United States
Securities and Exchange Commission

FORM 10-Q

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

or

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

     Commission file number:     0-13814

Cortland Bancorp

(Exact name of registrant as specified in its charter)

(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 þ No o

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

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.

CORTLAND BANCORP AND SUBSIDIARIES

(Amounts in thousands, except share data)

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

2

CORTLAND BANCORP AND SUBSIDIARIES

(Amounts in thousands, except per share data)

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

3

CORTLAND BANCORP AND SUBSIDIARIES

(Amounts in thousands)

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

4

CORTLAND BANCORP AND SUBSIDIARIES

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

5

CORTLAND BANCORP AND SUBSIDIARIES

(Fully taxable equivalent basis in thousands of dollars)

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

6

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 three months ended March 31, 2005 are not necessarily indicative of the results that may be expected for the year ending December 31, 2005. 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, 2004.

     2.) Reclassifications:

     Certain items contained in the 2004 financial statements have been reclassified to conform to the presentation for 2005. 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.

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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:

     Securities available for sale, carried at fair value, totaled $116,591 at March 31, 2005 and $121,348 at December 31, 2004 representing 53.7% and 53.7%, 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 $46,004 at March 31, 2005 and $48,114 at December 31, 2004 were pledged to secure deposits and for other purposes.

8

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

     The amortized cost and estimated market value of debt securities at March 31, 2005, 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.

9

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 March 31, 2005, are as follows:

10

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, 2004:

11

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, through its subsidiary bank, 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’s subsidiary bank 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’s subsidiary bank also offers limited overdraft protection as a non-contractual courtesy which is available to individually/jointly owned accounts in good standing for personal or household use. The Company reserves the right to discontinue this service without prior notice. The available amount of overdraft protection on depositors’ accounts at March 31, 2005 totaled $6,500. The total average daily balance of overdrafts used in 2005 was $120 , or less than 2% of the total aggregate overdraft protection available to depositors.

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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:

     There are $80 in mortgage loans held for sale included in 1-4 family residential mortgages as of March 31, 2005, and none at December 31, 2004. 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 March 31, 2005 and December 31, 2004:

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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 three months ended March 31, 2005 and 2004.

     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 March 31, 2005 the recorded investment in impaired loans was $2,965 while the related portion of the allowance for loan losses was $1,374. At December 31, 2004, there were $2,985 in loans considered impaired while the allocated portion of the allowance for loan losses for such loans was $1,355.

     Loans in the amount of $7,749 as of March 31, 2005, and $5,622 as of December 31, 2004, 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.

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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 March 31, 2005 and March 31, 2004:

     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; the cash flow coverage and trends evidenced by financial information supplied by customers; the nature and estimated value of any collateral supporting specific loan credits; risk classifications determined by the Company’s loan review systems or as the result of the regulatory examination process; and general economic conditions in the lending area of the Company’s bank subsidiary. Key risk factors and assumptions are dynamically updated to reflect actual experience and changing circumstances.

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CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

     The Company maintains an allowance for losses on unfunded commercial lending commitments to provide for the risk of loss inherent in these arrangements. The allowance is computed using a methodology similar to that used to determine the allowance for loan losses. This allowance is reported as a liability on the balance sheet within accrued expenses and other liabilities, while the corresponding provision for these losses is recorded as a component of other expense.

     Certain asset-specific loans are evaluated individually for impairment, based on management’s best estimate of discounted cash repayments and the anticipated proceeds from liquidating collateral. The actual timing and amount of repayments and the ultimate realizable value of the collateral may differ from management’s estimates.

     The expected loss for certain other commercial credits utilizes internal risk ratings. These loss estimates are sensitive to changes in the customer’s risk profile, the realizable value of collateral, other risk factors and the related loss experience of other credits of similar risk. Consumer credits generally employ statistical loss factors, adjusted for other risk indicators, applied to pools of similar loans stratified by asset type. These loss estimates are sensitive to changes in delinquency status and shifts in the aggregate risk profile.

5.) Legal Proceedings:

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

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. Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the applicable period.

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CORTLAND BANCORP AND SUBSIDIARIES

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

(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 2004 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 these policies and related methodologies are more

17

CORTLAND BANCORP AND SUBSIDIARIES

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

(Dollars in thousands)

critical than others. There has been no material change in critical accounting estimates since those presented in the 2004 annual report on Form 10-K.

Liquidity

     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 remained relatively stable compared to levels at year-end 2004 and March 31, 2004. Operating activities provided cash of $1,887 and $1,013 during the three months ended March 31, 2005 and 2004, respectively. Key differences stem mainly from: 1) an increase in net income of $117 compared to March 31, 2004; 2) loans held for sale increased by $80 at March 31, 2005 as compared to a decrease of $103 at March 31, 2004, which favorably impacted the proceeds and gains on loans realized in 2004; 3) the net increase in securities to settle in March 2004 was $174, while in March 2005 there was a net increase of $1,157; 4) $302 gains on sale of investments was realized in 2005 as compared to $232 in 2004; 5) amortization on securities was $270 in 2005 compared to $405 in 2004; and 6) loss on the sale of other real estate totaled $116 in 2004 and none in 2005. Refer to the Consolidated Statements of Cash Flows for a summary of the sources and uses of cash for March 31, 2005 and 2004, and the following table which details the cash flows from operating activities.

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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 2.8% for the three months ended March 31, 2005 and 2.2% for the three months ended March 31, 2004. 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 (2.7)%. 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.

