Cortland Bancorp
Annual Report 2007

Plain-text annual report

THE MISSION STATEMENT OF CORTLAND BANKS Cortland Banks' mission is to eam the enthusiastic, long-term Loyalty of customers by being responsive to their needs for products, convenience and personal service in a manner that routinely exceeds expectations. In building long-lasting relationships with our customers, we will generate solid financial returns for our shareholders, rewarding careers for our employees, and economic benefits for our communities. Success in this mission is vital to our continued independence as a community bank. Our success will require relentless focus on identifying and meeting the wants and needs of our constituents, as we demonstrate a genuine caring for customers, employees, shareholders and community. J^LAND CONTENTS Chairman's Message B Brief Description of the Business Report on Management's Assessment of Intemal Control Over Financial Reporting Report of Packer Thomas Independent Registered PubHc Accounting Firm Consolidated Statements of Income Consolidated Balance Sheets Consolidated Statements of Shareholders' Equity Consolidated Statements of Cash Flows Notes to the Consolidated Financial Statements Five Year Summary Average Balance Sheet, Yields and Rates Selected Financial Data Management's Discussion and Analysis Information as to Stock Prices and Dividends of Cortland Bancorp Cortland Bancorp Directors and Officers M Cortland Savings & Banking Directors and Officers Offices and Locations CHAIRMAN'S MESSAGE To Our Shareholders: In a period of economic uncertainty headlined by disruptions in the credit market and an overall weak ening of the mortgage and housing market, 1 am pleased to report that Cortland Bancorp remains a sound and profitable community bank. Our net income for 2007 totaled $4,350,000 or $0.97 per share which represents a return on average assets of 0.89%. Return on average equity measured 8.68%. This level of profitability is below the net income amount reported for the previous year, but in line with peer group measures of 0.87% for retum on average assets and 8.51% for return on average equity. The Company's capital position also remains strong. Capital ratios exceed all regulatory thresholds for capital adequacy, and consistently fall in the upper tiers among all financial institutions in our peer group. OTHER HIGHLIGHTS FOR 2007 INCLUDE: • Our Company's assets topped $500 million during the year, before closing at $492.7 million, an increase of more than 4% from the level reported at year end 2006. • Loans grew more than twice as fast as overall assets, producing an increase of approximately 9% in the loan portfolio, with residential real estate, commercial real estate and consumer loans all reflecting increases in portfolio balances. • The most significant loan growth came in the area of new commercial relationships, with commercial real estate originations increasing by approxi mately 14% from the previous year. • Asset quality improved during the year, as non- performing loans as a percentage of total loans decreased from 1.91 % at year end 2006 to 1.02% at year end 2007. The improvement in asset quality had a direct and positive impact on the Company's net income, as the loan loss provision required decreased from $225,000 in 2006 to $40,000 in 2007. B • The Company repurchased 205,986 shares of its common stock. This Stock Repurchase Program, approved by the Board of Directors in February of 2007, inifially permitted the Company to repur chase up to 100,000 shares. In August, the direc torate increased the authorization by an additional 100,000 shares, and followed that up with an iden tical increase in November. There are 94,014 shares remaining that may yet be purchased under the program. • The Company's dividend payout remains aggres sive as 89.7% of 2007 earnings were distributed to shareholders as cash dividends compared to 84.3% in the prior year. In addition, shareholders contin ued to receive an annual stock dividend as well. • Construction was completed on a new 2,500 square foot full service office in the Village of Windham. Our newest branch facility opened in May of 2007. • The Company's market footprint and physical plant will continue to grow, with the Board of Directors approving to open a fourteenth office in Middlefield. Our newest community banking office is expected to open in May of 2008. • Additionally during 2007, property was purchased in Brookfield to replace an aging rental facility housing our existing branch office. Our Brookfield office will relocate to a newly constructed bank building in June of 2008. • Property was also purchased for a new branch location in southern Mahoning County, and an existing branch office will relocate to this property located in North Lima by the early fall of 2008. • Selection and installation of a customer relation ship management ( CRM ) platform to accommo date growing demand while preserving responsive and personalized service was completed. The CRM platform will enable lenders and customer service personnel to better match customer needs with products and services and facilitate opportu nities to extend or increase credit for business- related accounts. • All of our branches were converted to electronic delivery during the year, eliminating the need to physically transport paper checks. Also during the year a pilot Remote Merchant Capture program was developed with plans for broad-scale intro duction in 2008. • Our Bank continues to give back generously to the communities we serve. Bank employees raised more than $10,000 for Relay for Life. The Bank also finished on top in Second Harvest Food's first- ever bank challenge, providing more in donations than our much larger competitors. The Bank also continued to contribute generously to Children's Rehabilitation, various United Way campaigns, and numerous local non profit organizations. The Board of Directors and I believe that the Com pany has made significant progress in meeting the strategic plan initiatives which I outlined for you last year. While we are proud of our many accomplish ments, and remain optimistic regarding the success of our Strategic Plan, we do realize that these are difficult times for consumers and businesses alike. Deteriorating economic conditions stemming from financial turbulence in the credit and housing mar kets will prove to be a challenge in our efforts to further improve profitability. grow Company assets and In addition to these deteriorating economic condi fions, profitability across the banking industry has been adversely affected by Federal Reserve mone tary policy efforts directed at containing inflation. Banks throughout the region and the nation have reported declining net interest margin ratios. Our own Company's net interest margin ratio narrowed from the 3.67% reported at year end 2006 to 3.45% at year end 2007. To compensate for this margin compression, the Company remains highly focused on asset quality issues, establishing fundamentally sound internal loan controls, maintaining effective and timely nriAND review pracfices, identifying and addressing problem loans on a timely basis, and subscribing to conser vative lending practices and stringent underwriting standards. Both lenders and borrowers have struggled with the consequences of the deteriorating market for resi denfial real estate. Foreclosure acfivity, restructuring of mortgage business units and the building of loan loss reserves have become quite notable in reviewing recent public records and competitor press releases and earning reports. I am pleased to report that, unlike many in the industry, our Company has noted no significant dete rioration in its residential real estate portfolio. As a matter of fact, contrary to general financial industry trends, our Company has experienced improvements in its overall asset quality. This is reflected in the reduction of problem loans, as 1 have previously noted. We are cautiously optimistic that these trends will continue, allowing us to remain an extremely safe and sound financial institution, and contributing to our efforts to improve profitability. In closing, I would like to thank our officers and employees for their many contributions to our suc cess, and to tell them that we are proud of them. For our customers, we wish to thank you for your loyalty and commitment to Cortland Banks and its philos ophy of community banking. Finally, the support and encouragement of our shareholders is sincerely appreciated, for it is what makes everything else possible. Thank you for your investment in Cortland Bancorp. Sincerely, ^ J / f ^ ^ f ^ ^- Karl Ray Mahan Chairman of the Board B BRIEF DESCRIPTION OF THE BUSINESS C O R T L A ND B A N C O RP incorporated Cortland Bancorp (the "Company") was under the laws of the State of Ohio in 1984, as a one bank holding company registered under the Bank Holding Com pany Act of 1956, as amended. 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 authorized by the Gramm-Leach- Bliley Act of 1999. The principal activity ofthe Company is to own, manage and supervise the Cortland Savings and Banking Company ("Cortland Banks" or the "Bank"). The Company owns all of the outstanding shares of the Bank. The Company is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). As a financial holding com pany, 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 Ser vices 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 deposi tory 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). As ofDecember 31, 2007, the Company's bank subsidiary was rated "satisfactory" for CRA purposes, and remained well capitalized and, in management's opinion, well managed. Cortland Bancorp owns no property. Operations are conducted at 194 'West Main Street, Cortland, Ohio. The business of the Company and the Bank is not seasonal to any significant extent and is not dependent on any single customer or group of customers. N EW R E S O U R C ES L E A S I NG C O M P A NY New Resources Leasing Company was in December 1988 as a separate entity to handle the function of commercial and consumer leasing. The wholly owned subsidiary has been inactive since incorporation. formed T HE C O R T L A ND SAVINGS A ND B A N K I NG C O M P A NY The Cortland Savings and Banking Company is a full service state chartered bank engaged in commercial and retail banking and tmst services. The Bank's services include checking accounts, savings accounts, time deposit accounts, commercial, mortgage and installment loans, night depository, automated teller services, safe deposit boxes and other miscellaneous services normally offered by commercial banks. Cortland Banks also offers a variety B of Intemet Banking products as well as discount brokerage services. Business is conducted at a total of thirteen offices, eight of which are located in Tmmbull County, Ohio. Two offices are located in the communities of Windham and Mantua, in Portage County, Ohio. One office is located in the com munity of Williamsfield, Ashtabula County, Ohio, while two are located in the community of Boardman, Mahoning County, Ohio. Cortland Bank's main office (as described in its charter) is located at 194 West Main Street, Cortland, Ohio. Admin istrative offices are located at the main office. The Brook field, Hubbard, Niles Park Plaza and both Boardman offices are leased, while all of the other offices are owned by Cortland Banks. The Bank, as a state chartered banking organization and member of the Federal Reserve System, is subject to periodic examination and regulation by both the Federal Reserve Bank of Cleveland and the State of Ohio Division of Financial Institutions. These examinations, which include such areas as capital, liquidity, asset quahty, man agement practices and other aspects of the Bank's opera tions, are primarily for the protection of the Bank's depositors. In addition to these regular examinations, the Bank must furnish periodic reports to regulatory authorities containing a full and accurate statement of its affairs. The Bank's deposits are insured by the Federal Deposit Insur ance Corporation (FDIC) up to the statutory limit of $100,000 per customer. Individual Retirement Account deposits are insured by the FDIC to $250,000 per customer. C O M P E T I T I ON Cortland Banks actively competes with state and national banks located in Northeast Ohio and Westem Pennsylva nia. It also competes for deposits, loans and other service business with a large number ofother financial institutions, such as savings and loan associations, credit unions, insur ance companies, consumer finance companies and com mercial finance companies. Also, money market mutual funds, brokerage houses and similar institutions provide in a relatively unregulated environment many of the financial services offered by banks. In the opinion of management, the principal methods of competition are the rates of interest charged on loans, the rates of interest paid on deposit funds, the fees charged for services, and the con venience, availability, timeliness and quality of the cus tomer services offered. E M P L O Y E ES As of December 31, 2007 the Company through its sub sidiary bank, employed 143 full-time and 34 part-time employees. The CTompany provides its employees with a full range of benefit plans, and considers its relations with its employees to be satisfactory. REPORT ON MANAGEMENT'S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING tJIAND Cortland Bancorp is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report. The consolidated financial statements and notes included in this annual report have been prepared in conformity with United States generally accepted accounting principles and necessarily include some amounts that are based on management's best esti mates and judgments. We, as management of Cortland Bancorp, are respon sible for estabUshing and maintaining effective inter nal control over financial reporting that is designed to produce reliable financial statements in conformity with United States generally accepted accounting principles. The system of internal control over finan cial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability through a program of intemal audits. Actions are taken to correct potential defi ciencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstate ments due to error or fraud may occur and not be detected. Also, because of changes in conditions, intemal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation. Management assessed the Company's system of reporting as of intemal control over financial December 31, 2007, in relation to criteria for effec tive internal control over financial reporting as described in Internal Control-Integrated Framework, issued by the Committee of Sponsoring Organization of the Treadway Commission. Based on this assess ment, management concludes that, as of Decem ber 31, 2007, its system of intemal control over financial reporting is effective and meets the criteria Internal Control-Integrated Framework. of Packer Thomas, registered public independent accounting firm, has issued an attestation report on the Company's financial reporting. internal control over the ''ao'v^tji- ' O t » C ^ > -^ Lawrence A. Fantauzzi President and Chief Executive Officer James M. Gasior Secretary Chief Financial Officer Cortland, Ohio February 29, 2008 B REPORT OF PACKER THOMAS INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM SHAREHOLDERS AND BOARD OF DKECTORS Cortland Bancorp We have audited the accompanying consolidated balance sheets of Cortland Bancorp and subsidiaries as of Decem ber 31, 2007 and 2006, and the related consolidated state ments of income, stockholders' equity, and cash flows for each of the years in the three-year period ended Decem ber 31, 2007. We also have audited Cortland Bancorp and subsidiaries internal control over financial reporting as of December 31, 2007, based on criteria established in Inter nal Control-Integrated Framework issued by the Commit tee of Sponsoring Organizations of the Treadway Commission (COSO). Cortland Bancorp's management is responsible for these financial statements, for maintain ing effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, and an opinion on the company's internal control over financial reporting based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting prin ciples used and significant estimates made by manage ment, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management's assessment, testing and evaluating the design and operating effectiveness of intemal control, and performing such other procedures as we considered necessary in the circum stances. We believe that our audits provide a reasonable basis for our opinions. A company's internal control over financial reporting is a process designed to provide reasonable assurance regard ing the reliability of financial reporting and the preparation offinancial statements for external purposes in accordance with generally accepted accounting principles. A compa ny's internal control over financial reporting includes those policies and procedures that (I) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions ofthe assets ofthe company; (2) provide reasonable assurance that transac tions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the com pany; and (3) provide reasonable assurance regarding pre vention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements. Because of its inherent limitations, intemal control over financial reporting may not prevent or detect misstate ments. Also, projections ofany evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or proce dures may deteriorate. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cortland Bancorp and subsidiaries as of December 31, 2007 and 2006, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2007 in conformity with accounting principles generally accepted in the United States of America. In our opinion, Cortland Bancorp and subsidiaries maintained, in all mate rial respects, effective internal control over financial reporting as of December 31, 2007, based on criteria in Intemal Control-Integrated Framework established issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Youngstown, Ohio Febmary 29, 2008 Packer Thomas B CORTLAND BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years ended December 31, 2007, 2006 and 2005 (Amounts in thousands except per share data) nriAND Interest income Interest and fees on loans Interest and dividends on investment securities: Taxable interest Nontaxable interest Dividends Interest on mortgage-backed securifies Other interest income Total interest income Interest expense Deposits Borrowed funds Subordinated debt Total interest expense Net interest income Provision for loan losses (Note 4) Net interest income after provision for loan losses Other income Fees for other customer services Investment securities gains - net Gain on sale of loans - net Other real estate losses - net Earnings on bank owned life insurance Other non-interest income Total other income Other expenses Salaries and employee benefits Net occupancy and equipment expense State and local taxes Office supplies Bank exam and audit expense Other operating expenses Total other expenses Income before federal income taxes Federal income taxes (Note 11) Net income 2007 2006 2005 $15,784 $14,291 $12,941 6,788 1,811 235 4,008 366 28,992 10,456 3,375 154 13,985 15,007 40 14,967 2,307 77 88 (1) 521 97 3,089 7,199 1,871 580 396 443 2,106 12,595 5,461 1,111 $ 4,350 5,943 2,051 202 3,795 215 26,497 4,387 2,162 167 3,810 119 23,586 8,509 3,073 6,159 2,506 11,582 14,915 225 14,690 8,665 14,921 545 14,376 2,239 18 106 (47) 433 86 2,835 2,254 308 89 (3) 341 126 3,115 6,776 1,811 552 367 486 2,029 12,021 5,504 928 $ 4,576 7,052 1,870 548 338 427 1,965 12,200 5,291 957 $ 4,334 Net income per share, both basic and diluted (Note 1) $ 0.97 $ 1.01 $ 0.97 Dividends declared per share $ 0.87 $ 0.85 $ 1.04 See accompanying notes to consolidated financial statements B CORTLAND BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS As of December 31, 2007 and 2006 (Amounts in thousands except per share data) ASSETS Cash and due from banks Federal funds sold Total cash and cash equivalents Investment securifies available for sale (Note 2) Investment securities held to maturity (approximate market value of $113,087 in 2007 and $124,136 in 2006) (Note 2) Total loans (Note 3) Less allowance for loan losses (Note 4) Net loans Premises and equipment (Note 5) Other assets Total assets LIABILITIES Noninterest-bearing deposits Interest-bearing deposits (Note 6) Total deposits Federal Home Loan Bank advances and other borrowings (Note 7) Subordinated debt (Note 8) Other liabilifies Total liabilities Commitments and contingent liabilities (Notes 9 and 17) 2007 2006 $ 9,441 9,441 $ 10,100 4,275 14,375 126,507 108,484 112,115 223,109 (1,621) 221,488 6,206 16,937 124,619 205,208 (2,211) 202,997 4,780 16,496 $492,694 $471,751 $ 58,224 306,564 364,788 70,413 5,155 3,514 443,870 $ 60,983 294,835 355,818 62,015 3,326 421,159 SHAREHOLDERS' EQUITY Common stock - $5.00 stated value - authorized 20,000,000 shares; issued 4,639,973 shares in 2007 and 4,594,344 shares in 2006 (Note 1) Addifional paid-in capital (Note 1) Retained eamings Accumulated other comprehensive (loss) income (Note 1) Treasury stock, at cost, 250,545 shares in 2007 and 95,809 shares in 2006 Total shareholders' equity (Note 16) 23,200 20,976 9,386 (94) (4,644) 48,824 22,972 20,835 9,553 (455) (2,313) 50,592 Total liabilities and shareholders' equity $492,694 $471,751 See accompanying notes to consolidated financial statements B CORTLAND BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY Years ended December 31, 2007, 2006 and 2005 ) (Amounts in thousands except per share data J'LAND slGOl^ Balance at December 31, 2004 Comprehensive Income: Net income Other comprehensive income, net of tax: Unrealized gains on available for sale securities, net of reclassification adjustment Total comprehensive income Common Stock Transactions: Treasury shares reissued net of shares repurchased Cash dividends declared ($0.83 per share) Special cash dividend ($0.21 per share) . . 3% stock dividend Cash paid in lieu of fractional shares . . . . Balance at December 31, 2005 Comprehensive Income: Net income Other comprehensive income, net of tax: Unrealized gains on available for sale securities, net of reclassification adjustment Total comprehensive income Common Stock Transactions: Treasury shares reissued net of shares repurchased Cash dividends declared ($0.85 per share) 2% stock dividend Cash paid in lieu of fractional shares . .. Balance at December 31, 2006 Comprehensive Income: Net income Other comprehensive income, net of tax: Unrealized gains on available for sale securities, net of reclassification adjustment Total comprehensive income Common Stock Transactions: Treasury shares reissued Treasury shares purchased Cash dividends declared ($0.87 per share) 1% stock dividend Cash paid in lieu of fractional shares . . . Common Stock $21,869 Additional Paid-in Capital $18,531 Retained Earnings $13,131 4,334 Accumulated Other Comprehensive Income (Loss) $ 1,061 Treasury Stock $(5,194) (184) 654 1,864 22,523 20,211 (390) 449 1,014 22,972 20,835 (249) 228 390 (1,938) 1,352 (877) (3,842) 422 1,529 (455) (2,313) (3,701) (929) (2,518) (7) 10,310 4,576 (3,865) (1,463) (A) 9,553 4,350 361 1,195 (3,526) $ (94) $(4,644) (3,895) (618) (4) $ 9,386 Total Share holders Equity $49,398 4,334 (1,938) 2,396 1,168 (3,701) (929) (2) 48,325 4,576 422 4,998 1,139 (3,865) (5) 50,592 4,350 361 4,711 946 (3,526) (3,895) (4) $48,824 Balance at December 31, 2007 $23,200 $20,976 DISCLOSURE OF RECLASSIFICATION FOR AVAILABLE FOR SALE SECURITY GAINS AND LOSSES: Unrealized holding gains (losses) on available for sale securities arising during the period net of tax of $212, $224 and $(894) Less: Reclassification adjustment for gains realized in net income, net of tax of $26, $6 and $105 Net unrealized gains (losses) on available for sale securities, net of tax See accompanying notes to consolidated financial statements 2007 2006 2005 $412 51 $361 $434 $(1,735) 12 $422 203 $(1,938) B CORTLAND BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years ended December 31, 2007, 2006 and 2005 (Amounts in thousands) Cash flows from operating activities Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation, amortization and accretion Provision for loan loss Deferred tax expense (benefit) Investment securities gains Gains on sales of loans Loss on the sale or disposal of fixed assets Other real estate losses Loans originated for sale Proceeds from sale of loans originated for sale Changes in: Interest and fees receivable Interest payable Other assets and liabilities Net cash flows from operating activities Cash flows from investing activities Purchases of securities available for sale Purchases of securities held to maturity Proceeds from sales of securities available for sale Proceeds from call, maturity and principal payments on securities Net (increase) decrease in loans made to customers Proceeds from disposition of other real estate Purchases of premises and equipment Net cash flows from investing activities Cash flows from financing activities Net increase in deposit accounts Net increase in borrowings Proceeds from subordinated debt issuance Dividends paid Purchases of treasury stock Treasury shares reissued Net cash flows from financing acfivities Net change in cash and cash equivalents Cash and cash equivalents Beginning of year End of year 2007 2006 2005 $ 4,350 $ 4,576 $ 4,334 775 40 189 (77) (88) 4 1 (6,199) 6,396 (59) 174 (497) 5,009 (13,502) (36,283) 44,692 (18,922) 34 (2,006) (25,987) 8,970 8,398 5,155 (3,899) (3,526) 946 16,044 (4,934) 991 225 (205) (18) (106) 3 47 (6,978) 6,975 (245) 185 (368) 5,082 1,469 545 50 (308) (89) 3 (6,618) 6,707 (341) (30) (1,447) 4,275 (13,339) (12,017) 1,006 (19,593) (47,280) 1,479 26,050 (17,223) 143 (1,180) (16,560) 53,082 2,462 22 (316) (10,144) 5,443 3,904 5,456 10,222 (3,870) 1,139 6,616 (4,862) (4,637) (3) 1,171 12,209 6,340 14,375 $ 9,441 19,237 $ 14,375 12,897 $ 19,237 See accompanying notes to consolidated financial statements I CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 TIAND iJCDl^ NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES The accounting and reporting policies of Cortland Bancorp, and its bank subsidiary, Cortland Savings and Banking Co., reflect banking industry practices and conform to U.S. generally accepted accounting principles. A summary of the significant accounting policies followed by the Company in the preparation of the accompanying consolidated financial statements is set forth below. Principles of Consolidation: The consolidated financial statements include the accounts of Cortland Bancorp (the Company) and its wholly-owned subsidiaries, Cortiand Savings and Banking Company (the Bank) and New Resources Leasing Co. All significant intercompany balances and transactions have been eliminated. Industry Segment Information: The Company and its subsidiaries operate in the domestic banking industry which accounts for substantially all of the Company's assets, revenues and operating income. The Company, through its subsidiary bank, grants residential, consumer, and commercial loans and offers a variety of saving plans to customers located primarily in the Northeastern Ohio and Western Pennsylvania area. Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date ofthe fmancial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates. Cash Flow: Cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. The Company reports net cash flows for customer loan transactions, deposit transactions and deposits made with other financial institutions. The Company paid interest of $13,810,000, $11,397,000 and $8,695,000 in 2007, 2006 and 2005, respectively. Cash paid for income taxes was $950,000 in 2007, $1,120,000 in 2006 and $993,000 in 2005. Transfers ofloans to other real estate were $282,000 in 2007, $144,000 in 2006 and $107,000 in 2005. Investment Securities: Investments in debt and equity securities are classified as held to maturity, trading or available for sale. Securities classified as held to maturity are those that management has the positive intent and ability to hold to maturity. 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 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 available for sale are carried at fair value with unrealized gains and losses recorded as a separate component of shareholders' equity, net of tax effects. Realized gains or losses on dispositions are based on net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. Interest on securities is accrued and credited to operations based on the principal balance outstanding, adjusted for amortization of premiums and accretion of discounts. Unrealized losses on corporate bonds have not been recognized into iticome. Management has the intent and ability to hold these securities for the foreseeable future. The fair value is expected to recover as the bonds approach their maturity date and/or market conditions become more favorable to the bonds' intrinsic value. Trading Securities: Trading securities are principally held with the intention of selling in the near term and are carried at market value. Realized and unrealized gains and losses on trading account securities are recognized in the Statement of Income as they occur. The Company did not hold any trading securities at December 31, 2007, 2006 or 2005. There was no trading activity in 2007, 2006 or 2005. Loans: Loans are stated at the principal amount outstanding net of the unamortized balance of deferred loan origination fees and costs. Deferred loan origination fees and costs are amortized as an adjustment to the related (Continued) B CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) loan yield over the contractual life using the level yield method. Interest income on loans is accrued over the term of the loans based on the amount of principal outstanding. The accmal of interest is discontinued on a loan when management determines that the collection of interest is doubtful. Generally a loan is placed on nonaccrual status once the borrower is 90 days past due on payments, or whenever sufficient information is received to question the collectability ofthe loan or any time legal proceedings are initiated involving a loan. Interest income accrued up to the date a loan is placed on nonaccrual is reversed through interest income. 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'sjudgment as to the collectibility of principal. A loan is returned to accraal status when either all of the principal and interest amounts contractually due are brought current and future payments are, in manage ment'sjudgment, 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. Loans Held for Sale: The Company originates certain residential mortgage loans for sale in the secondary mortgage loan market. For the majority of loan sales, the Company concurrently sells the rights to service the related loans. In addition, the Company may periodically idenfify other loans which may be sold. These loans are classified as loans held for sale, and carried, in the aggregate, at the lower of cost or estimated market value based on secondary market prices. To mitigate interest rate risk, the Company may obtain fixed commitments to sell such loans at the time loans are originated or identified as being held for sale. Such a commitment would be referred to as a derivative loan commitment if the loan that will result from exercise of the commitment will be held for sale upon funding under Statement of Financial Accounfing Standards No. 133 ("SFAS 133"), Accounting for Derivative Instruments and Hedging Activities, as amended by Statement ofFinancial Account ing Standards No. 149 ("SFAS 149"), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. Loans held for sale was $109,000 at December 31, 2006, and none at December 31, 2007. Allowance for Loan Losses and Allowance for Losses on Lending Related Commitments: Because some loans may not be repaid in full, an allowance for loan losses is recorded. Increases to the allowance consist of provisions for loan losses charged to expense and recoveries of previously charged-off loans. Reductions to the allowance result from the charge-off of loans deemed uncollectable by management. After a loan is charged-off, collection efforts continue and future recoveries may occur. A loan is considered impaired when it appears probable that all principal and interest amounts will not be collected according to the loan contract. Allowances for loan losses on impaired loans are determined using the estimated future cash flows ofthe loan, discounted to their present value using the loan's effective interest rate. Allowances for loan losses for impaired loans that are collateral dependent are generally determined based on the estimated fair value of the underlying collateral. Smaller balance homogeneous loans are evaluated for impairment in the aggregate. Such loans include one-to-four family residential, home equity and consumer loans. Commercial loans and commercial mortgage loans are evaluated individually for impairment. Impaired loans are generally classified as nonaccrual loans. Estimating the risk of loss and the amount of loss on any loan is necessarily subjective. Accordingly, the allowance is maintained by management at a level considered adequate to cover possible losses that are currently anticipated. 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 manage ment in determining the amounts charged to operations include previous 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 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 i (Continued) CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 TLAND NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued) experience and changing circumstances. While management may periodically allocate portions ofthe allowance for specific problem loans, the entire allowance is available for any charge-offs that occur. 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 intemal 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. Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation. Depreci ation is computed generally on the straight-line method over the estimated useful lives of the various assets. Maintenance and repairs are expensed and major improvements are capitalized. Other Real Estate: Real estate acquired through foreclosure or deed-in-lieu of foreclosure is included in other assets. Such real estate is carried at the lower of cost or fair value less estimated costs to sell. Any reduction from the carrying value of the related loan to fair value at the time of acquisition is accounted for as a loan loss. Any subsequent reduction in fair market value is reflected as a valuation allowance through a charge to income. Costs of significant property improvements are capitalized, whereas costs relating to holding and maintaining the property are charged to expense. Intangible Asset: A core deposit intangible asset resulting from a branch acquisition is being amortized over a 15 year period. The intangible asset, net of accumulated amortization, was $98,000 and $134,000 at December 31, 2007 and 2006, respectively, and is included in other assets. The annual expense was $37,000 at December 31, 2007, 2006 and 2005. The estimated aggregate amortization expense for the next two years is $37,000 per year, and $24,000 in the third year. Cash Surrender Value of Life Insurance: Bank-owned life insurance ("BOLI") represents life insurance on the lives of certain Company employees, officers and directors who have provided positive consent allowing the Company to be the co-beneficiary of such policies. Since the Company is the owner of the insurance policies, increases in the cash value ofthe policies, as well as its share of insurance proceeds received, are recorded in other noninterest income, and are not subject to income taxes. The cash value ofthe policies is included in other assets. The Company reviews the financial strength of the insurance carriers prior to the purchase of BOLI and quarterly thereafter. The amount of BOLI with any individual carrier is limited to 15% of Tier 1 Capital. The Company has purchased BOLI to provide a long-term asset to offset long-term benefit liabilities, while generating competifive investment yields. Advertising: The Company expenses advertising costs as incurred. (Continued) I CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 2 - INVESTMENT SECURITIES The following is a summary of investment securities: (Amounts in thousands) Amortized Cost Gross Unrealized Gains Gross Unrealized Losses Estimated Fair Value December 31, 2007 Investment securities available for sale U.S. Government agencies and corporations Obligations of states and poUtical subdivisions Mortgage-backed and related securities Corporate securities Total debt securities Other securities Total available for sale Investment securities held to maturity U.S. Treasury securities U.S. Govemment agencies and corporations Obligations of states and political subdivisions Mortgage-backed and related securities Total held to maturity December 31, 2006 Investment securities available for sale U.S. Government agencies and corporations Obligations of states and political subdivisions Mortgage-backed and related securities Corporate securities Total debt securities Other securities Total available for sale Investment securities held to maturity U.S. Treasury securities U.S. Government agencies and corporations Obligations of states and political subdivisions Mortgage-backed and related securities Total held to maturity $ 12,365 8,428 66,508 35,769 123,070 3,581 $126,651 $ 139 71,179 23,990 16,807 $112,115 $ 12,919 9,451 55,062 28,160 105,592 3,581 $109,173 $ 143 73,743 31,009 19,724 $124,619 $ 314 344 607 36 1,301 $ 2 268 1,175 1,445 $1,301 $1,445 $ 7 361 886 63 $1,317 $ 13 348 192 101 654 $ 24 7 314 $ 345 $ 136 1 1,057 149 1,343 $ 654 $1,343 $ 1,067 $1,067 $ 1,239 13 298 $1,550 $ 12,677 8,772 66,847 34,630 122,926 3,581 $126,507 $ 146 71,516 24,869 16,556 $113,087 $ 12,796 9,798 54,197 28,112 104,903 3,581 $108,484 $ 143 72,504 32,063 19,426 $124,136 At December 31, 2007 and 2006, other securities consisted of $3,355,000 in Federal Home Loan Bank (FHLB) stock and $226,000 in Federal Reserve Bank (FED) stock. Each investment is carried at cost, and the Company is required to hold such investments as a condition of membership in order to transact business with the FHLB and the FED. B (Continued) CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 tJIAND NOTE 2 - INVESTMENT SECURITIES (Continued) The amortized cost and estimated market value of debt securities at December 31, 2007, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties. (Amounts in thousands) December 31, 2007 Amortized Cost Estimated Fair Value Investment securities available for sale Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Subtotal Mortgage-backed securities Total Investment securities held to maturity Due in one year or less Due after one year through five years Due after five years through ten years Due after ten years Subtotal Mortgage-backed securities Total $ 3,447 4,048 4,506 44,561 56,562 66,508 $123,070 $ 17,780 4,443 22,048 51,037 95,308 16,807 $112,115 $ 3,459 4,110 4,282 44,228 56,079 66,847 $122,926 $ 17,784 4,473 22,213 52,061 96,531 16,556 $113,087 The following table sets forth the proceeds, gains and losses realized on securities sold or called for each of the years ended December 31: (Amounts in thousands) 2007 2006 2005 $9,991 77 $1,526 18 $13,563 308 Proceeds Gross realized gains Gross realized losses Investment securities with a carrying value of approximately $95,137,000 at December 31, 2007 and $75,489,000 at December 31, 2006 were pledged to secure deposits and for other purposes. I (Continued) B CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 2 - INVESTMENT SECURITIES (Continued) The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at December 31, 2007: U.S. Govemment agencies and corporations Obligations of states and political subdivisions Mortgage-backed and related securities Corporate securities (Amounts in thousands) Less than 12 Months Unrealized Losses Fair Value 12 Months or More Fair Value Unrealized Losses Total Fair Value Unrealized Losses $ 3,466 $ 23 $ 2,741 $ 105 24,930 1 761 391 29,695 5,949 3 7 581 414 $ 6,207 $ 26 391 7 29,800 30,879 582 1,175 $28,501 $785 $38,776 $1,005 $67,277 $1,790 The above table represents 123 investment securities where the current value is less than the related amortized cost. The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at December 31, 2006: U.S. Government agencies and corporations Obligations of states and political subdivisions Mortgage-backed and related securities Corporate securities (Amounts in thousands) Less than 12 Months Unrealized Losses Fair Value 12 Months or More Fair Value Unrealized Losses Total Fair Value Unrealized Losses $11,716 $125 $ 69,233 $1,250 $ 80,949 $1,375 1,043 14 1,043 14 10,812 2,012 159 6 52,351 4,215 1,196 143 63,163 6,227 1,355 149 $24,540 $290 $126,842 $2,603 $151,382 $2,893 The above table represents 201 investment securities where the current value is less than the related amortized cost. The unrealized losses on the Bank's investment in U.S. Government agencies and corporations, obligations of states and political subdivisions, and mortgage-backed and related securities were caused by interest rate increases. Accordingly, it is expected that the securities would not be settied at a price less than the amortized cost of the Bank's investment because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity. The Bank does not consider those investments to be other than temporarUy impaired at December 31, 2007. The Bank's unrealized loss on investments in corporate securities relates to a $2,350,000 investment in the General Motors Corporation. The unrealized loss was primarily caused by (a) the decrease in profitability and I (Continued) CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 TIAND NOTE 2 - INVESTMENT SECURITIES (Confinued) profit forecasts by industry analysts resulting from intense competitive pressure in the automotive industry and (b) a sector downgrade by industry analysts. The contractual terms of those investments do not permit General Motors Corporation to settle the security at a price less than the amortized cost of the investment. While the General Motors Corporation credit rating has decreased from A3 to Caal (Moodys), the Bank believes it is probable that it will be able to collect all amounts due according to the contractual terms of the investment. Therefore, it is expected that the bonds would not be settled at a price less than the amortized cost of the investment. Because the Bank has the ability and intent to hold the investments until a recovery of fair value, which may be maturity, it does not consider the investment in the General Motors Corporate notes to be other- than-temporarily impaired at December 31, 2007. The remaining loss on investments in corporate securities relates to a $31,410,000 investment at December 31, 2007, in Collateralized Debt Obligations, (CDO's), representing pools of tmst preferred debt. The credit ratings on the securities range from Aa3 to Baa3 at Moody's, with none of the securities experiencing downgrades at December 31, 2007. NOTE 3 - LOANS RECEIVABLE The following is a summary of loans: (Amounts in thousands) 1-4 family residential mortgage loans 1-4 family residential mortgage loans held for sale Commercial mortgage loans Consumer loans Commercial loans Home equity loans Total loans December 31, 2007 2006 $ 68,135 $ 62,882 120,950 8,484 14,981 10,559 109 106,160 7,745 17,505 10,807 $223,109 $205,208 NOTE 4 - ALLOWANCE FOR LOAN LOSSES The following is an analysis of changes in the allowance for loan losses for the year ended: (Amounts in thousands) Balance at beginning of year Loan charge-offs Recoveries Net loan charge-offs Provision charged to operations Balance at end of year December 31, 2007 2006 2005 $2,211 (728) 98 (630) 40 $1,621 $2,168 (288) 106 (182) 225 $2,211 $2,629 (1,119) 113 (1,006) 545 $2,168 Loans on which the accrual of interest has been discontinued because circumstances indicate that collection is questionable amounted to $2,285,000, $3,923,000 and $3,746,000 at December 31, 2007, 2006 and 2005, (Continued) B CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 4 - ALLOWANCE FOR LOAN LOSSES (Continued) respectively. Interest income on these loans, if accraed, would have increased pretax income by approximately $188,000, $315,000 and $266,000 for 2007, 2006 and 2005, respectively. Impaired loans are generally included in nonaccraal loans. Management does not individually evaluate certain smaller balance loans for impairment as such loans are evaluated on an aggregate basis. These loans generally include 1-4 family, consumer and home equity loans. Impaired loans are generally evaluated using the fair value of collateral as the measurement method. At December 31, 2007, December 31, 2006 and December 31, 2005, the recorded investment in impaired loans was $2,274,000, $1,939,000 and $1,857,000 while the aUocated portion of the aUowance for loan losses for such loans was $716,000, $815,000 and $714,000, respectively. Interest income recognized on impaired loans using the cash basis was $68,000 for 2007, $44,000 for 2006 and $51,000 for 2005. There were $546,000 in renegotiated loans at December 31, 2007 and none at December 31, 2006 and 2005. The total interest recognized on these loans was $12,000 at December 31, 2007. There were no renegotiated loans for which interest has been reduced at December 31, 2007, December 31, 2006 and December 31, 2005. As of December 31, 2007, 2006 and 2005, there were $14,691,000, $13,765,000 and $5,304,000 in loans that were neither classified as nonaccrual nor considered impaired, but which can be considered 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. NOTE 5 - PREMISES AND EQUIPMENT The following is a summary of premises and equipment: (Amounts in thousands) Land Premises Equipment Leasehold improvements Construction in progress Less accumulated depreciation December 31, 2007 2006 $ 1,384 6,522 7,789 275 280 16,250 10,044 $ 877 5,720 7,488 291 349 14,725 9,945 Net book value $ 6,206 $ 4,780 Depreciation expense was $576,000 in 2007, $485,000 in 2006 and $597,000 for 2005. (Continued) m CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 6 - DEPOSITS The following is a summary of interest-bearing deposits: (Amounts in thousands) Demand Money Market Savings Time: In denominations under $100,000 In denominations of $100,000 or more Total December 31, 2007 2006 $ 23,460 19,698 74,024 120,864 68,518 $306,564 $ 27,136 19,117 79,585 114,052 54,945 $294,835 The following is a summary of time deposits of $100,000 or more by remaining maturities: (Amounts in thousands) 2007 Certificates of Deposit Other Time Deposits $17,572 $17,572 12,811 24,193 4,668 1,381 $60,625 $ 435 288 340 5,316 1,514 $7,893 December 31, 2006 Certificates of Deposit Other Time Deposits $17,997 7,775 11,786 8,219 1,529 $47,306 $ 543 749 2,087 4,260 $7,639 Total $18,007 13,099 24,533 9,984 2,895 $68,518 Total $17,997 8,318 12,535 10,306 5,789 $54,945 Three months or less Three to six months Six to twelve months One through five years Over five years Total (Continued) B CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 9 - COMMITMENTS (Continued) 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 instraments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instraments include commitments to extend credit, standby letters of credit and financial guarantees. Such instraments involve, to varying degrees elements of credit risk in excess of the amount recognized on the balance sheet. The contract or notional amounts or those instraments 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 instraments 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 instraments recorded on the balance sheet. The amount and nature of collateral obtained, if any, is based on management's credit evaluation. The following is a summary of such contractual commitments: (Amounts in thousands) Financial instraments whose contract amounts represent credit risk: Commitments to extend credit Fixed rate Variable rate Standby letters of credk December 31, 2007 2006 $ 2,125 36,576 1,179 $ 3,102 44,422 1,810 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. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management's credit evaluation ofthe counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties. The Company's subsidiary bank also offers limited overdraft protection as a non-contractual courtesy which is available to businesses as well as 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 December 31, 2007, totaled $11,698,000. The total average daily balance of overdrafts used in 2007 was $153,000, or less than 2% of the total aggregate overdraft protection available to depositors. (Continued) B CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 rriAND NOTE 10 - BENEFIT PLANS The Bank has a contributory defined contribution retirement plan (a 401(k) plan) which covers substantially all employees. Total expense under the plan was $244,000 for 2007, $229,000 for 2006 and $224,000 for 2005. The Bank matches participants' voluntary contributions up to 5% of gross pay. Participants may make voluntary contributions to the plan up to a maximum of $15,500 with an additional $5,000 catchup deferral for plan participants over the age of 50. The Bank makes monthly contributions to this plan equal to amounts accrued for plan expense. The Bank and Bancorp provide supplemental retirement benefit plans for the benefit of certain officers and non officer directors. The plan for officers is designed to provide post-retirement benefits to supplement other sources of retirement income such as social security and 401(k) benefits. The benefits will be paid for a period of 15 years after retirement. The amount of each officer's benefit is determined by their salary at retirement as well as their other sources of retirement income. Director Retirement Agreements provide for a benefit of $10,000 annually on or after the director reaches normal retirement age, which is based on a combination of age and years of service. Director retirement benefits are paid over a period of 10 years following retirement. The Bank and Bancorp accrae the cost ofthese post-retirement benefits during the working careers ofthe officers and directors. At December 31, 2007, the cumulative expense accrued for these benefits totaled $1,689,000, with $1,386,000 accrued for the officers' plan and $303,000 for the directors' plan. The following table reconciles the accumulated liability for the benefit obUgafion of these agreements: (Amounts in thousands) Beginning balance Benefit expense Benefit payments Ending balance Years Ended December 31, 2007 2006 $1,484 $1,283 275 263 (70) (62) $1,689 $1,484 Supplemental executive retirement agreements are unfunded plans and have no plan assets. The benefit obligation represents the vested net present value of future payments to individuals under the agreements. The benefit expense, as specified in the agreements for the entire year 2007, is expected to be under $300,000. The benefits expected to be paid in the next year is $70,000. The Bank has purchased insurance contracts on the lives ofthe participants in the supplemental retirement benefit plan and has named the Bank as the beneficiary. Similarly, the Bancorp has purchased insurance contracts on the lives of the directors with the Bancorp as beneficiary. While no direct linkage exists between the supplemental retirement benefit plan and the life insurance contracts, it is management's current intent that the revenue from the insurance contracts be used as a funding source for the plan. At December 31, 2007, the cumulative income accraed on these contracts totaled $2,542,000 on a tax equivalent basis, with $1,750,000 accraed on the officers' contracts and $792,000 on the directors' contracts. In accordance with the Emerging Issues Task Force issue 06-04 "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements" the Bank and the Bancorp will begin to accrue for the monthly benefit expense of postretirement cost of insurance for split-dollar life insurance coverage. The accrual for the year ended December 31,2008 is expected to be under $50,000. Also, (Continued) B CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 10 - BENEFIT PLANS (Continued) as of January 1,2008, the Bank and Bancorp will record the cumulative effect of a change in accounting principle for recognizing a liability for the death benefit promised under a split-dollar Ufe insurance arrangement. The total liability will be $539,000 with the offset to retained earnings. NOTE 11 - FEDERAL INCOME TAXES The composition of income tax expense is as follows: (Amounts in thousands) Current Deferred Total Years Ended December 31, 2005 2006 2007 $ 922 189 $L111 $1,133 (205) $ 928 $907 50 $957 The following is a summary of net deferred taxes included in other assets: (Amounts in thousands) Gross deferred tax assets: Provision for loan and other real estate losses . . .. AMT credit* Other items Loan origination cost - net Unrealized loss (gain) on available for sale securities Gross deferred tax liabilities: Depreciation Other items Net deferred tax asset (Uability) December 31, 2006 2005 2007 $ 227 776 141 49 $ 428 47 764 103 $ 413 29 641 28 235 452 (330) (572) $ 2 91 (350) (561) $ 666 (387) (498) $ 678 * Represents the Company's cumulative alternative minimum tax credit which was used in 2007. The following is a reconciliation between tax expense using the statutory tax rate of 34% and the income tax provision: (Amounts in thousands) Statutory tax Tax effect of non-taxable income Tax effect of non-deductible expense Tax effect of change in estimate* Total income taxes Years Ended December 31, 2005 2006 2007 $1,798 $1,871 $1,857 (921) (909) (846) 80 111 100 (145) $ 928 $ 957 $1,111 * A one time adjustment to tax accrual estimate was recorded in the first quarter of 2006. The related income tax expense on investment securities gains and losses amounted to $26,000 for 2007, $6,000 for 2006 and $105,000 for 2005, and is included in the total federal income tax provision. (Continued) m CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 TIAND NOTE 12 - FAIR VALUE OF FINANCIAL INSTRUMENTS The carrying amounts and estimated fair values of the Company's financial instruments are as follows: (Amounts in thousands) December 31, 2007 December 31, 2006 Carrying Amount Estimated Fair Value Carrying Amount Estimated Fair Value ASSETS: Cash and cash equivalents Federal Funds sold Investment securities Loans, net of allowance for loan losses LIABILITIES: Demand and savings deposits Timedeposits FHLB advances Other borrowings Subordinated Debt $ 9,441 $ 9,441 238,766 221,488 239,594 220,692 $175,406 189,382 64,000 6,413 5,155 $175,406 190,656 64,952 6,413 5,155 $ 10,100 4,275 233,792 202,997 $186,821 168,997 55,000 7,015 $ 10,100 4,275 232,620 201,269 $186,821 169,113 54,917 7,015 For purposes of the above disclosures of estimated fair value, the following assumptions were used as of December 31, 2007 and 2006. The estimated fair value for cash and cash equivalents is considered to approximate cost. The estimated fair value for securities is based on quoted market values for individual securities or for equivalent securities when specific quoted prices are not available. Carrying value is considered to approximate fair value for loans, FHLB advances and other borrowings that reprice frequently and for deposit liabilities subject to immediate withdrawal. The fair values of loans, FHLB advances and other borrowings and time deposits that reprice less frequently are approximated by a discount rate valuation technique utilizing estimated market interest rates as of December 31, 2007 and 2006. The fair value of unrecorded commitments at December 31, 2007 and 2006, is not material. In addition, other assets and liabilities of the Company that are not defined as financial instraments are not included in the above disclosures, such as property and equipment. Also, non-financial instraments typically not recognized in financial statements nevertheless may have value but are not included in the above disclosures. These include, among other items, the estimated earning power of core deposit accounts, the trained work force, customer goodwill and similar items. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. NOTE 13 - REGULATORY MATTERS The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company's assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. (Continued) B CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 13 - REGULATORY MATTERS (Continued) Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain: (1) a minimum ratio of 4% both for total Tier 1 risk-based capital to risk-weighted assets and for Tier 1 risk-based capital to average assets, and (2) a minimum ratio of 8% for total risk-based capital to risk-weighted assets. Under the regulatory framework for prompt corrective action, the Company is categorized as well capitalized, which requires minimum capital ratios of 10% for total risk-based capital to risk-weighted assets, 6% for Tier I risk-based capital to risk-weighted assets, and 5% for Tier 1 risk-based capital to average assets (also known as the leverage ratio). There are no conditions or events since the most recent communication from regulators that management believes would change the Company's capital classification. Total Risk-Based Capital Ratio to Risk-Weighted Assets Tier 1 Risk-Based Capital Ratio to Risk-Weighted Assets Ratio to Average Assets (Amounts in thousands) December 31, 2007 December 31, 2006 Amount Ratio Amount Ratio $55,455 $53,820 $53,151 $50,913 19.18% 18.62 %> 10.99% 19.93% 19.09% 11.04% Tier 1 risk-based capital is shareholders' equity, noncumulative and cumulative perpetual preferred stock, qualifying trust preferred securities and minority interests less intangibles and the unrealized market value adjustment of investment securities available for sale. Total risk-based capital is Tier 1 risk-based capital plus the qualifying portion of the allowance for loan losses. Assets and certain off balance sheet items adjusted in accordance with risk classification comprise risk-weighted assets of $289,081,000 and $266,686,000 as of December 31, 2007 and 2006, respectively. Assets less intangibles and the net unrealized market value adjustment of investment securities available for sale averaged $489,443,000 and $461,215,000 for the years ended December 31, 2007 and 2006, respectively. NOTE 14 - RELATED PARTY TRANSACTIONS Certain directors, executive officers and companies with which they are affiliated were loan customers during 2007. The following is an analysis of such loans: (Amounts in thousands) Total related-party loans at December 31, 2006 New related-party loans Repayments or other $1,648 858 121 Total related-party loans at December 31, 2007 . . . $2,385 B (Continued) CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 TIAND NOTE 15 - CONDENSED FINANCIAL INFORMATION Below is condensed financial information of Cortland Bancorp (parent company only). In this information, the parent's investment in subsidiaries is stated at cost, including equity in the undistributed earnings of the subsidiaries since inception, adjusted for any unrealized gains or losses on available for sale securities. BALANCE SHEETS (Amounts in thousands) Assets: Cash Investment securities available for sale Investment in bank subsidiary Investment in non-bank subsidiary Subordinated note from subsidiary bank Other assets Liabilities: Other liabilities Subordinated debt Shareholders' equity: Common stock (Note 1) Additional paid-in capital (Note 1) Retained earnings Accumulated other comprehensive income Treasury stock Total shareholders' equity December 31, 2007 2006 $ 2,293 650 42,500 15 6,000 2,837 $54,295 $ 316 5,155 23,200 20,976 9,386 (94) (4,644) 48,824 $54,295 $ 2,949 684 44,638 15 2,507 $50,793 $ 201 22,972 20,835 9,553 (455) (2,313) 50,592 $50,793 STATEMENTS OF INCOME (Amounts in thousands) Dividends from bank subsidiary Interest and dividend income Other income Interest on subordinated debt Other expenses Income before income tax and equity in undistributed net income of subsidiaries Income tax benefit (expense) Equity in undistributed net income of subsidiaries Net income (Continued) Years ended December 31, 2006 2007 $2,800 $ 7,000 46 51 110 89 (154) (257) 2005 $3,500 56 70 (283) (270) 6,750 120 (2,520) $ 4,350 2,652 78 1,846 $4,576 3,356 72 906 $4,334 m CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 15 - CONDENSED FINANCIAL INFORMATION (Continued) STATEMENTS OF CASH FLOWS (Amounts in thousands) Cash flows from operating activities Net income Adjustments to reconcile net income to net cash flows from operating $ 4,350 $ 4,576 $ 4,334 Years ended December 31, 2007 2006 2005 activities: Equity in undistributed net income of subsidiaries Accretion on securities Deferred tax benefit Change in other assets and liabilities Net cash flows from operating activities Cash flows from investing activities Purchases of investment securities available for sale Purchases of investment securities held to maturity Proceeds from sales of securities available for sale Proceeds from call, maturity and principal payments on securities Purchase of subordinated note from subsidiary bank Net cash flows from investing activities Cash flows from financing activities Proceeds from subordinated debt Dividends paid Net treasury shares (repurchased) reissued Net cash flows from financing activities Net change in cash Cash Beginning of year End of year 2,520 2 (12) (192) 6,668 (1,846) 2 (13) (141) 2,578 (906) 3 (7) (148) 3,276 (356) 450 94 (6,000) (6,000) 5,155 (3,899) (2,580) (1,324) (656) (3,870) 1,139 (2,731) (153) (4,637) 1,168 (3,469) (99) 2,949 $ 2,293 3,102 $ 2,949 3,201 $ 3,102 NOTE 16 - DIVIDEND RESTRICTIONS The Bank is subject to regulations ofthe Ohio Division of Banks which restrict dividends to retained earnings (as defined by statute) of the current and prior two years. Under this restriction, at December 31, 2007, approx imately $232,000 is available for the payment of dividends by the Bank without seeking prior regulatory approval. In addition, regulations specify that dividend payments may not reduce capital levels below minimum regulatory guidelines. NOTE 17 - LITIGATION The Bank is involved in 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. Q (Continued) CORTLAND BANCORP AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS Years ended December 31, 2007, 2006 and 2005 NOTE 18 - STOCK REPURCHASE PROGRAM TIAND J*JC0I^ On February 27, 2007, the Company's Board of Directors approved a Stock Repurchase Program which permitted the Company to repurchase up to 100,000 shares of its outstanding common shares in the over-the- counter market or in privately negotiated transactions in accordance with applicable regulations of the Securities and Exchange Commission. Based on the value ofthe Company's stock on February 27, 2007, the commitment to repurchase the stock over the program was approximately $1,715,000. Subsequently, on August 14, 2007, the Company's Board ofDirectors authorized the repurchase of up to an additional 100,000 shares ofits outstanding common shares in over-the-counter market or in privately negotiated transactions. Based on the value of the Company's stock on August 14, 2007, the commitment to repurchase these additional shares over the program was approximately $1,635,000. Once again, on November 27,2007, the Company's Board ofDirectors increased to 300,000 shares the size of its current stock buyback program by authorizing the repurchase of up to an additional 100,000 ofits outstanding common shares in the over-the-counter market or in privately negotiated transactions. Based on the value ofthe Company's stock on November 27, 2007, the commitment to repurchase these additional shares over the program was approximately $1,375,000. The repurchase program will terminate on Febraary 28, 2009 or upon the purchase of 300,000 shares, if earlier. Repurchased shares are designated as treasury shares, available for general corporate purposes, including possible use in connection with the Company's dividend reinvestment program, employee benefit plans, acquisitions or other distributions. Under the program the Company has repurchased 205,986 shares. The Company has also reissued 53,670 shares to existing shareholders through its dividend reinvestment program during 2007, net of repurchased fractional shares. The 1% common stock dividend paid January 1, 2008 increased treasury shares by an additional 2,420 shares. Based on the price of the Company's stock at December 31, 2007, the remaining commitment to repurchase the 94,014 remaining shares of stock was approximately $1,170,000. The following table shows information relating to the repurchase of shares of the Company's common stock during 2007: October November . . .. December . . .. Fourth Quarter. Third Quarter. . Second Quarter First Quarter . . TOTAL Total Number of Shares Purchased Average Price Paid Per Share 22,000 25,843 6,000 53,843 66,929 85,214 NONE $ 15.40 15.12 15.00 $ 15.22 $ 16.90 $ 18.47 NONE 22,000 25,843 6,000 53,843 66,929 85,214 NONE 205,986 $ 17.11 205,986 Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs Maximum Number of Shares That May Yet Be Purchased Under the Plans or Programs 25,857 100,014 94,014 94,014 47,857 14,786 NONE 94,014 B F I VE Y E AR S U M M A RY A V E R A GE B A L A N CE S H E E T, Y I E L DS A ND R A T ES The following schedules show average balances of interest-eaming and non interest-earning assets and liabilities, and Shareholders' equity for the years indicated. Also shown are the related amounts of interest earned or paid and the related average yields or interest rates paid for the years indicated. The averages are based on daily balances. (Fully taxable equivalent basis in thousands of dollars) 2007 2006 Interest-eaming assets: Federal funds sold and other money markets Investment securities: U.S. Treasury and other U.S. Government agencies and corporations U.S. Government mortgage-backed pass through certificates States of the U.S. and political subdivisions (Note 1, 2, 3) Other securities TOTAL INVESTMENT SECURITIES Loans (Note 2, 3, 4) Trading account securities TOTAL INTEREST-EARNING ASSETS Non interest-eaming assets: Cash and due from banks Premises and equipment Other TOTAL ASSETS Interest-bearing liabilities: Deposits: Interest-bearing demand deposits Savings Time TOTAL INTEREST-BEARING DEPOSITS Borrowings: Federal funds purchased Securities sold under agreement to repurchase Subordinated debt Other borrowings under one year Other borrowings over one year TOTAL BORROWINGS TOTAL INTEREST-BEARING LIABILITIES Non interest-bearing liabilities: Demand deposits Other liabilities Shareholders equity Average Balance Outstanding Interest Yield E a r n ed or P a id Rate or Average Balance Interest Yield Earned or Outstanding or Paid Rate $ 6,950 $ 366 5.3% $ 4,228 $ 215 5.1% 87,867 4,772 5.4% 83,615 4,257 5.1% 80,689 4,008 5.0% 79,317 3,795 4.8% 37,488 32,860 238,904 215,496 2,633 2,251 13,664 15,856 7.0% 6.9% 5.7% 7.4% 42,409 29,628 234,969 195,838 2,995 1,888 12,935 14,381 7.1% 6.4% 5.5% 7.4% 461,350 $29,886 6.5% 435,035 $27,531 6.3% 8,220 5,374 14,103 $489,047 8,733 4,226 12,365 $460,359 $ 46,508 78,072 184,586 309,166 $ 888 799 8,769 10,456 1.9% 1.0% 4.8% 3.4% $ 47,415 82,845 161,050 291,310 $ 752 850 6,907 8,509 1.6% 1.0% 4.3% 2.9% 605 5,764 2,175 13,963 45,843 68,350 377,516 57,668 3,775 50,088 29 243 154 715 2,388 3,529 $13,985 4.8% 4.2% 7.1% 5.1% 5.2% 5.2% 3.7% 478 3,991 25 158 5.3% 4.0% 7,924 46,858 59,251 350,561 365 2,525 3,073 $11,582 4.6% 5.4% 5.2% 3.3% 57,271 3,214 49,313 $460,359 $15,901 $15,949 2 ^% 3.5% 3X)% 3.7% TOTAL LIABILITIES AND SHAREHOLDERS EQUITY $489,047 Net interest income Net interest rate spread (Note 5) Net interest margin (Note 6) Note 1 ~ Includes both taxable and tax exempt securities. Note 2 - The amounts are presented on a fully taxable equivalent basis using the statutory tax rate of 34% in 2007, 2006, 2005, 2004 and 2003, and have been adjusted to retlect the effect of disallowed interest expense related to carrying tax exempt assets. Tax-free income from states ofthe U.S. and political subdivisions, and loans amounted to $1,809 and $155 for 2007, $2,045 and $192 for 2006, $2,156 and $209 for 2005, $2,545 and $193 for 2004 and $2,466 and $214 for 2003, respectively. Note 3 - Average balance outstanding includes the average amount outstanding of all nonaccmal investment securities and loans. States and political subdivisions consist of average total principal adjusted for amortization of premium and accretion of discount less average allowance for estimated losses, and include both taxable and tax exempt securities. Loans consist of average total loans less average uneamed income. (Fully taxable equivalent basis in thousands of dollars) 2005 2004 2003 Average Balance Outstanding Interest Earned or Paid Yield or Rate Average Balance Outstanding Interest Earned or Paid Yield or Rate Average Balance Outstanding Interest Earned or Paid Yield or Rate $ 3,619 119 3.3% $ 5,623 $ 83 1.5% $ 10,338 $ 118 1.1% 67,402 3,259 4.8% 62,418 2,920 4.7% 52,587 2,640 5.0% 84,928 3,810 4.5% 85,357 3,634 4.3% 89,652 4,009 4.5% 44,756 24,758 221,844 192,873 3,184 1,294 11,547 13,040 7.1% 5.2% 5.2% 6.8% 53,832 14,953 216,560 193,927 3,764 716 11,034 12,474 7.0% 4.8% 5.1% 6.4% 418,336 $24,706 5.9% 416,110 $23,591 5.7% 51,363 10,997 204,599 191,392 1,190 407,519 3,649 559 10,857 13,141 68 $24,184 7.1% 5.1% 5.3% 6.9% 5.7% 5.9% 9,417 4,316 12,418 $444,487 9,276 4,637 14,252 $444,275 10,140 5,119 13,461 $436,239 $ 49,355 89,107 144,793 283,255 $ 389 647 5,123 6,159 0.8% 0.7% 3.5% 2.2% $ 48,945 90,584 147,662 287,191 $ 263 501 5,023 5,787 0.5% 0.6% 3.4% 2.0% $ 50,714 88,953 139,568 279,235 $ 249 540 5,030 5,819 0.5% 0.6% 3.6% 2.1% 428 2,540 15 59 3.5% 2.3% 599 46,365 49,932 333,187 21 2,411 2,506 $ 8,665 3.5% 5.2% 5.0% 2.6% 58,320 3.315 49,665 $444,487 289 2,698 2,781 40,325 46,093 333,284 56,778 4,385 49,828 $444,275 4 26 1.4% 1.0% 57 1,999 1 17 1.8% 0.9% 37 2,156 2,223 $ 8,010 1.3% 5.3% 4.8% 2.4% 3,671 39,178 44,905 324,140 160 2,135 2,313 $ 8,132 4.4% 5.4% 5.2% 2.5% 55,898 4,394 51,807 $436,239 $16,041 $15,581 $16,052 3.3% 3.8% 3.3% 3.7% 3.4% 3.9% Note 4 - Interest eamed on loans includes net loan fees of $219 in 2007, $291 in 2006, $242 in 2005, $203 in 2004 and $241 in 2003. Note 5 - Net interest rate spread represents the difference between the yield on eaming assets and the rate paid on interest-bearing liabilities. Note 6 - Net interest margin is calculated by dividing the difference between total interest eamed and total interest expensed by total interest-eaming assets. B CORTLAND BANCORP AND SUBSIDIARIES SELECTED FINANCIAL DATA (In thousands of dollars, except for ratios and per share amounts) S U M M A RY OF O P E R A T I O NS Total Interest Income Total Interest Expense NET INTEREST INCOME (NII) Provision for Loan Losses NII After Loss Provision Security Gains (losses) Gain on Sale of Loans Total Other Income INCOME BEFORE EXPENSE Total Other Expenses INCOME BEFORE TAX Federal Income Tax NET INCOME BALANCE SHEET DATA Assets Investments Total Loans Allowance for Loan losses Deposits Borrowings Subordinated Debt Shareholders' Equity AVERAGE BALANCES Assets Investments Net Loans Deposits Subordinated Debt Borrowings Shareholders' Equity PER COMMON SHARE DATA (1) Net Income, both Basic arid Diluted Cash Dividends Declared Book Value ASSET QUALITY RATIOS Loans 30 days or more beyond their contractual due date as a percent of total loans Underperforming Assets as a Percentage of: Total Assets Equity plus Allowance for Loan Losses Tier I Capital FINANCIAL RATIOS Return on Average Equity Return on Average Assets Effective Tax Rate Average Equity to Average Assets Equity to Asset Ratio Tangible Equity to Tangible Asset Ratio Cash Dividend Payout Ratio Net Interest Margin Ratio . . .. Years Ended December 31, 2006 2005 2004 $ 26,497 11,582 14,915 225 14,690 18 106 2,711 17,525 12,021 5,504 928 $ 4,576 $ 23,586 8,665 14,921 545 14,376 308 89 2,718 17,491 12,200 5,291 957 $ 4,334 $ 22,288 8,010 14,278 415 13,863 1,052 54 2,725 17,694 11,861 5,833 990 $ 4,843 2003 $ 22,907 8,132 14,775 240 14,535 946 470 2,433 18,384 11,529 6,855 1,371 $ 5,484 $471,751 233,103 205,208 2,211 355,818 62,015 $459,701 234,652 188,202 2,168 350,375 58,111 $446,393 225,841 191,777 2,629 344,919 47,889 $438,392 222,775 189,262 2,408 337,556 47,886 50,592 48,325 49,398 49,881 $460,359 234,969 193,648 348,581 59,251 49,313 $444,487 221,844 190,329 341,575 49,932 49,665 $444,275 216,560 191,428 343,969 46,093 49,828 $436,239 204,599 188,360 335,133 44,905 51,807 ^ ^ ^ '^ $ 28,992 13,985 15,007 40 14,967 77 88 2,924 18,056 12,595 5,461 1,111 $ 4,350 $492,694 238,622 223,109 1,621 364,788 70,413 5,155 48,824 $489,047 238,904 213,568 366,834 2,175 66,175 50,088 0.97 0.87 11.12 1.01 0.85 11.14 0.97 1.04 10.78 1.10 1.01 11.17 1.23 0.98 11.31 1.32% 2.26% 2.95% 2.45% 1.77% 0.63 6.17 6.38 8.68%, 0.89 20.34 10.24 9.91 9.89 89.69 3.45 0.84 7.50 7.78 9.28% 0.99 16.86 10.71 10.72 10.70 84.31 3.67 0.83 7,58 7.81 8.73% 0.98 18.09 11.17 10.51 10.48 107.00 3.83 0.76 6.52 7.05 9,72% 1.09 16.97 11.22 11.07 11.02 91.45 3.74 0.70 5.84 6.44 10.59% 1.26 20.00 11.88 11.38 11.33 79.85 3.94 (1) Basic and diluted earnings per common share are based on weighted average shares outstanding adjusted retroactively for stock dividends. Cash dividends per common share are based on actual cash dividends declared, adjusted retroactively for the stock dividends. Book value per common share is based on shares outstanding at each period, adjusted retroactively for the stock dividends. B CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) FINANCIAL REVIEW The following is management's discussion and anal ysis of the financial condition and results of opera tions of Cortiand Bancorp (the "Company"). The discussion should be read in conjunction with the Consolidated Financial Statements and related notes and summary financial information included else where in this annual report. NOTE REGARDING FORWARD-LOOKING STATEMENTS The Private Securities Litigation Reform Act of 1995 provides a "safe harbor" for forward-looking state ments. In addition to historical information, certain information included in this discussion and other material filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other writ ten statements made or to be made by the Company) may contain forward-looking statements that involve risks and uncertainties. The words "believes," "expects," "may," "wiU," "should," "projects," "con templates," "anticipates," "forecasts," "intends," or similar terminology identify forward-looking state ments. These statements reflect management's beliefs and assumptions, and are based on informa tion 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 asso ciated 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 rea son, even if new information becomes available. CERTAIN NON GAAP MEASURES Certain financial information has been determined by methods other than Generally Accepted Accounting Principles (GAAP). Specifically, certain financial measures are based on core earnings rather than net income. Core earnings exclude income, expense, gains and losses that either are not reflective of ongoing operations or that are not expected to reoccur with any regularity or reoccur with a high degree of uncertainty and volatility. Such information may be useful to both investors and management, and can aid them in understanding the Company's current per formance trends and financial condition. Core earn ings are a supplemental tool for analysis and not a substitute for GAAP net income. Reconciliation from GAAP net income to the non GAAP measure of core earnings is shown as part of management's discussion and analysis of quarterly and year-to-date financial results of operations. OVERVIEW and OUTLOOK Net income for 2007 was $4,350. The performance represented a decrease of $226 from the $4,576 in 2006. Earnings per share measured earned $0.97, down $0.04 or 4.0% from $1.01 in 2006. Core earnings, which exclude the net gains on loans sold and investment securities either sold or called, loss on other real estate, and certain other non recur ring items, were $4,244 million in 2007, compared to the $4,382 million earned in 2006. Core eamings per share were $0.94 in 2007 and $0.97 in 2006, down $0.03 or 3.0%. R C O R T L A ND B A N C O RP A ND S U B S I D I A R I ES M A N A G E M E N T 'S D I S C U S S I ON A ND A N A L Y S IS (In t h o u s a n ds of dollars, except for p er share a m o u n t s) Analysis of Net Interest Income — Years Ended December 31, 2006 and 2005 INTEREST-EARNING ASSETS Federal funds sold and other money market funds Investment securities(l)(2) Loans(2)(3) NET INTEREST MARGIN FOR YEAR ENDED December 31, 2006 December 31, 2005 Average Balance(l) Interest Average Rate Average Balance(l) Interest Average Rate $ 4,228 $ 215 5.1% 12,935 5.5 %e 14,381 7.4%, 234,969 195,838 $ 3,619 $ 119 3.3% 11,547 5.2% 13,040 6.8% 221,844 192,873 Total interest-earning assets $435,035 $27,531 6.3%, $418,336 $24,706 5.9% INTEREST-BEARING LIABILITIES Interest-bearing demand deposits Savings Time Total interest-bearing deposits Federal funds purchased Other borrowings Total interest-bearing liabilities Net interest income Net interest rate spread(4) Net interest margin(5) $ 47,415 82,845 161,050 $ 752 850 6,907 1.6%, 1.0%, 4.3% $ 49,355 89,107 144,793 $ 389 647 5,123 291,310 478 58,773 8,509 25 3,048 2.9% 5.3% 5.2%, 283,255 428 49,504 6,159 15 2,491 0.8% 0.7% 3.5% 2.2% 3.5% 5.0% $350,561 $11,582 3.3% $333,187 $ 8,665 2.6% $15,949 $16,041 3.0% 3.7% 3.3% 3.8% (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 difference between total interest eamed and total interest expensed by total interest-eaming assets. The increase in interest income was the product of a 4.0% year-over-year increase in average earning assets and a 43 basis point increase in interest rates earned, while the increase in interest expense was a product of a 5.2% increase in interest-bearing liabil ities and a 70 basis point increase in rates paid. The net result was a 0.6% decrease in net interest income on a fully tax equivalent basis and a 16 basis point decrease in the net interest margin. Interest and dividend income on securities registered an increase of $1,465, or 13.9%, during the year ended December 31, 2006 when compared to 2005. On a fully tax equivalent basis, income on investment securities increased by $1,388, or 12.0%. The average invested balances increased by $13,125 from the levels of a year ago. The increase in the average balance of investment securities was accom panied by a 30 basis point increase in the tax equiv alent yield of the portfolio. Interest and fees on loans increased by $1,341 on a fully tax equivalent basis, or 10.3%, for the twelve months of 2006 compared to 2005. A $2,965 increase in the average balance ofthe loan portfoUo, or 1.5%, was accompanied by a 60 basis point increase in the portfolio's tax equivalent yield. Also contributing to the increase in loan income in 2006 was $185 in back interest and loan fees collected on three loans which had been in foreclosure. Other interest income increased by $96 from the same period a year ago. The average balance of federal funds sold and other money market funds increased by $609, or 16.8%. The yield increased by 180 basis points during 2006 compared to 2005. Average interest-bearing demand deposits and money market accounts decreased by $1,940, and savings decreased by $6,262. The average rate paid on these products increased by 48 basis points in the aggre gate. The average balance on time deposit products increased by $16,257, as the average rate paid increased by 75 basis points, from 3.5% to 4.3%. Compared to last year, average borrowings and fed eral funds purchased increased by $9,319 while the average rate paid on borrowings increased by 17 basis points. I CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) TIAND The following table provides a detailed analysis of changes in net interest income, identifying that portion of the change that is due to a change in the volume of average assets and liabilities outstanding versus that portion which is due to a change in the average yields on earning assets and average rates on interest-bearing liabilities. Changes in interest due to both rate and volume which cannot be segregated have been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each. Analysis of Net Interest Income Changes (Taxable Equivalent Basis) Increase (Decrease) in Interest Income: Federal funds sold and other money markets Investment Securities U.S. Treasury and other U.S. Government agencies and corporations U.S. Government mortgage-backed pass-through certificates States of the U.S. and political subdivisions Other securities Loans 2007 Compared to 2006 Total Volume Rate 2006 Compared to 2005 Total Rate Volume $ 143 $ 8 $ 151 $ 23 $ 73 $ 96 223 292 66 147 (346) 215 1,446 (16) 148 29 515 213 (362) 363 1,475 818 180 998 (260) 245 (15) (166) 281 203 (23) 313 1,138 (189) 594 1,341 Total Interest Income Change 1,747 608 2,355 899 1,926 2,825 Increase (Decrease) in Interest Expense: Interest-bearing demand deposits Savings deposits Time deposits Federal funds purchased Securities sold under agreements to repurchase Other borrowings under one year Other borrowings over one year Subordinated debt 150 (2) 790 (2) 11 45 (83) (14) (49) 1,072 6 74 305 (54) 154 136 (51) 1,862 4 85 350 (137) 154 (16) (48) 617 2 44 335 26 379 251 363 203 1,167 1,784 8 55 9 88 10 99 344 114 Total Interest Expense Change 1,494 909 2,403 960 1,957 2,917 Increase (Decrease) in Net Interest Income on a Taxable Equivalent Basis $ 253 $(301) $ (48) $ (61) $ (31) $ (92) B CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) Analysis of Other Income, Other Expense and Federal Income Tax Total other income for 2007 increased $254, or 9.0% compared to a decrease of $280, or 9.0% in 2006. Fees for customer services increased by $68, or 3.0%, compared to a decrease of $15 or 0.7% in the prior year. The increase is primarily due to an increase in service charge income. Loans originated for sale in the secondary market showed gains of $88 in 2007, compared to $106 and $89 in 2006 and 2005, respectively. The early call of held to maturity securities, and transactions involving available for sale securities, combined to produce net gains of $77 in 2007, $18 in 2006 and $308 in 2005. Other real estate losses amounted to $1 in 2007, $47 in 2006 and $3 in 2005. Earnings on bank owned life insurance showed an increase of $88 in 2007 com pared to an increase of $92 in 2006. Other non- interest income increased by $11 during 2007 fol lowing a $40 decrease in 2006. This income category is subject to fluctuation due to nonrecurring items. Other Income 2007 2006 2005 2004 2003 Fees for other customer services $2,307 $2,239 $2,254 $2,327 $1,636 88 106 89 54 470 (1) (47) (3) (171) 265 Gaiu on sale of loans Other real estate losses Gain on sale of trading Securities Eamings on bank owned life insurance Other operating income 97 86 126 125 123 3,012 2,817 2,807 2,779 2,903 Investment securities net gains 77 18 308 1,052 946 Total other income $3,089 $2,835 $3,115 $3,831 $3,849 Total other expenses increased by $574 or 4.8% in 2007. This compares to adecrease of $179 or 1.5% in 2006. During 2007, expenditures for salaries and employee benefits increased by $423 or 6.2%. This increase is a combination of regular staff salary and these expenditures In 2006 benefit increases. ^ decreased by $276 or 3.9%. This is due mainly to a one time cash bonus of $243 awarded to the retiring President and CEO in 2005. Occupancy and equip ment expense increased by $60, or 3.3%, during 2007 and decreased by $59, or 3.2%, in 2006. The increase in 2007 is due in part to construction of a banking facility to replace an existing leased bank location. The decrease in 2006 is due mainly to a $112 decrease in depreciation expense as some assets became fully depreciated, and a $36 increase in equipment and building maintenance. the State and local taxes stayed fairly consistent from 2005 to 2007. Bank exam and audit expense decreased by $43 or 8.8% in 2007 following an increase of $59 or 13.8% in 2006 primarily due to requirements of expenses associated with Section 404 of the Sarbanes-Oxley Act of 2002. All other categories of non-interest expense increased by $ 106 in 2007 following an increase of $93 in 2006. This expense category is subject to fluctuation due to non-recurring items. The increase in 2007 is due in part to expenses associated with the Company's Stra tegic Growth Plan. These expenses include costs for professional consulting, information system software licensing and maintenance and educational programs for the Company's employees. The increase in 2006 is due partly to an increase in collection and fore closure expense of $41, a one-time sundry charge-off of $22, and a $29 increase in office supplies expense. Non-Interest Expense Salaries and benefits Net occupancy and equipment expense State and local taxes Office supplies Bank exam and audit Other operating expense