911		8,229		5.1	%		204,599		10,857		5.3	%		200,868		8,094		5.4	%
Loans (2)(3)		194,288		9,345		6.4	%		191,392		13,141		6.9	%		192,207		9,993		6.9	%
Trading account securities									1,190		68		5.7	%		1,366		58		5.7	%

Total interest-earning assets		414,298	$	17,608		5.7	%		407,519	$	24,184		5.9	%		407,381	$	18,256		6.0	%

Cash and due from banks		9,250							10,140							10,214
Bank premises and equiptment		4,702							5,119							5,168
Other assets		14,322							13,461							13,190

Total non-interest-earning assets		28,274							28,720							28,572

Total Assets	$	442,572						$	436,239						$	435,953

LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing demand deposits	$	48,045		179		0.4	%	$	50,714	$	249		0.5	%	$	51,092		194		0.5	%
Savings		90,444		381		0.5	%		88,953		540		0.6	%		88,791		425		0.6	%
Time		147,080		3,742		3.4	%		139,568		5,030		3.6	%		138,686		3,775		3.6	%

Total interest-bearing deposits		285,569		4,302		2.0	%		279,235		5,819		2.1	%		278,569		4,394		2.1	%
Federal funds purchased		386		4		1.2	%		57		1		1.8	%		15
Other borrowings		46,268		1,658		4.8	%		44,848		2,312		5.2	%		45,284		1,761		5.2	%

Total interest-bearing liabilities		332,223	$	5,964		2.4	%		324,140	$	8,132		2.5	%		323,868	$	6,155		2.5	%

Demand deposits		56,365							55,898							55,469
Other liabilities		4,311							4,394							4,329
Shareholders’ equity		49,673							51,807							52,287

Total liabilities and Shareholders’ equity	$	442,572						$	436,239						$	435,953

Net interest income			$	11,644						$	16,052						$	12,101

Net interest rate spread (4)						3.3	%						3.4	%						3.5	%

Net interest margin (5)						3.7	%						3.9	%						4.0	%

Ratio of interest-earning assets to interest-bearing liabilities						1.25							1.26							1.26

(1) Includes both taxable and tax exempt securities

(2) Tax exempt interest is shown on a tax equivalent basis for proper comparison using a statutory federal income tax rate of 34%.

(3) Includes loan origination and commitment fees.

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

(5) Interest margin is calculated by dividing the diffence between total interest earned and total interest expensed by total interest-earning assets.

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

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED AVERAGE BALANCE SHEETS,
YIELDS AND RATES (UNAUDITED)

(Fully taxable equvalent basis in thousands of dollars)


	QUARTER TO DATE AS OF
	SEPTEMBER 30, 2004							June 30, 2004							September 30, 2003
	Average				Average			Average				Average			Average				Average
	Balance (1)		Interest		Rate			Balance (1)		Interest		Rate			Balance (1)		Interest		Rate
ASSETS
Federal funds sold and other money market funds	$	4,846	$	17		1.4	%	$	5,595	$	13		1.0	%	$	6,345	$	15		0.9	%
Investment securities (1)(2)		218,530		2,842		5.2	%		213,127		2,630		4.9	%		207,997		2,616		5.0	%
Loans (2)(3)		195,159		3,125		6.4	%		197,019		3,124		6.4	%		191,303		3,242		6.8	%
Trading account securities																2,454		34		5.5	%

Total interest-earning assets		418,535	$	5,984		5.7	%		415,741	$	5,767		5.6	%		408,099	$	5,907		6.0	%

Cash and due from banks		9,264							9,383							10,273
Bank premises and equiptment		4,574							4,713							5,123
Other assets		13,369							14,123							13,245

Total non-interest-earning assets		27,207							28,219							28,641

Total Assets	$	445,742						$	443,960						$	436,740

LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing demand deposits	$	50,430	$	78		0.6	%	$	48,136	$	53		0.4	%	$	50,235	$	56		0.4	%
Savings		90,549		132		0.6	%		91,054		129		0.6	%		88,953		123		0.5	%
Time		148,414		1,259		3.4	%		147,981		1,243		3.4	%		139,710		1,245		3.5	%

Total interest-bearing deposits		289,393		1,469		2.0	%		287,171		1,425		2.0	%		278,898		1,424		2.0	%

Federal funds purchased		30							86							41
Other borrowings		45,504		555		4.8	%		45,969		549		4.8	%		45,326		593		5.2	%

Total interest-bearing liabilities		334,927	$	2,024		2.4	%		333,226	$	1,974		2.4	%		324,265	$	2,017		2.5	%

Demand deposits		57,100							57,077							56,942
Other liabilities		4,200							4,470							3,938
Shareholders’ equity		49,515							49,187							51,595

Total liabilities and Shareholders’ equity	$	445,742						$	443,960						$	436,740

Net interest income			$	3,960						$	3,793						$	3,890

Net interest rate spread (4)						3.3	%						3.2	%						3.5	%

Net interest margin (5)						3.8	%						3.6	%						3.8	%

Ratio of interest-earning assets to interest-bearing liabilities						1.25							1.25							1.26

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

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

1.) Basis of Presentation:

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, 2004 are not necessarily indicative of the results that may be expected for the year ending December 31, 2004. 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, 2003.