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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 March 31, 2005 and December 31, 2004.

     Assets, less intangibles and the net unrealized market value adjustment of investment securities available for sale, averaged $440,493 for the three months ended March 31, 2005 and $442,428 for the year ended December 31, 2004.

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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 March 31, 2005 and December 31, 2004. As of those dates, Cortland Bancorp was “well capitalized” under regulatory prompt corrective action provisions.

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CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

First Three Months of 2005 as Compared to First Three Months of 2004

     During the first three months of 2005, net interest income after provision for loan losses increased by $45 compared to the first three months of 2004. Total interest income increased by $121 or 2.2%, from the level recorded in 2004. This was accompanied by an increase in interest expense of $39 or 2.0%, and an increase in the provision for loan losses of $37. On a fully taxable equivalent basis, net interest income after provision for loan losses increased by $10.

     The increase in net income was the product of a 1.7% year-over-year increase in average earning assets. The Company’s tax equivalent net interest margin for the first three months of both 2005 and 2004 measured 3.8%.

     The average rate paid on interest sensitive liabilities increased by 5 basis points year-over-year. The average balance of interest sensitive liabilities increased by $2,889 or 0.9%. Compared to the first three months of last year, average borrowings decreased by $940 while the average rate paid on borrowings increased by 38 basis points.

     Average interest-bearing demand deposits and money market accounts increased by $1,201, while savings increased by $799. The average rate paid on these products increased by 6 basis points in the aggregate. The average balance on time deposit products increased by $1,829, as the average rate paid decreased by 4 basis points, from 3.44% to 3.40%.

     Interest and dividend income on securities registered an increase of $80, or 3.3%, during the first three months of 2005 when compared to 2004, while on a fully tax equivalent basis income on investment securities increased by $41 or 1.5%. The average invested balances increased by $4,062 from the levels of a year ago. The increase in the average balance of investment securities was accompanied by a 2 basis point decline in the tax equivalent yield of the portfolio.

     Interest and fees on loans increased by $31, or 1.0%, for the first three months of 2005 compared to 2004,while on a fully tax equivalent basis income on loans increased by $34 or 1.1%. A $2,230 increase in the average balance of the loan portfolio, or 1.2%, was accompanied by a 4 basis point increase in the portfolio’s tax equivalent yield.

     Other interest income increased by $10 from the same period a year ago. The average balance of Federal Funds sold and other money market funds increased by $472, or 25.5%. The yield on federal funds increased by 156 basis points compared to the same period of 2004.

     The composite tax equivalent yield on earning assets increased by 1 basis point from the same quarter a year ago. The tax equivalent yield of the investment portfolio measured 5.1%, a 2 basis point decrease from the same quarter a year ago, while the loan portfolio yielded 6.5%, up 4 basis points from last year’s rate. Meanwhile, the rate paid on interest-bearing liabilities increased 5 basis points compared to a year ago. The average rate on federal funds sold and other money market funds was 2.5 % up 156 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%.

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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 increased by $172 from the same period a year ago. Gains on 1-4 residential mortgage loans sold in the secondary mortgage market decreased by $2 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 $70 from year ago levels. Fees for other customer services increased by $12. In the first three months of 2004, losses on other real estate owned of $116 were recorded with none in the similar period of 2005. Other sources of non-recurring non-interest income decreased by $24 from the same period a year ago. This income category is subject to fluctuation due to nonrecurring items.

     Loans net of the allowance for losses decreased by $608 during the 12-month period from March 31, 2004 to March 31, 2005, and increased by $3,791 from year-end. Gross loans as a percentage of earning assets stood at 47.1% as of March 31, 2005 and 47.8% at March 31, 2004. The loan to deposit ratio at the end of the first three months of 2005 was 57.5% and 58.3% for the same period a year ago. The investment portfolio represented 63.8% of each deposit dollar, up from 62.5% a year ago.

     Loan charge-offs during the first three months were $46 in 2005 compared to $44 in 2004, while the recovery of previously charged-off loans amounted to $39 in 2005 compared to $20 in 2004. A provision for loan loss of $112 was charged to operations in 2005 and $75 in 2004. Non-accrual loans at March 31, 2005 represented 1.9% of the loan portfolio and 1.8% at December 31, 2004. At March 31, 2005, the loan loss allowance of $2,734 represented approximately 1.4% of outstanding loans.

     Total other expenses in the first three months were $2,950 in 2005 compared to $2,957 in 2004, a decrease of $7, or 0.2%. Full time equivalent employment during the first three months averaged 160 employees in 2005, a 3.0% decrease from the 165 employed in the same period of 2004. Salaries and benefits increased by $5, or 0.3%, compared to the similar period a year ago.

     For the first three months of 2005, state and local taxes decreased by $10 or 6.7%. Occupancy and equipment expense decreased by $9 or 1.9%. Office supplies decreased by $6. Marketing expense decreased by $15. All other expense categories increased by 5.3%, or $28 as a group. This expense category is subject to fluctuation due to nonrecurring items.

     Income before income tax expense amounted to $1,584 for the first three months of 2005 compared to $1,360 for the similar period of 2004. The effective tax rate for the first three months was 20.5% in 2005 compared to 16.1% in 2004, resulting in income tax expense of $326 and $219, respectively. The increase in the effective tax rate reflects an increase in taxable income, while income exempt from taxation from all sources decreased by $76. 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: