1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
------------------
Commission file number 0-13814
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Cortland Bancorp
- --------------------------------------------------------------------------------
(Exact name of registrant as specified in its charter)
Ohio 34-1451118
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(State or other jurisdiction of (I.R.S. Employer Identification
incorporation or organization) Number)
194 West Main Street, Cortland, Ohio 44410
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(Address of principal executive offices) (Zip Code)
(330) 637-8040
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(Registrant's telephone number, including area code)
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
--- ---
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.
Class Outstanding at November 9, 1998
----- -------------------------------
Common Stock, No Par Value 3,462,612 Shares
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2
PART I - FINANCIAL INFORMATION
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Item 1. Financial Statements (Unaudited)
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Cortland Bancorp and Subsidiaries:
Consolidated Balance Sheets - September 30,
1998 and December 31, 1997 2
Consolidated Statements of Income - Nine
months ended September 30, 1998 and 1997 3
Consolidated Statement of Shareholders'
Equity - Nine months ended September 30, 1998 4
Consolidated Statements of Cash Flows -
Nine months ended September 30, 1998 and 1997 5
Notes to Consolidated Financial Statements -
September 30, 1998 6 - 15
Item 2. Management's Discussion and Analysis of
- ------- ---------------------------------------
Financial Condition and Results of Operations 16 - 25
---------------------------------------------
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings 26
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Item 2. Changes in Securities 26
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Item 3. Defaults Upon Senior Securities 26
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Item 4. Submission of Matters to a Vote of Security Holders 26
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Item 5. Other Information 26
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Item 6. Exhibits and Reports on Form 8-K 27
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Signatures 28
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3
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
SEPTEMBER 30, DECEMBER 31,
1998 1997
------------------------ -----------------------
ASSETS
Cash and due from banks $ 9,608 $ 9,509
Federal Funds sold 4,000 3,100
------------------------ -----------------------
Total cash and cash equivalents 13,608 12,609
------------------------ -----------------------
Investment securities available for sale (Note 3) 115,339 115,413
Investment securities held to maturity (approximate market
value of $65,030 in 1998 and $73,684 in 1997) (Note 3) 63,868 73,183
Total loans (Note 4) 197,429 184,491
Less allowance for loan losses (Note 4) (3,029) (2,817)
------------------------ -----------------------
Net loans 194,400 181,674
------------------------ -----------------------
Premises and equipment 5,570 5,744
Other assets 4,684 4,139
------------------------ -----------------------
Total assets $397,469 $392,762
======================== =======================
LIABILITIES
Noninterest-bearing deposits $ 45,782 $ 45,652
Interest-bearing deposits 273,991 274,086
------------------------ -----------------------
Total deposits 319,773 319,738
------------------------ -----------------------
Federal Home Loan Bank advances and other borrowings 29,869 30,814
Other liabilities 3,249 2,001
------------------------ -----------------------
Total liabilities 352,891 352,553
------------------------ -----------------------
Commitments and contingent liabilities (Notes 4 & 5)
SHAREHOLDERS' EQUITY
Common stock - $5.00 stated value - authorized
5,000,000 shares; issued 3,467,226 shares
in 1998 and 3,414,711 in 1997 (Note 6) 17,335 17,073
Additional paid-in capital (Note 6) 2,641 1,928
Retained earnings 23,455 20,429
Accumulated other comprehensive income 1,220 779
Treasury stock, at cost, 3,697 shares (73) 0
------------------------ -----------------------
Total shareholders' equity 44,578 40,209
------------------------ -----------------------
Total liabilities and shareholders' equity $397,469 $392,762
======================== =======================
See accompanying notes to consolidated financial statements
of Cortland Bancorp and Subsidiaries
2
4
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
(AMOUNTS IN THOUSANDS, EXCEPT SHARE DATA)
THREE NINE
MONTHS ENDED MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ------------------------
1998 1997 1998 1997
------ ------ ------- -------
INTEREST INCOME
Interest and fees on loans $4,355 $4,076 $12,931 $11,834
Interest and dividends on investment securities:
Taxable interest income 1,104 1,540 3,728 4,696
Nontaxable interest income 356 194 902 571
Dividends 61 67 187 181
Interest on mortgage-backed securities 1,234 1,267 3,689 3,745
Other interest income 60 52 172 130
------ ------ ------- -------
Total interest income 7,170 7,196 21,609 21,157
------ ------ ------- -------
INTEREST EXPENSE
Deposits 2,824 3,037 8,560 9,037
Borrowed funds 427 362 1,265 906
------ ------ ------- -------
Total interest expense 3,251 3,399 9,825 9,943
------ ------ ------- -------
Net interest income 3,919 3,797 11,784 11,214
Provision for loan losses 125 0 325 0
------ ------ ------- -------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 3,794 3,797 11,459 11,214
------ ------ ------- -------
OTHER INCOME
Fees for other customer services 356 328 1,029 955
Investment securities gains - net 123 15 192 46
Trading securities gains - net 0 13 0 13
Gain on sale of loans - net 47 30 93 40
Other non-interest income 39 34 160 144
------ ------ ------- -------
Total other income 565 420 1,474 1,198
------ ------ ------- -------
OTHER EXPENSES
Salaries and employee benefits 1,399 1,421 4,161 4,184
Net occupancy expense 190 180 559 508
Equipment expense 278 249 835 792
State and local taxes 141 128 424 393
Office supplies 120 110 354 341
Marketing expense 63 66 215 189
Legal and litigation expense 46 45 142 140
Other operating expenses 367 346 1,057 941
------ ------ ------- -------
Total other expenses 2,604 2,545 7,747 7,488
------ ------ ------- -------
INCOME BEFORE FEDERAL INCOME TAXES 1,755 1,672 5,186 4,924
Federal income taxes 480 516 1,471 1,524
------ ------ ------- -------
NET INCOME $1,275 $1,156 $ 3,715 $ 3,400
====== ====== ======= =======
BASIC EARNINGS PER COMMON SHARE (NOTE 6) $0.37 $0.34 $1.08 $1.00
====== ====== ======= =======
DILUTED EARNINGS PER COMMON SHARE (NOTE 6) $0.37 $0.34 $1.08 $1.00
====== ====== ======= =======
See accompanying notes to consolidated financial statements
of Cortland Bancorp and Subsidiaries
3
5
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (UNAUDITED)
(AMOUNTS IN THOUSANDS)
TOTAL
ADDITIONAL ACCUMULATED SHARE-
COMMON PAID-IN RETAINED TREASURY COMPREHENSIVE HOLDERS
STOCK CAPITAL EARNINGS STOCK INCOME EQUITY
------- ---------- -------- -------- ------------- -------
BALANCE AT JANUARY 1, 1998 $ 5,691 $13,310 $20,429 $ 779 $40,209
Adjustment for the effect of
3-for-1 common stock split 11,382 (11,382)
BALANCE AT JANUARY 1, 1998 ------- ---------- -------- -------- ------------- -------
RESTATED 17,073 1,928 20,429 779 40,209
------- ---------- -------- -------- ------------- -------
Comprehensive Income:
Net income 3,715 3,715
Other comprehensive income,
net of tax:
Unrealized gains on available-
for-sale securities, net of
reclassification adjustment 441 441
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Total comprehensive income 4,156
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Common stock transactions:
Shares sold 262 713 975
Treasury shares purchased (73) (73)
Cash dividends declared
($0.20 per share) (689) (689)
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BALANCE AT SEPTEMBER 30, 1998 $17,335 $ 2,641 $23,455 ($73) $1,220 $44,578
======= ========== ======== ======== ============= =======
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 478
Less: Reclassification adjustment
for net gains realized in net income 37
Net unrealized gains on available- -------------
for-sale securities, net of tax 441
=============
See accompanying notes to consolidated financial statements
of Cortland Bancorp and Subsidiaries
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6
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(AMOUNTS IN THOUSANDS)
FOR THE
NINE MONTHS ENDED
SEPTEMBER 30,
---------------------
1998 1997
-------- --------
NET CASH FLOWS FROM OPERATING ACTIVITIES $ 3,100 $5,404
CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities held to maturity (20,030) (9,141)
Purchases of securities available for sale (24,457) (29,043)
Proceeds from sales of securities available for sale 3,947 16,194
Proceeds from call, maturity and principal
payments on securities 50,410 28,616
Net increase in loans made to customers (10,817) (15,239)
Proceeds from disposition of other real estate 0 12
Purchase of premises and equipment (457) (503)
-------- --------
Net cash flows from investing activities (1,404) (9,104)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase (decrease) in deposit accounts 35 (3,662)
Net increase (decrease) in borrowings (945) 6,135
Proceeds from sale of common stock 975 991
Dividends paid on common stock (689) (548)
Purchase of treasury stock (73) 0
-------- --------
Net cash flows from financing activities (697) 2,916
-------- --------
NET CHANGE IN CASH AND CASH EQUIVALENTS 999 (784)
CASH AND CASH EQUIVALENTS
Beginning of period 12,609 10,083
-------- --------
End of period $13,608 $9,299
======== ========
SUPPLEMENTAL DISCLOSURES
Interest paid $ 9,906 $9,909
Income taxes paid $ 1,544 $1,419
See accompanying notes to consolidated financial statements
of Cortland Bancorp and Subsidiaries
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7
CORTLAND BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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(Dollars in thousands)
1.) Management Representation:
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, 1998
are not necessarily indicative of the results that may be expected for the year
ending December 31, 1998. 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, 1997.