2.) Reclassifications:

Certain items contained in the 2003 financial statements have been reclassified to conform to the presentation for 2004. Such reclassifications had no effect on the net results of operations.

3.) Investment Securities:

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.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

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:


	THREE MONTHS				NINE MONTHS
	September 30,				September 30,
	2004		2003		2004		2003
Proceeds on securities sold	$	9,252	$	1,448	$	18,675	$	6,911
Gross realized gains		357		203		663		570
Gross realized losses		0		0		10		0
Proceeds on securities called	$	7,681	$	0	$	9,731	$	8,890
Gross realized gains		9		0		21		117
Gross realized losses		0		0		0		0

Securities available for sale, carried at fair value, totaled $121,218 at September 30, 2004 and $125,841 at December 31, 2003 representing 54.9% and 56.5%, 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 $49,175 at September 30, 2004 and $43,909 at December 31, 2003 were pledged to secure deposits and for other purposes.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

The amortized cost and estimated market value of debt securities at September 30, 2004, 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.


Investment securities	AMORTIZED		ESTIMATED
available for sale	COST		FAIR VALUE
Due in one year or less	$	1,250	$	1,254
Due after one year through five years		6,220		6,487
Due after five years through ten years		12,684		12,790
Due after ten years		39,162		40,582

		59,316		61,113
Mortgage-backed securities		56,168		56,897

	$	115,484	$	118,010


Investment securities	AMORTIZED		ESTIMATED
held to maturity	COST		FAIR VALUE
Due in one year or less	$	43	$	45
Due after one year through five years		197		212
Due after five years through ten years		17,240		17,447
Due after ten years		55,509		57,567

		72,989		75,271
Mortgage-backed securities		26,511		26,125

	$	99,500	$	101,396

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

The amortized cost and estimated fair value of investment securities available for sale and investment securities held to maturity as of September 30, 2004, are as follows:


			GROSS		GROSS		ESTIMATED
Investment securities	AMORTIZED		UNREALIZED		UNREALIZED		FAIR
available for sale	COST		GAINS		LOSSES		VALUE
U.S. Treasury Securities	$	2,278	$	340	$		$	2,618
U.S. Government agencies and corporations		20,790		309		9		21,090
Obligations of states and political subdivisions		22,677		1,199		8		23,868
Mortgage-backed and related securities		56,168		912		183		56,897
Corporate securities		13,571		24		58		13,537

Total debt securities		115,484		2,784		258		118,010
Other securities		3,208						3,208

Total available for sale	$	118,692	$	2,784	$	258	$	121,218


			GROSS		GROSS		ESTIMATED
Investment securities	AMORTIZED		UNREALIZED		UNREALIZED		FAIR
held to maturity	COST		GAINS		LOSSES		VALUE
U.S. Treasury Securities	$	153	$	6	$		$	159
U.S. Government agencies and corporations		38,691		353		97		38,947
Obligations of states and political subdivisions		34,145		2,046		26		36,165
Mortgage-backed and related securities		26,511		35		421		26,125

Total held to maturity	$	99,500	$	2,440	$	544	$	101,396

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

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, 2003:


			GROSS		GROSS		ESTIMATED
Investment securities	AMORTIZED		UNREALIZED		UNREALIZED		FAIR
available for sale	COST		GAINS		LOSSES		VALUE
U.S. Treasury Securities	$	4,635	$	336	$		$	4,971
U.S. Government agencies and corporations		31,843		621		43		32,421
Obligations of states and political subdivisions		19,727		1,062		16		20,773
Mortgage-backed and related securities		52,396		1,174		143		53,427
Corporate securities		10,786		397		53		11,130

Total debt securities		119,387		3,590		255		122,722
Other securities		3,119						3,119

Total available for sale	$	122,506	$	3,590	$	255	$	125,841


			GROSS		GROSS		ESTIMATED
Investment securities	AMORTIZED		UNREALIZED		UNREALIZED		FAIR
held to maturity	COST		GAINS		LOSSES		VALUE
U.S. Treasury Securities	$	156	$	4	$		$	160
U.S. Government agencies and corporations		24,976		230		62		25,144
Obligations of states and political subdivisions		32,730		1,653		47		34,336
Mortgage-backed and related securities		39,072		62		323		38,811

Total held to maturity	$	96,934	$	1,949	$	432	$	98,451

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

4.) Concentration of Credit Risk and Off Balance Sheet Risk:

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.


	CONTRACT OR
	NOTIONAL AMOUNT
	September 30,		December 31,
	2004		2003
Financial instruments whose contract amount represents credit risk:
Commitments to extend credit:
Fixed rate	$	2,124	$	96
Variable		28,575		29,411
Standby letters of credit		1,499		761

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.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

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:


	September 30,			December 31,
	2004			2003
1-4 family residential mortgages		32.3	%		30.7	%
Commercial mortgages		48.6	%		49.0	%
Consumer loans		3.4	%		3.8	%
Commercial loans		9.9	%		11.5	%
Home equity loans		5.8	%		5.0	%

There are no mortgage loans held for sale included in 1-4 family residential mortgages as of September 30, 2004, and $103 at December 31, 2003. 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, 2004 and December 31, 2003:


	September 30,		December 31,
	2004		2003
Loans accounted for on a nonaccrual basis	$	3,305	$	2,067
Loans contractually past due 90 days or more as to interest or principal payments (not included in nonaccrual loans above)	NONE		NONE
Loans considered troubled debt restructurings (not included in nonaccrual loans or loans contractually past due above)	NONE		NONE

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

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, 2004 and 2003.


	September 30,		September 30,
	2004		2003
Gross interest income that would have been recorded if the loans had been current in accordance with their original terms	$	190	$	249
Interest income actually included in income on the loan		58		93

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, 2004 the recorded investment in impaired loans was $2,905 while the related portion of the allowance for loan losses was $1,164. At December 31, 2003, there were $871 in loans considered impaired while the allocated portion of the allowance for loan losses for such loans was $177.

Loans in the amount of $3,323 as of September 30, 2004, and $2,113 as of December 31, 2003, 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.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

The following is an analysis of the allowance for loan losses for the periods ended September 30, 2004 and September 30, 2003:


	THREE MONTHS						NINE MONTHS
	2004			2003			2004			2003
Balance at beginning of period	$	2,496		$	2,991		$	2,408		$	3,134
Loan charge-offs:
1-4 family residential mortgages		56			75			77			75
Commercial mortgages		—			—			—			—
Consumer loans		21			24			42			108
Commercial loans		—			49			10			270
Home equity loans		—			—			—			—

		77			148			129			453
Recoveries on previous loan losses:
1 - 4 family residential mortgages		—			—			—			—
Commercial mortgages		—			40			—			40
Consumer loans		14			30			50			88
Commercial loans		—			3			4			7
Home equity loans		—			—			—			—

		14			73			54			135

Net charge-offs		(63	)		(75	)		(75	)		(318	)
Provision charged to operations		175			60			275			160

Balance at end of period	$	2,608		$	2,976		$	2,608		$	2,976

Ratio of annualized net charge-offs to average loans outstanding		0.13	%		0.16	%		0.05	%		0.22	%

The increase in the reserve in the third quarter of 2004 was due to an increase in the specific loss reserve on a commercial real estate loan. The decrease in charge-offs in 2004 primarily reflects the effect of an impaired commercial loan credit charged off in 2003 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.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

5.) Legal Proceedings:

Since 1993 the Company’s subsidiary bank had been a defendant in a class action lawsuit, involving purchased interest in two Ohio campgrounds, Slentz, et al (Plaintiffs) versus Cortland Savings and Banking Company (Defendant) and McDonagh, et al (Plaintiffs), versus Cortland Savings and Banking Company (Defendant).

These class action cases originated with filings in the Northern District of Ohio Eastern Division of the Federal Court system. In addition to their alleged Federal claims, Plaintiffs 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 federal court to grant summary judgment in favor of the defendant bank and to dismiss 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.

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 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.

Plaintiffs appealed the judgment rendered by the Common Pleas Court of Trumbull County. The Company and the Plaintiffs filed all permitted briefs with the 11th District Court of Appeals and oral arguments were made before the Court of Appeals on October 20,2003. On March 4, 2004, the Company received notice that the 11th District Court of Appeals had upheld the decision of the Court of Common Pleas in Trumbull County, Ohio in favor of the registrant and its subsidiary bank.

On April 15, 2004 the Plaintiffs appealed the 11th District Court’s decision to the Ohio Supreme Court. On July 14, 2004 the Ohio Supreme Court ruled that it would not accept the Plaintiffs’ cases for review and for briefing on the merits. Plaintiffs failed to file a motion for reconsideration with the Ohio Supreme Court by the July 26, 2004 deadline.