2.) Reclassifications:
Certain items contained in the 1997 financial statements have been
reclassified to conform with the presentation for 1998. 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.
6
8
CORTLAND BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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(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, 1998 September 30, 1998
------------------ ------------------
Proceeds on securities sold $ 2,998 $ 3,947
Gross realized gains 1 32
Gross realized losses 0 0
Proceeds on securities called $ 6,730 $13,841
Gross realized gains 123 161
Gross realized losses 1 1
Securities available for sale, carried at fair value, totalled $115,339
at September 30, 1998 and $115,413 at December 31, 1997 representing 64.4% and
61.2%, respectively, of all investment securities. These levels were deemed to
provide an adequate level of liquidity in management's opinion.
Investment securities with a carrying value of approximately $27,755 at
September 30, 1998 and $33,191 at December 31, 1997 were pledged to secure
deposits and for other purposes.
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9
CORTLAND BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
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(Dollars in thousands)
The amortized cost and estimated market value of debt securities at
September 30, 1998, 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 $ 15,832 $ 15,971
Due after one year
through five years 21,445 21,962
Due after five years
through ten years 8,497 8,666
Due after ten years 5,075 5,092
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50,849 51,691
Mortgage-backed Securities 58,419 59,534
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$109,268 $111,225
========== ===========
INVESTMENT SECURITIES AMORTIZED ESTIMATED
HELD TO MATURITY COST FAIR VALUE
---------- -----------
Due in one year or less $ 7,453 $ 7,544
Due after one year
through five years 7,958 8,135
Due after five years
through ten years 14,748 15,121
Due after ten years 13,892 14,150
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44,051 44,950
Mortgage-backed Securities 19,817 20,080
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$ 63,868 $ 65,030
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10
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, 1998, are as follows:
INVESTMENT GROSS GROSS ESTIMATED
SECURITIES AVAILABLE AMORTIZED UNREALIZED UNREALIZED FAIR
FOR SALE COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
U.S. Treasury
securities $ 23,743 $ 511 $ 0 $ 24,254
U.S. Government
agencies and
corporations 16,168 219 3 16,384
Obligations of states
and political
subdivisions 10,938 151 36 11,053
Mortgage-backed and
related securities 58,419 1,157 42 59,534
--------- ---------- ---------- ---------
Total 109,268 2,038 81 111,225
Marketable equity
securities 2,171 136 158 2,149
Other securities 1,965 0 0 1,965
--------- ---------- ---------- ---------
Total available
for sale $113,404 $ 2,174 $ 239 $115,339
========= ========== ========== =========
INVESTMENT GROSS GROSS ESTIMATED
SECURITIES HELD AMORTIZED UNREALIZED UNREALIZED FAIR
TO MATURITY COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
U.S. Government
agencies and
corporations $ 22,570 $ 363 $ 2 $ 22,931
Obligations of states
and political
subdivisions 21,481 546 8 22,019
Mortgage-backed and
related securities 19,817 269 6 20,080
--------- ---------- ---------- ---------
Total held to
maturity $ 63,868 $ 1,178 $ 16 $ 65,030
========= ========== ========== =========
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11
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, 1997:
INVESTMENT GROSS GROSS ESTIMATED
SECURITIES AVAILABLE AMORTIZED UNREALIZED UNREALIZED FAIR
FOR SALE COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
U.S. Treasury
securities $ 29,855 $ 299 $ 20 $ 30,134
U.S. Government
agencies and
corporations 18,867 212 1 19,078
Obligations of states
and political
subdivisions 7,103 70 1 7,172
Mortgage-backed and
related securities 54,241 873 82 55,032
--------- ---------- ---------- ---------
Total 110,066 1,454 104 111,416
Marketable equity
securities 2,171 166 214 2,123
Other securities 1,874 1,874
--------- ---------- ---------- ---------
Total available
for sale $114,111 $ 1,620 $ 318 $115,413
========= ========== ========== =========
INVESTMENT GROSS GROSS ESTIMATED
SECURITIES HELD AMORTIZED UNREALIZED UNREALIZED FAIR
TO MATURITY COST GAINS LOSSES VALUE
--------- ---------- ---------- ---------
U.S. Government
agencies and
corporations $ 39,448 $ 246 $ 83 $ 39,611
Obligations of states
and political
subdivisions 13,867 193 34 14,026
Mortgage-backed and
related securities 19,868 200 21 20,047
--------- ---------- ---------- ---------
Total held to
maturity $ 73,183 $ 639 $ 138 $ 73,684
========= ========== ========== =========
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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 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,
1998 1997
------------- ------------
Financial instruments whose contract
amount represents credit risk:
Commitments to extend credit:
Fixed rate $ 7,724 $ 6,241
Variable 25,368 36,774
Standby letters of credit 378 361
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.
11
13
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 its immediate lending area. The following represents the
composition of the loan portfolio:
September 30, December 31,
1998 1997
------------- ------------
1-4 family residential mortgages 43.9% 43.1%
Commercial mortgages 28.4% 27.1%
Consumer loans 9.7% 10.3%
Commercial loans 13.4% 14.1%
Home equity loans 4.6% 5.4%
Included in 1-4 family residential mortgages as of September 30, 1998
are $3,990 of mortgage loans held for sale in the secondary market. Loans held
for sale at December 31, 1997 totaled $1,756.
The following table sets forth the aggregate balance of underperforming
loans for each of the following categories at September 30, 1998 and December
31, 1997:
September 30, December 31,
1998 1997
------------ ------------
Loans accounted for on a
nonaccrual basis $2,443 $1,653
Loans contractually past due
90 days or more as to
interest or principal
payments (not included in
nonaccrual loans above) 3 10
Loans considered troubled debt
restructurings (not included
in nonaccrual loans or loans
contractually past due above) 165 173
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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 as of
September 30, 1998.
Gross interest income that would have been recorded if the loans had been
current in accordance with
their original terms $251
Interest income actually included in income on
the loans 98
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 charged-off, any
interest that has been accrued and 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, 1998, the
recorded investment in impaired loans was $768 while the related portion of the
allowance for loan losses was $138.
As of September 30, 1998, there were $293 in loans, not included in the
above categories and not considered impaired, but which can be considered
potential problem loans. The Small Business Administration has guaranteed $215
of this total.
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.
13
15
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
nine month periods ended September 30, 1998 and 1997:
1998 1997
------ ------
Balance at beginning of period $2,817 $2,966
Loan charge-offs:
1-4 family residential mortgages 4 9
Commercial mortgages 0 10
Consumer loans 129 120
Commercial loans 46 0
Home equity loans 1 12
------ ------
180 151
------ ------
Recoveries on previous loan losses:
1 - 4 family residential mortgages 0 1
Commercial mortgages 0 0
Consumer loans 61 60
Commercial loans 6 7
Home equity loans 0 5
------ ------
67 73
------ ------
Net loan losses 113 78
Provision charged to operations 325 0
------ ------
Balance at end of period $3,029 $2,888
------ ------
Ratio of annualized net charge-offs to
average net loans outstanding 0.08% 0.06%
====== ======
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
anticipated impact of Year 2000 problems on certain commercial customers, the
quality of financial information supplied by customers and the general economic
condition present in the lending area of the Company's bank subsidiary.
14
16
CORTLAND BANCORP AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
------------------------------------------------------
(Dollars in thousands except per share data)
5.) Legal Proceedings:
The Company's subsidiary bank was a defendant in a class action lawsuit
FRANK SLENTZ, ET AL. V. CORTLAND SAVINGS AND BANKING COMPANY, involving
purchased interests in two campgrounds.
On October 20, 1997 the judge presiding over this case filed a judgment
entry dismissing all claims against the Bank without prejudice. The judgment was
appealed by the plaintiffs. The ultimate outcome of this litigation presently
cannot be determined, and therefore no provision for any liability relative to
such litigation has been made in the accompanying consolidated financial
statements.
The Bank is also involved in other legal actions arising in the
ordinary course of business. In the opinion of management, the outcome of these
matters is 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.
THREE MONTHS ENDED NINE MONTHS ENDED
SEPTEMBER 30, SEPTEMBER 30,
---------------------- ----------------------
1998 1997 1998 1997
-------- -------- -------- --------
Net Income $ 1,275 $ 1,156 $ 3,715 $ 3,400
Average common
shares outstanding * 3,464,862 3,413,115 3,453,362 3,393,242
Basic earnings per share * $0.37 $0.34 $1.08 $1.00
Diluted earnings per share * $0.37 $0.34 $1.08 $1.00
(*) On April 14, 1998, the Company's Board of Directors approved a
three-for-one common stock split which was paid May 15 to shareholders of record
as of April 25, 1998. Average shares outstanding and resultant per share amounts
have been restated to give retroactive effect to both the 3% stock dividend of
January 1, 1998, and the three-for-one stock split of May 15, 1998.
Common stock issued and additional paid-in capital have been restated
for the aforementioned stock split for both September 30, 1998 and December 31,
1997.
15
17
CORTLAND BANCORP AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ----------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS
-----------------------------------
(Dollars in thousands)
Note Regarding Forward-looking Statements
- -----------------------------------------
In addition to historical information contained herein, the following
discussion may contain forward-looking statements that involve risks and
uncertainties. 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 nationally or in the
Company's market area; 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 market
volatility; unforeseen risks associated with the Year 2000 issue.
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 increased $999 compared to year end 1997.
Operating activities provided cash of $3.1 million and $5.4 million during the
nine months ended September 30, 1998 and 1997, respectively. Refer to the
Consolidated Statements of Cash Flows for a summary of the sources and uses of
cash for September 30, 1998 and 1997.
16
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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. Internal capital generation
was 8.6% for the nine months ended September 30, 1998, as compared to 10.7% for
the like period during 1997. Overall during the first nine months of 1998,
capital grew at the annual rate of 14.5%, a figure which reflects earnings,
dividends paid, common stock issued, treasury shares purchased and the net
change in the estimated fair value of available for sale securities.
During the first nine months of 1998, the Company issued 52,516 shares
of common stock (restated for the 3-for-1 common stock split effective May 15,
1998) which resulted in proceeds of $975. Of the 52,516 shares issued, 46,887
shares were issued through the Company's dividend reinvestment plan. The
remaining 5,629 shares were issued through the subsidiary bank's 401-k Plan,
which offers employees the opportunity to invest in the common stock of the
Company as one of several participant directed investment alternatives.
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.
17
19
CORTLAND BANCORP AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ----------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-----------------------------------------------
(Dollars in thousands)
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
net unrealized loss on equity securities with readily determinable fair values
and intangible assets. 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.
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 nontraditional 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, 1998 and December 31, 1997.
September 30, 1998 December 31, 1997
------------------ -----------------
Tier 1 Capital $ 42,907 $ 38,933
Tier 2 Capital 2,481 2,326
------------------ -----------------
TOTAL QUALIFYING
CAPITAL $ 45,388 $ 41,259
================== =================
Risk Adjusted
Total Assets (*) $197,959 $185,571
Tier 1 Risk-Based
Capital Ratio 21.67% 20.98%
Total Risk-Based
Capital Ratio 22.93% 22.23%
Tier 1 Risk-Based
Capital to Average Assets
(Leverage Capital Ratio) 10.93% 10.17%
(*) Includes off-balance sheet exposures.
18
20
CORTLAND BANCORP AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ----------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-----------------------------------------------
(Dollars in thousands)
Assets, less intangibles and the net unrealized market value adjustment
of investment securities available for sale, averaged $392,723 for the nine
months ended September 30, 1998 and $382,785 for the year ended December 31,
1997.
First Nine Months of 1998 as Compared to First Nine Months of 1997
- ------------------------------------------------------------------
During the first nine months of 1998, net interest income after
provision for loan losses increased by $245 compared to the first nine months of
1997. Total interest income increased by $452 or 2.1% from the level recorded in
1997. This was accompanied by a decrease in interest expense of $118 or 0.1%,
and a provision for loan loss of $325 in 1998 compared to no provision
requirement in 1997.
The average rate paid on interest sensitive liabilities declined by 8
basis points year-over-year. The average balance of interest sensitive
liabilities increased by $2,142 or 0.7%, primarily reflecting a $9,562 increase
in average borrowings from the Federal Home Loan Bank and a $6,531 decrease in
large certificates of deposit (amounts of $100,000 of more).
Interest and dividend income on securities registered a decrease of
$687 or 7.4% during the first nine months of 1998 when compared to 1997. The
average invested balances declined by 4.4%, decreasing by $8,261 over the levels
of a year ago. The decrease in the average balance of investment securities was
accompanied by an 11 basis point decrease in the portfolio yield.
Interest and fees on loans increased by $1,097 for the first nine
months of 1998 compared to 1997, representing the net effect of a $14,052
increase in the average balance of the loan portfolio. This 7.9% year-over-year
increase was accompanied by a 13 basis point decline in yield.
Other interest income increased by $42 from the same period a year ago
due to an increase in the average balance of Federal Funds sold, which increased
by $949. The yield increased by 1 basis point reflecting a steady Fed policy
over the past year.
19
21
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 $276 from the same period a
year ago. Gains on 1-4 residential mortgage loans in the secondary mortgage
market increased by $53 from the same period a year ago, reflecting favorable
market conditions and an increased allocation of resources to this activity.
With interest rates significantly lower than a year ago, gains on securities
called and gains on the sale of available for sale investment securities showed
an increase of $146 from year ago levels. Fees for other customer services
increased by $74, while other sources of non-interest income increased by $3
from the same period a year ago.
Loan charge-offs during the first nine months were $180 in 1998 and
$151 in 1997, while the recovery of previously charged-off loans amounted to $67
in 1998 compared to $73 in 1997. A provision for loan loss of $325 was charged
to operations in 1998, compared to no provision charged in 1997. The provision
was booked due to increased loan volume and concerns related to certain specific
credits. At September 30, 1998, the loan loss allowance of $3,029 represented
1.5% of outstanding loans. Non accrual loans at September 30, 1998 represented
1.2% of the loan portfolio compared to 0.9% at December 31, 1997.
Total other expenses in the first nine months were $7,747 in 1998
compared to $7,488 in 1997, an increase of $259 or 3.5%. Full time equivalent
employment during the first nine months averaged 186 employees in 1998, a 5.6%
decline from the 197 in 1997. Salaries and benefits decreased by $23 over the
similar period a year ago.
For the first nine months of 1998, state and local taxes increased by
$31 or 7.9%. Occupancy and equipment expense increased by $94 or 7.2%. All other
expense categories increased by 9.7% or $157 as a group. 1998 expenses include
the newest branch office of the Company's Bank subsidiary which opened late in
the third quarter of 1997. Commencing with the third quarter of 1998, other
operating expenses include quarterly costs of $38 related to the outsourcing of
the internal audit function. Also included are non recurring costs in the amount
of $35 associated with the three-for-one common stock split, and $25 related to
development and introduction costs for a new deposit product.
20
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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)
Income before income tax expense amounted to $5,186 for the first nine
months of 1998 compared to $4,924 for the similar period of 1997. The effective
tax rate for the first nine months was 28.4% in 1998 compared to 31.0% in 1997,
resulting in income tax expense of $1,471 and $1,524, respectively. Net income
for the first nine months registered $3,715 in 1998 compared to $3,400 in 1997,
representing an 8.0% increase in per share amounts from the $1.00 earned in 1997
to the $1.08 recorded in 1998.
Third Quarter of 1998 as compared to Third Quarter 1997
- -------------------------------------------------------
During the third quarter of 1998 net interest income, after provision
for loan loss but before adjustment for the effect of tax exempt income,
decreased by $3 as compared to third quarter 1997. Average earning assets
increased by 2.5% while average interest-bearing liabilities were unchanged.
Average loans exhibited growth of 10.4%, while average investments declined by
5.4%.
The tax equivalent yield on earning assets decreased by 14 basis points
from the same quarter a year ago. The tax equivalent yield of the investment
portfolio measured 6.5%, a 16 basis point decline from the same quarter a year
ago, while the loan portfolio yielded 8.9%, down 29 basis points from last
year's rate. Meanwhile, the rate paid on interest-bearing liabilities decreased
20 basis points compared to a year ago. The net effect of these changes was that
the tax equivalent net interest margin increased to 4.3%, an increase of 11
basis points from that achieved during last year's third quarter.
Loans increased by $1,586 during the period. Loans as a percentage of
earning assets stood at 51.9% as of September 30, 1998 as compared to 47.8% on
September 30, 1997. The loan to deposit ratio at the end of the first nine
months of 1998 was 61.7% compared to 57.0% at the end of the same period a year
ago. The investment portfolio represented 56.0% of each deposit dollar, down
from 59.4% a year ago.
Loan charge-offs during the third quarter were $79 in 1998 up from $48
in 1997, due to one problem commercial loan. The recovery of previously
charged-off loans amounted to $24 during the third quarter of 1998 compared to
$28 in the same period of 1997.
21
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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 for the quarter increased by $145 or 25.7% compared to the
same period a year ago. The favorable mortgage rate environment was evidenced by
a net gain on sales of loans of $47 compared to the $30 generated a year ago.
Net gains on investment and trading securities transactions netted $123 while a
$15 gain was recorded in 1997.
Total other expenses in the third quarter were $2,604 in 1998 and
$2,545 in 1997, an increase of $59 or 2.3%. Employee salaries and benefits
decreased by $22 or 1.5%. Occupancy and equipment expense increased by $39 or
9.1%, primarily reflecting the Company's newest branch office opened in the
third quarter of 1997. Other expenses as a group increased by $42, or 6.0%
compared to the same period last year, and included quarterly costs of $38
related to the outsourcing of the internal audit function which commenced with
the third quarter of 1998.
Income before tax for the quarter increased by 5.0% to $1,755 in 1998
from the $1,672 recorded in 1997. Net income for the quarter of $1,275
represented a 10.3% increase from the $1,156 earned a year ago.
New Accounting Standards
- ------------------------
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards (SFAS) No. 130, "Reporting Comprehensive Income". This
statement establishes standards for reporting the components of comprehensive
income and requires that all items that are required to be recognized under
accounting standards as components of comprehensive income be included in a
financial statement that is displayed with the same prominence as other
financial statements. Comprehensive income includes net income as well as
certain items that are reported directly within a separate component of
shareholders' equity and bypass net income. Adoption of this standard did not
have a material impact on the Company's financial position or results of
operation.
In June 1998 the Financial Accounting Standards Board issued (SFAS) No. 133
"Accounting for Derivative Instruments and Hedging Activities". This standard is
effective for all fiscal quarters of fiscal years beginning after June 15, 1999.
Management does not anticipate that adoption of this standard will have a
material impact on the Company's financial position or results of operation.
22
24
CORTLAND BANCORP AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ----------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-----------------------------------------------
(Dollars in thousands)
Year 2000
- ---------
In 1997, Cortland Bancorp established a "Year 2000 (Y2K) project management
team" to provide a structured format for thoroughly addressing the Year 2000
problem. The project team's mission is to ensure that the Company's operation is
not adversely impacted by systemic errors arising from calculations using the
year 2000 date. At this time the Company expects to expend $650,000 on its Year
2000 program. It is anticipated that approximately 65% of these costs comprise
capital expenditures for normal lifecycle replacement/upgrades for the Company's
information systems, 20% represent capital expenditures directly associated with
Year 2000, and the remaining 15% embrace consulting, testing and other
miscellaneous Year 2000 expenses. As the majority of these costs constitute
normal lifecycle replacement/upgrades for the Company's information systems, it
is anticipated that costs associated with the Year 2000 project will not have a
material adverse impact on net income. As of September 30, 1998 the Company had
spent approximately $10,000 on it's Year 2000 project. The Company expects to
have expended approximately $420,000 by December 31, 1998 to ensure Y2K
readiness.
In conjunction with the May 5, 1997 Federal Financial Institutions
Examination Council Interagency Statement, the Company has outlined key phases,
and important aspects, essential for effective Year 2000 project management. An
overview of these phases and their completion status are as follows:
AWARENESS (100% COMPLETE): Outline the Year 2000 problem, gaining executive
level support for the resources to perform compliance work. Establish a
Year 2000 project team and develop an overall plan to perform Y2K compliance
work that encompasses vendors, customers, suppliers, correspondent banks,
service bureaus, The Federal Reserve, insurance providers, manufacturers and
distributors of information systems and related equipment.
ASSESSMENT (100% COMPLETE): Assess the size and complexity of the problem
and detail the magnitude of the effort necessary to address Year 2000 issues.
Identify all hardware, software, networks, ATM's, and other various platforms,
as well as customer and vendor interdependencies affected by the Year 2000 date
change. The assessment includes environmental systems that are dependent on
embedded microchips, such as security equipment, elevators, voice/data
telecommunications and vaults.
23
25
CORTLAND BANCORP AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ----------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-----------------------------------------------
(Dollars in thousands)
RENOVATION (25% COMPLETE): This phase includes hardware and software
upgrades, system replacements, vendor certification, and other associated
changes deemed necessary to assure Y2K compliance. The renovation stage is
expected to be completed by March 31,1999.
VALIDATION (20% COMPLETE): This stage includes the testing of incremental
changes to hardware and software components. In addition to testing upgraded
components, connections with other systems are verified and system performance
evaluated utilizing a variety of key sensitive dates. The Company has completed
the development of test and validation methodoligies, and tested some
subsystems. The validation stage is expected to be essentially complete by
March 31, 1999.
IMPLEMENTATION (15% COMPLETE): Mission critical systems must be certified
as Year 2000 compliant and accepted by the Company. Any noncompliant mission
critical system will be brought to the attention of executive management
immediately for resolution. The Company has formulated contingency plans in the
event that critical applications are determined to be inoperable on or near the
year 2000. These contingency plans are labor intensive and would result in
additional payroll expense until the functionality of the mission critical
applications are restored. For any system failing certification, the business
effect will be assessed and the organization's Year 2000 contingency plans
activated. The implementation stage is expected to be essentially complete by
March 31, 1999.
The Company's personnel are also actively educating and alerting customers
to potential Y2K issues and problems. Loan review personnel have conducted
surveys and made inquiries of key loan customers as to their Y2K readiness to
determine whether any additional provisions to the allowance for loan loss are
required. As of September 30, 1998, no additional provisions were required.
Due to the scope and magnitude of the Year 2000 project, the Company has
designed an extensive monitoring process to oversee the completion of the Year
2000 project with results presented to the Board of Directors on a quarterly
basis. The Company and its bank subsidiary are also regulated by the Federal
Reserve and the State of Ohio, who periodically review the Company's Y2K
readiness, and who have the power and authority to issue sanctions to enforce
Y2K compliance.
24
26
CORTLAND BANCORP AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
- ----------------------------------------------------------
CONDITION AND RESULTS OF OPERATIONS (CONTINUED)
-----------------------------------------------
(Dollars in thousands)
Ultimate success is dependent upon the cooperation and ability of vendors,
customers and all levels of government and governmental agencies to meet the Y2K
challenge. The problem is truly global in nature, and its successful resolution
depends upon everyone, everywhere, doing their part. It is recognized that the
failure of any of these parties to achieve Year 2000 compliance could result in
material additional expense to the Company, including possible litigation. The
Company currently believes that the reasonably "worst case" Y2k scenario
involves the failure of utilities and governments to achieve Y2K compliance,
causing a general disruption of commerce resulting in a material increase in
nonperforming loans and credit losses, accompanied by a lack of liquidity due to
financial market dysfunctions. The Company's net income would be adversely
impacted by increased operating costs, additional collection and foreclosure
expense, and the effects of a compressed net interest margin. The Company
maintains capital levels significantly in excess of regulatory minimum
guidelines as additional protection in the event of such "worst case" scenarios.
If you would like more information on Cortland Banks Year 2000 efforts,
please e-mail Timothy Carney at www.cbinfo@cortland-banks.com.
25
27
CORTLAND BANCORP AND SUBSIDIARIES
PART II - OTHER INFORMATION
---------------------------
Item 1. Legal Proceedings
- ------- -----------------
See Note (5) of the financial statements.
Item 2. Changes in Securities
- ------- ---------------------
Not applicable
Item 3. Defaults upon Senior Securities
- ------- -------------------------------
Not applicable
Item 4. Submission of Matters to a Vote of Security Holders
- ------- ---------------------------------------------------
None
Item 5. Other Information
- ------- -----------------
As discussed in the Company's Proxy Statement for the 1998 Annual
Meeting of Shareholders, any qualified shareholder of the Company who
intends to submit a proposal to the Company at the 1999 Annual Meeting
of Shareholders must submit such proposal to the Company not later
than November 17, 1998 to be considered for inclusion in the Company's
Proxy Statement and form of Proxy (the "Proxy Materials") relating to
that meeting. If a shareholder intends to present a proposal at the
1999 Annual Meeting of Shareholders, but has not sought the inclusion
of such proposal in the Company's Proxy Materials, such proposal must
be received by the Company prior to February 1, 1999, or the Company's
management proxies for the 1999 Annual Meeting will be entitled to use
their discretionary voting authority should such proposal then be
raised, without any discussion of the matter in the Company's Proxy
Material.
26
28
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
27. Financial Data Schedule
99. Not applicable
(b) Reports on Form 8-K
-------------------
Not applicable
27
29
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Cortland Bancorp
----------------
(Registrant)
DATED: November 9, 1998 Lawrence A. Fantauzzi
---------------- ---------------------
Controller/Treasurer
(Principal Financial Officer)
DATED: November 9, 1998 Dennis E. Linville
---------------- ------------------
Executive Vice-President,
Secretary and Director
(Duly Authorized Officer)
28