The Bank is 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.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands except per share data)

6.) Earnings Per Share and Capital Transactions:

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


	THREE MONTHS ENDED				NINE MONTHS ENDED
	September 30,				September 30,
	2004		2003		2004		2003
Net Income	$	1,315	$	1,317	$	3,538	$	4,144
Weighted average common shares outstanding *		4,036,293		4,093,898		4,028,954		4,102,995
Basic earnings per share *	$	0.33	$	0.32	$	0.88	$	1.01
Diluted earnings per share *	$	0.33	$	0.32	$	0.88	$	1.01
Dividends declared per share*	$	0.22	$	0.21	$	0.66	$	0.64

*Average shares outstanding and resultant per share amounts have been restated to give retroactive effect to the 3% stock dividend of January 1, 2004.

7.) Stock Repurchase Program

On February 6, 2004, the Company concluded the fourth consecutive year of stock repurchase programs. These programs were approved and authorized each year by the Company’s Board of Directors. The following table shows the results of these programs.


							WEIGHTED
			NUMBER OF		COST OF		AVERAGE
	DATE BOARD	DATE	SHARES		SHARES		PRICE PER
PROGRAM	AUTHORIZED	EXPIRED	REPURCHASED		REPURCHASED		SHARE
“2000 Program”	January 26, 2000	February 3, 2001		138,218	$	2,284	$	16.51
“2001 Program”	January 23, 2001	February 6, 2002		51,321		987		19.32
“2002 Program”	January 22, 2002	February 6, 2003		114,073		2,848		25.02
“2003 Program”	January 28, 2003	February 6, 2004		137,869		4,170		30.24

TOTAL				441,481	$	10,289	$	23.31

Currently, there is no stock repurchase program in effect.

CORTLAND BANCORP AND SUBSIDIARIES

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.

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 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.

Critical Accounting Policies and Estimates

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the industries in which it operates. The most significant accounting policies followed by the Company are presented in “Notes to Consolidated Financial Statements Summary of Significant Accounting Policies” in the 2003 annual report on Form 10-K. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. Some of

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

these policies and related methodologies are more critical than others. There has been no material change in critical accounting estimates since those presented in the 2003 annual report on Form 10-K.

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.

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 increased compared to levels at year-end 2003, as the Company moved to increase its level of Federal Funds Sold. Operating activities provided cash of $6,406 and $5,179 during the nine months ended September 30, 2004 and 2003, respectively. Key differences stem mainly from: 1) a decrease in net income of $606 compared to September 30, 2003; 2) loans held for sale decreased by $103 at September 30, 2004 as compared to a decrease of $1,919 at September 30, 2003, which favorably impacted the proceeds and gains on loans realized in 2003; 3) the net increase in securities to settle in September 2003 was $532, while in September 2004 there was a net increase of $1,520; and 4) an increase in the cash surrender value of life insurance of $2,776 in September 2003 and $455 in September 2004, with the difference being due to the purchase of additional life insurance policies aggregating $2,500 in 2003. Refer to the Consolidated Statements of Cash Flows for a summary of the sources and uses of cash for September 30, 2004 and 2003, and the following table which details the cash flows from operating activities.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

Capital Resources

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 2.5% for the nine months ended September 30, 2004 and 4.1% for the nine months ended September 30, 2003. 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) increased at an annual rate of 0.9%. 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.

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.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

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, 2004 and December 31, 2003.


	September 30, 2004			December 31, 2003
Tier 1 Capital	$	48,346		$	47,433
Tier 2 Capital		2,608			2,408

TOTAL QUALIFYING CAPITAL	$	50,954		$	49,841

Risk Adjusted Total Assets (*)	$	231,305		$	231,034
Tier 1 Risk-Based Capital Ratio		20.90	%		20.53	%
Total Risk-Based Capital Ratio		22.03	%		21.57	%
Tier 1 Risk-Based Capital to Average Assets (Leverage Capital Ratio)		10.99	%		10.94	%

(*) Includes off-balance sheet exposures.

Assets, less intangibles and the net unrealized market value adjustment of investment securities available for sale, averaged $439,793 for the nine months ended September 30, 2004 and $433,513 for the year ended December 31, 2003.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

In management’s opinion, as supported by the data in the table below, the Company met all capital adequacy requirements to which it was subject as of September 30, 2004 and December 31, 2003. As of those dates, Cortland Bancorp was “well capitalized” under regulatory prompt corrective action provisions.


	Actual Regulatory						Regulatory Capital Ratio
	Capital Ratios as of:						requirements to be:

	September 30,			Dec 31,			Well			Adequately
	2004			2003			Capitalized			Capitalized
Total risk-based capital to risk-weighted assets		22.03	%		21.57	%		10.00	%		8.00	%
Tier 1 capital to risk-weighted assets		20.90	%		20.53	%		6.00	%		4.00	%
Tier 1 capital to average assets		10.99	%		10.94	%		5.00	%		4.00	%

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

First Nine Months of 2004 as Compared to First Nine Months of 2003

During the first nine months of 2004, net interest income after provision for loan losses decreased by $594 compared to the first nine months of 2003. Total interest income decreased by $670 or 3.9%, from the level recorded in 2003. This was accompanied by a decrease in interest expense of $191 or 3.1%, and an increase in the provision for loan losses of $115. On a fully taxable equivalent basis, net interest income after provision for loan losses declined by $572.

The decline in net income was the product of a 1.7% year-over-year increase in average earning assets and the resultant compression in the Company’s net interest margin ratio as short-term interest rates trended toward zero. The Company’s tax equivalent net interest margin for the first nine months of 2004 measured 3.7% compared to 4.0% a year ago.

The average rate paid on interest sensitive liabilities decreased by 14 basis points year-over-year. The average balance of interest sensitive liabilities increased by $8,355 or 2.6%. Compared to the first nine months of last year, average borrowings increased by $1,355 while the average rate paid on borrowings decreased by 44 basis points.

Average interest-bearing demand deposits and money market accounts decreased by $3,047, while savings increased by $1,653. The average rate paid on these products decreased by 6 basis points in the aggregate. The average balance on time deposit products increased by $8,394, as the average rate paid decreased by 24 basis points, from 3.6% to 3.4%.

Interest and dividend income on securities registered an increase of $103, or 1.4%, during the first nine months of 2004 when compared to 2003, while on a fully tax equivalent basis income on investment securities increased by $135, or 1.7%. The average invested balances increased by $15,043 from the levels of a year ago. The increase in the average balance of investment securities was accompanied by a 30 basis point decline in the tax equivalent yield of the portfolio.

Interest and fees on loans decreased by $638, or 6.4%, for the first nine months of 2004 compared to 2003. A $2,081 increase in the average balance of the loan portfolio, or 1.1%, was accompanied by a 52 basis point decline in the portfolio’s tax equivalent yield.

Interest on trading account securities measured $58 at September 30, 2003. There was no trading account activity in the first nine months of 2004. Other interest income decreased by $77 from the same period a year ago. The average balance of Federal Funds sold and other money market funds decreased by $8,841, or 68.3%. The yield on federal funds decreased by 3 basis points compared to the same period of 2003.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

Other income from all sources decreased by $100 from the same period a year ago. Gains on 1-4 residential mortgage loans sold in the secondary mortgage market decreased by $408 from the same period a year ago. Gains on securities called and net gains on the sale of available for sale investment securities decreased by $13 from year ago levels. Gains on trading account securities in 2003 were $173 with no activity recorded in 2004. Fees for other customer services increased by $612, primarily due to the introduction of a new deposit product first offered to customers late in the third quarter of 2003. In the first nine months of 2004, losses on other real estate owned of $171 were recorded with none in the similar period of 2003. Other sources of non-recurring non-interest income increased by $53 from the same period a year ago. This income category is subject to fluctuation due to nonrecurring items.

Loan charge-offs during the first nine months were $129 in 2004 in contrast to $453 in 2003, while the recovery of previously charged-off loans amounted to $54 in 2004 compared to $135 in 2003. The higher level of charge-offs during 2003 primarily reflected an impaired commercial loan credit for which a specific loss reserve had previously been established. A provision for loan loss of $275 was charged to operations in 2004 and $160 in 2003. Non-accrual loans at September 30, 2004 represented 1.7% of the loan portfolio and 1.1% at December 31,2003. At September 30, 2004, the loan loss allowance of $2,608 represented approximately 1.3% of outstanding loans.

Total other expenses in the first nine months were $8,862 in 2004 compared to $8,589 in 2003, an increase of $273, or 3.2%. Full time equivalent employment during the first nine months averaged 163 employees in 2004, a 2.4% decrease from the 167 employed in the same period of 2003. Salaries and benefits increased by $101, or 2.1%, compared to the similar period a year ago.

For the first nine months of 2004, state and local taxes increased by $33 or 8.3%. Occupancy and equipment expense decreased by $82 or 5.5%. Office supplies increased by $10, due mainly to increased postage and supply costs. Marketing expense increased by $6. All other expense categories increased by 14.4%, or $205 as a group, primarily reflecting costs associated with the Company’s new deposit product and expenses associated with the review and implementation of the requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

Income before income tax expense amounted to $4,228 for the first nine months of 2004 compared to $5,195 for the similar period of 2003. The effective tax rate for the first nine months was 16.3% in 2004 compared to 20.2% in 2003, resulting in income tax expense of $690 and $1,051, respectively. The decline in the effective tax rate reflects a decline in taxable income, while income exempt from taxation from all sources increased slightly. The provision for income taxes differs from the amount of income tax determined applying the applicable U.S. statutory federal income tax rate to pre-tax income as a result of the following differences:


	September 30,
	2004			2003
Provision at statutory rate	$	1,438		$	1,766
Add (Deduct):
Tax effect of non-taxable income		(816	)		(782	)
Tax effect of non-deductible expense		68			67

Federal income taxes	$	690		$	1,051

Net income for the first nine months registered $3,538 in 2004 compared to $4,144 in 2003, representing per share amounts of $0.88 in 2004 and $1.01 in 2003. Dividends declared per share were $0.66 in 2004 and $0.64 in 2003.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

Third Quarter of 2004 as Compared to Third Quarter of 2003

During the third quarter of 2004 net interest income after provision for loan losses decreased by $75 as compared to third quarter 2003. Year-over-year average earning assets increased by 2.6% and average interest-bearing liabilities increased by 3.3%. Average loans increased by 2.0%, while average investments increased by 5.1%.

The composite tax equivalent yield on earning assets decreased by 6 basis points from the same quarter a year ago. The tax equivalent yield of the investment portfolio and the trading account measured 5.2%, a 17 basis point increase from the same quarter a year ago, while the loan portfolio yielded 6.4%, down 36 basis points from last year’s rate. Meanwhile, the rate paid on interest-bearing liabilities decreased 7 basis points compared to a year ago. The average rate on federal funds sold and other money market funds was 1.4% up 43 basis points from last year’s rates. The net effect of these changes was that the tax equivalent net interest margin remained steady at 3.8%.

Loans net of the allowance for losses increased by $5,426 during the 12-month period from September 30, 2003 to September 30, 2004, and by $5,474 from year-end. This result reflects the effect of a $6.0 million dollar purchase of residential mortgage loans in the first half of 2004. Gross loans as a percentage of earning assets stood at 46.3% as of September 30, 2004 and at September 30, 2003. The loan to deposit ratio at the end of the first nine months of 2004 was 56.4% and the same at the end of the same period a year ago. The investment portfolio represented 63.8% of each deposit dollar, up from 63.7% a year ago.

Loan charge-offs during the third quarter were $77 in 2004 and $148 in 2003, while the recovery of previously charged-off loans amounted to $14 during the third quarter of 2004 compared to $73 in the same period of 2003.

Other income for the quarter increased by $193 or 20.3% compared to the same period a year ago. The net gain on loans sold during the quarter amounted to $18 compared to $147 a year ago. There was $366 in gains on investment and trading securities transactions in the third quarter of 2004 compared to the $251 gain realized in 2003. Fees from other customer services increased by $214 from the same period of 2003. A loss on other real estate of $3 was realized in the third quarter of 2004, while none was incurred during the comparable period of 2003. Other sources of non-recurring non-interest income decreased by $4 from the same period a year ago.

Total other expenses in the third quarter were $2,986 in 2004 and $2,835 in 2003, an increase of $151 or 5.3%. Employee salaries and benefits increased by $72 or 4.4%. Occupancy and equipment expense showed a $43 decrease, or 8.5%. Other expenses as a group increased by $122, or 17.3%, compared to the same period last year, primarily reflecting expenses associated with the Company’s new deposit product introduced late in the third quarter of 2003 and expenses associated with the review and implementation of the requirements of Section 404 of the Sarbanes-Oxley Act of 2002.

Income before tax for the quarter decreased by 2.0% to $1,607 in 2004 from the $1,640 recorded in 2003. Net income for the quarter of $1,315 represented a 0.2% decline from the $1,317 earned a year ago. Earnings per share amounted to $0.33 and $0.32 for the third quarter of 2004 and 2003, respectively.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

Regulatory Matters

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, and remains well capitalized and well managed in Management’s opinion.

New Accounting Standards

On March 9, 2004, the SEC staff released Staff Accounting Bulletin No. 105 – Application of Accounting Principles to Loan Commitments. This bulletin requires all registrants to account for mortgage loan interest rate lock commitments related to loans held for sale as written options, effective no later than for commitments entered into after March 31, 2004. This guidance requires the Company to recognize a liability on its balance sheet equal to fair value of the commitment at the time the loan commitment is issued. As a result, this guidance delays the recognition of any revenue related to these commitments until such time as the loan is sold. However, the new accounting standard has no effect on the ultimate amount of revenue or the cash flows recognized over time. Adoption of this guidance did not have a material impact on the Company’s financial position or results of operation.

Emerging Issues Task Force (“EITF”) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (“EITF 03-1”), provides application guidance to determine when an investment is considered impaired, whether that impairment is other-than-temporary, and whether recognition of an impairment loss is required. The guidance also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than temporary impairments. In September 2004, the FASB decided to delay full implementation of the accounting requirements of EITF 03-1, pending finalization of a FASB staff position currently expected not later than December 2004.

Available Information

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.

CORTLAND BANCORP AND SUBSIDIARIES

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. Interest rate risk is measured as the impact of interest rate changes on the Company’s net interest income. Components of interest rate risk comprise repricing risk, basis risk and yield curve risk. Repricing risk arises due to timing differences in the repricing of assets and liabilities as interest rate changes occur. Basis risk occurs when repricing assets and liabilities reference different key rates. Yield curve risk arises when a shift occurs in the relationship among key rates across the maturity spectrum.

The effective management of interest rate risk seeks to limit the adverse impact of interest rate changes on the Company’s net interest margin, providing the Company with the best opportunity for maintaining consistent earnings growth. Toward this end, Management uses computer simulation to model the Company’s financial performance under varying interest rate scenarios. These scenarios may reflect changes in the level of interest rates, changes in the shape of the yield curve, and changes in interest rate relationships. During the second quarter of 2004, the Company upgraded its simulation model to provide for increased operating efficiency and to enable more effective risk measurement and balance sheet management. The new model enables Management to better evaluate the impact of individual strategies and transactions, the effects of changing conditions such as prepayment speeds, and provides greater flexibility in modeling Management’s response to changing conditions.

The simulation model allows Management to test and evaluate alternative responses to a changing interest rate environment. Typically when confronted with a heightened risk of rising interest rates, the Company will evaluate strategies that shorten investment and loan repricing intervals and maturities, emphasize the acquisition of floating rate over fixed rate assets, and lengthen the maturities of liability funding sources. When the risk of falling rates is perceived, Management will typically consider strategies that shorten the maturities of funding sources, lengthen the repricing intervals and maturities of investments and loans, and emphasize the acquisition of fixed rate assets over floating rate assets.

The most significant assumptions used in the simulation relate to the cash flows and repricing characteristics of the Company’s balance sheet. Repricing and runoff rate assumptions are based upon specific product parameters modified by historical trends and internal projections. Assumptions are periodically reviewed and benchmarked against historical results. Actual results may differ from simulated results not only due to the timing, magnitude and frequency of interest rate changes, but also due to changes in general economic conditions, changes in customer preferences and behavior, and changes in strategies by both existing and potential competitors.

The table on the following page shows the Company’s current estimate of interest rate sensitivity based on the composition of the balance sheet at September 30, 2004, and December 31, 2003. Simulated results are based on the Company’s new simulation model for both periods. For purposes of this analysis, short term interest rates as measured by the federal funds rate and

CORTLAND BANCORP AND SUBSIDIARIES

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

(CONTINUED)

(Dollars in thousands)

the prime lending rate are assumed to increase (decrease) gradually over the subsequent twelve months reaching a level 300 basis points higher (lower) than the rates in effect at September 30, 2004 and December 31, 2003 for the respective simulations. Under both the rising rate scenario and the falling rate scenario, the yield curve is assumed to exhibit a parallel shift.

Over the past twelve months, the Federal Reserve has increased its target rate for overnight federal funds by 75 basis points. At September 30, 2004, the difference between the yield on the ten-year Treasury and the three-month Treasury had decreased to a positive 243 basis points from the positive 332 basis points that existed at December 31, 2003. The change denotes a “flattening” of the yield curve. The yield curve, however, remains positively sloping, as interest rates increase with a lengthening of maturities, with rates peaking at the long-end of the Treasury curve.

The base case against which interest rate sensitivity is measured assumes no change in short term rates. The base case also assumes no growth in assets and liabilities and no change in asset or liability mix. Under these simulated conditions the base case projects net interest income of $15,553 for the twelve month period ending September 30, 2005.


	Simulated Net Interest Income (NII) Scenarios
	Fully Taxable Equivalent Basis
	For the Twelve Months Ending
	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	2005		2004		2005			2004			2005			2004
Graduated increase of +300 basis points	$	15,882	$	15,474	$	329		$	111			2.1	%		0.7	%
Short term rates unchanged		15,553		15,363
Graduated decrease of - -300 basis points		15,154		14,870		(399	)		(493	)		(2.6	)%		(3.2	)%

The level of interest rate risk indicated is 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 parameters in a manner not presently embodied by the model.

It is Management’s opinion that hedging instruments currently available are not a cost effective means of controlling interest rate risk for the Company. Accordingly, the Company does not currently use financial derivatives, such as interest rate options, swaps, caps, floors or other similar instruments.

CORTLAND BANCORP AND SUBSIDIARIES

ITEM 4. CONTROLS AND PROCEDURES

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.

CORTLAND BANCORP AND SUBSIDIARIES

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

See Note (5) of the financial statements.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

Company’s Common Stock. The following table shows information relating to the repurchase of shares of its common stock during the nine months ended September 30, 2004:

Total Number

Maximum

of Shares

Number

Purchased as

of Shares

Part Of Publicly

That May Yet Be

Total Number

Average

Announced

Purchased Under

of Shares

Price Paid

Plans or

the Plans or

Purchased

Per Share

Programs

Programs*

January

29,314

29.89

29,314

63,422

February

5,291

29.50

5,291

March-Sept.

Total

34,605

29.83

34,605

*The “2003” Program expired on February 6, 2004. See Note 7.

Item 3. Defaults upon Senior Securities

Not applicable

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

Not applicable

Item 5. Other Information

Not applicable

CORTLAND BANCORP AND SUBSIDIARIES

PART II — OTHER INFORMATION (CONTINUED)

Item 6. Exhibits and Reports on Form 8-K

(a) Exhibits

2. Not applicable

4. Not applicable

10. Not applicable

11. See Note (6) of the Financial Statements

15. Not applicable

18. Not applicable

19. Not applicable

22. Not applicable

23. Not applicable

24. Not applicable

31.1 CEO certification (Filed herewith)

31.2 CFO certification (Filed herewith)

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

(b) Reports on Form 8-K

Form 8-K was filed with the United States Securities and Exchange Commission dated August 27, 2004. The 8-K applied to Item 5.02 – Departure of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers, per the 8-K instructions, and announced the Board appointment of Jerry A. Carleton.


PART I — FINANCIAL INFORMATION
Item 1. Financial Statements (Unaudited)
Cortland Bancorp and Subsidiaries:
Consolidated Balance Sheets — September 30, 2004, December 31, 2003 and September 30, 2003			2
Consolidated Statements of Income — Nine months ended September 30, 2004 and 2003 and Three months ended September 30, 2004 and September 30, 2003			3
Consolidated Statement of Shareholders’ Equity — Nine months ended September 30, 2004 and 2003			4
Consolidated Statements of Cash Flows — Nine months ended September 30, 2004 and 2003			5
Consolidated Average Balance Sheets, Yields And Rates — Year to Date September 30, 2004 December 31, 2003 and September 30, 2003			6
Consolidated Average Balance Sheets, Yields And Rates — Quarter to Date September 30, 2004 June 30, 2004 and September 30, 2003			7
Notes to Consolidated Financial Statements September 30, 2004			8 - 18
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			19 - 27
Item 3. Quantitative and Qualitative Disclosures about Market Risk			28 - 29
Item 4. Controls and Procedures			30
PART II — OTHER INFORMATION
Item 1. Legal Proceedings			31
Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities			31
Item 3. Defaults Upon Senior Securities			31
Item 4. Submission of Matters to a Vote of Security Holders			31
Item 5. Other Information			31
Item 6. Exhibits and Reports on Form 8-K			32
Signatures			33
EX-31.1 CEO CERTIFICATION (FILED HEREWITH)
EX-31.2 CFO CERTIFICATION (FILED HEREWITH)
EX-32 CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER AND CHIEF FINANCIAL OFFICER REQUIRED UNDER SECTION 906 OF SARBANES-OXLEY ACT OF 2002 (FILED HEREWITH)


		Cortland Bancorp

		(Registrant)

DATED: November 2, 2004		/s/ Lawrence A. Fantauzzi

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

DATED: November 2, 2004		/s/ Rodger W. Platt

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

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(1)		Includes both taxable and tax exempt securities

(2)		Tax exempt interest is shown on a tax equivalent basis for proper comparison using a statutory federal income tax rate of 34%.

(3)		Includes loan origination and commitment fees.

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

(5)		Interest margin is calculated by dividing the diffence between total interest earned and total interest expensed by total interest-earning assets.


	For the Nine
	Months Ended September 30,
	2004			2003
Net Income	$	3,538		$	4,144
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation, amortization and accretion		1,687			1,767
Provision for loan loss		275			160
Investment securities gains		(674	)		(687	)
Trading account gain					(173	)
Other real estate losses		171
Impact of loans held for sale		103			1,919
Changes in:
Securities sold to settle		1,520			532
Cash surrender value of life insurance		(455	)		(2,776	)
Other assets and liabilities		278			160
Other		(37	)		133

Net cash flows from operating activities	$	6,406		$	5,179