Total other expenses $ 7,199 $ 6,776 $ 7,052 $ 6,722 $ 6,586 1,871 1,811 1,870 1853 1,963 580 396 552 367 548 338 544 346 524 347 443 486 427 515 349 2,106 2,029 1,965 1,881 1,760 $12,595 $12,021 $12,200 $11,861 $11,529 521 433 341 444 409 2007 2006 2005 2004 2003 CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) nriAND NCGB^ Salaries and employee benefits represented 57.2% of all non-interest expenses in 2007, 56.4% in 2006 and 57.8% in 2005. Salaries and employee benefits decreased by $276 in 2006 followed by an increase of $423 in 2007. The following details components of these increases: Salaries Benefits Profit Sharing Analysis of Changes in Salaries & Benefits 2007 2006 Amounts 2005 2004 2003 2007 2006 Percent 2005 2004 2003 $252 $(176) $317 $(28) $ 67 4.7% (3.2)% 6.1%c (1.14)%o 1.3%o 145 (77) (29) 85 112 (336) (157) (55) 9.0 (4.6) (1.7) 5.2 5.7 16.1 (3.5) (16,7) 4.2 23.3 0.8 30.5 7.3 (100.0) (2.2) (27.0) Def'd Loan Origination 397 26 (253) (23) 288 42 57 79 $423 $(276) $330 $136 ($212) 6.2% (3.9)%) 4.9%) 2.1% (3.1%) Wage and salary expense per employee averaged $33,994 in 2007, $33,063 in 2006, and $33,942 in 2005. Excluding the one-time retirement bonus, the average per employee would have been $32,444 in 2005. Full-time equivalent employment averaged 164 employees in 2007, 161 employees in 2006 and 162 employees in 2005. Average earning assets per employee measured $2,813 in 2007, $2,702 in 2006 and $2,582 in 2005. Income before income tax expense amounted to $5,461 for to $5,504 and $5,291 for the similar periods of 2006 and 2005, respectively. The effective tax rate was the year ended 2007 compared 20.3% in 2007, 16.9% in 2006 and 18.1% in 2005, resulting in income tax of $1,111, $928 and $957, respectively. The decrease in the effective tax rate in 2006 reflects a one time adjustment to tax expense of $145 due to a change in tax accrual estimate. The effective tax rate before the $145 adjustment was 19.5%. The increase in 2007 is an increase from prior years because of a reduction in tax free income. The provision for income taxes differs from the amount of income the applicable U.S. statutory federal income tax rate to pre-tax income as a result of the following differences: tax determined applying Provision at statutory rate Add (Deduct): Tax effect of non-taxable income Tax effect of non-deductible expense . . . . Tax effect of change in estimate* . . .. 2007 2006 2005 2004 December 31 . . .. $1,857 $1,871 $1,798 $ 1,983 2003 $ 2,331 (846) 100 (909) 111 (145) (921) 80 (1,084) 91 (1,052) 92 Federal income taxes . . .. $1,111 $ 928 $ 957 $ 990 $ 1,371 One time adjustment to tax accraal estimate I CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) Net income registered $4,350 in 2007, $4,576 in 2006 and $4,334 in 2005 representing per share amounts of $0.97 in 2007, $1.01 in 2006 and $0.97 in 2005. Dividends declared per share were $0.87 in 2007, $0.85 in 2006 and $1.04 in 2005. The decrease in FOURTH QUARTER 2007 AS COMPARED TO FOURTH QUARTER 2006 (Unaudited) INTEREST-EARNING ASSETS Federal funds sold and other money market funds Investment securities(l)(2) Loans(2)(3) Total interest-earning assets INTEREST-BEARING LIABILITIES Interest-bearing demand deposits Savings Time Total interest-bearing deposits Federal funds purchased Other borrowings Subordinated debt Total interest-bearing liabilities Net interest income Net interest rate spread(4) Net interest margin(5) 2007 and 2006 is due to elimination of the special dividend. Per share amounts have been restated to give retroactive effect to the 1% common stock div idend of January 1, 2008. NET INTEREST MARGIN FOR QUARTER ENDED December 31, 2006 December 31, 2007 Average Balance(l) Interest Average Average Balance(l) Rate Interest Average Rate $ 951 242,596 222,208 $465,755 $ 13 3,541 4,125 $7,679 $ 47,497 75,332 185,152 $ 235 197 2,220 307,981 2,374 68,589 5,155 2,652 29 849 93 5.2%c 5.8%e 7.4%) 6.6%e 2.0%e 1.0%c 4.S% 3.4% 4.8% 4.9% 7.0%e $ 9,882 231,009 202,709 $443,600 $ 132 3,231 3,773 $7,136 5.3%c 5.6% 7.3% 6.4% $ 48,286 80,207 169,222 $ 225 207 1,942 1.9%c 1.0% 4.6% 297,715 2,374 3.2% 59,795 792 5.2% $384,099 $3,623 3.7%e $357,510 $3,166 3.5% $4,056 $3,970 2.9% 3.5%, 2.9% 3.5% (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 difference between total interest earned and total interest expensed by total interest-earning assets. Tax equivalent net interest income for the Company during the fourth quarter of 2007 increased by $86, a 2.2% increase from the fourth quarter of 2006. The yield on eaming assets increased by 19 basis points while fourth quarter average earning assets increased by 5.0%, or $22,155, when compared to a year ago. The result was an increase in tax equivalent interest income of $543. The rate paid on interest-bearing liabilities increased by 23 basis points, while fourth quarter average interest-bearing liabilities increased by $26,589 when compared to a year ago, resulting in an increase in total interest expense of $457. The net interest margin for the quarter registered 3.49%, down 6 basis points from the same quarter a year ago. Q CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) TIAND The following table shows financial results by quarter for the years ending December 31, 2007 and 2006: FINANCIAL RESULTS BY QUARTER (Unaudited) 2007 For the Quarter Ended Sept. 30 June 30 March 31 Dec. 31 2006 For the Quarter Ended Sept. 30 June 30 March 31 $ 7,344 3,651 $ 7,251 3,495 $ 6,930 3,216 $ 6,889 3,166 $ 6,796 2,980 $ 6,493 2,783 $ 6,319 2,653 3,693 3,756 3,714 5 35 749 (3,132) 1,350 275 $ 1,075 $ 0.24 $ 1,048 $ 0.23 20 27 (1) 719 (3,206) 1,315 258 $ 1,057 $ 0.24 $ 1,027 $ 0.23 12 16 696 (3,063) 1,375 273 $ 1,102 $ 0.24 $ 1,086 $ 0.24 3,723 (50) 3,816 (45) 37 (12) 747 (2,962) 1,483 301 13 (7) 703 (3,041) 1,439 296 3,710 (64) 18 42 (28) 700 (3,049) 1,329 253 $ 1,182 $ 0.26 $ 1,166 $ 0.26 $ 1,143 $ 0.25 $ 1,139 $ 0.25 $ 1,076 $ 0.24 $ 1,057 $ 0.24 3,666 (66) 14 608 (2,969) 1,253 78 $ 1,175 $ 0.26 $ 1,020 $ 0.23 Dec. 31 $ 7,467 3,623 3,844 (40) 40 10 761 (3,194) 1,421 305 $ 1,116 $ 0.25 $ 1,083 $ 0.24 $ 4,056 2.9% 3.5% $ 3,911 2.7% 3.4% $ 3,984 2 . 7% 3.5% $ 3,950 2.8%, 3.5% $ 3,970 2.9%) 3.5% $ 4,067 3.1%, 3.7%) $ 3,973 3.0% 3.7% $ 3,939 3.1%o 3.1% Interest Income Interest Expense Net Interest Income Loan Loss Provision Net Security Gains Net Gain on Loans Other real estate losses Other Income Other Expenses Income Before Tax Federal Income Tax Net Income Net Income Per Share Net Core Income Net Core Income Per Share Net Interest Income (fully taxable equivalent basis) Net Interest Rate Spread Net Interest Margin Loan charge-offs during the quarter were $191 in 2007 compared to $67 in 2006, while the recovery of previously charged-off loans amounted to $28 during the fourth quarter of 2007 compared to $19 in the same period of 2006. The Company's provision for loan losses during the quarter was $40 compared to $50 a year ago. Other income increased by $14 or 1.9% from a year ago. The net gain on loans sold during the quarter amounted to $10, compared to $37 a year ago. Loss on the sale of other real estate decreased from $12 in 2006 to none in 2007. The early call of held to maturity securities, and transactions involving avail able for sale securities produced gains of $40 in the fourth quarter of 2007 compared to none in the same quarter of 2006. Total other non-interest expenses in the fourth quarter were $3,194 in 2007 compared to $2,962 in 2006, an increase of $232 or 7.8%. Salaries and benefits con stituted a $72 increase, or 4.3%. Bank exam and audit fees increased by $14 or 11.6% mainly due to the the timing associated with expenses of implementation of the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Other expenses increased by $146 or 12.7%. The increase is due in part to expenses associated with the Company's Stra tegic Growth Plan. These expenses include costs for professional consulting, information system software licensing and maintenance and educational programs for Company's employees. Income before income tax during the fourth quarter amounted to $1,421 in 2007 compared to $1,483 in 2006. Income tax expense for the fourth quarter of 2007 was $305 as compared to $301 in 2006. Fourth quarter net income was $1,116 in 2007 compared to $1,182 in 2006, representing a decrease of $66, or 5.6%. Earnings per share for the fourth quarter, adjusted for the 1% stock dividend paid January 1, 2008, were $0.25 in 2007 and $0.26 in 2006. Core earnings (earnings before gains on loans sold, investment securities sold or called and certain other non recurring items) decreased by 7.1% in the fourth quarter of 2007 compared to 2006. Core eamings for the fourth quarter of 2007 were $1,083 compared to s CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) LOAN PORTFOLIO The following table represents the composition ofthe loan portfolio as ofDecember 31, for the years indicated: Types of Loans 1 -4 family residential mortgages Commercial mortgages Consumer loans Commercial loans Home equity loans 1-4 family residential loans held for sale 2007 2006 Balance % Balance 2005 Balance 2004 2003 Balance Balance $ 68,135 120,950 8,484 14,981 10,559 30.5 54.3 3.8 6.7 4.7 $ 62,882 106,160 7,745 17,505 10,807 30.6 5L7 3.8 8.5 5.3 $ 59,910 90,983 6,714 19,767 10,828 31.8 48.3 3.6 10.5 5.8 $ 61,238 94,019 6,087 19,188 11,245 31.9 49.0 3.2 10.0 5.9 $ 57,854 92,822 7,231 21,711 9,541 30.6 49.0 3.8 11.5 5.0 109 0.1 103 0.1 Total loans $223,109 $205,208 $188,202 $191,777 $189,262 The following schedule sets forth maturities based on remaining scheduled repayments of principal or next repricing opportunity for loans (excluding mortgage and consumer loans) as ofDecember 31, 2007: Types of Loans Commercial loans Home equity 1 Year or Less l to 5 Years Over 5 Years . . $ 4,737 $4,560 $5,684 10,559 Total $14,981 10,559 Total loans (excluding consumer loans) . . mortgage and . . $15,296 $4,560 $5,684 $25,540 The following schedule sets forth loans as of December 31, 2007 based on next repricing opportunity for floating and adjustable interest rate products, and by remaining scheduled principal payments for loan products with fixed rates of interest. Mortgage and consumer loans have again been excluded. Types of Loans Floating or adjustable rates of interest Fixed rates of interest Total loans (excluding mortgage and consumer loans) 1 Year or Less . . $14,962 334 Over 1 Year $ 1,243 9,001 Total $16,205 9,335 . . $15,296 $10,244 $25,540 D CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) The Company recorded an increase of $17,901 in the loan portfolio from the level of $205,208 recorded at December 31, 2006. Between 2006 and 2007, the balance of residential mortgage loans remained relatively unchanged. 1-4 family residential mortgages represent 30.5% oftotal loans in the loan portfolio compared to 30.7% in 2006. The portion ofthe loan portfolio represented by commercial loans (including commercial real estate) increased from 60.2% in 2006 to 61.0% in 2007. Consumer loans) decreased from 9.1% in 2006 to 8.5% in 2007. loans (including home equity Real estate loans which include residential loans and commercial loans continue to comprise the largest share of the Company's loan portfolio. At the end of 2007, residential loans and commercial loans com prised a combined 91.5% of the portfolio, compared to 90.5% five years ago. Home equity loans at 4.7% and consumer installment at 3.8% comprise the remainder of the portfolio in 2007. LOAN PORTFOLIO COMPOSITION (In Percentages) Home Equity 47 Consumer 3.8 1-4 Family iVlortgages 30.5 Home Equity 4 4 1-4 Family Mortgages 33.6 2007 2002 During 2007, approximately $16,300 in new mort gage loans were originated by the Company, an increase of approximately $1,100 from 2006. The following shows the disposition of mortgage loans originated during 2003 to 2007 (in millions): 2007 2006 2005 2004 2003 Retained in Portfolio Loans Sold to Investors with Servicing Rights Released $10.1 $8.3 $7.6 $8.0 $11.6 $ 6.2 $6.9 $6.6 $4.0 $27.3 TLAND The Company's product offerings continue to include a service release sales program, which permits the Company to offer competitive long-term fixed inter est rates without incurring additional credit or interest rate risk. During 2007, the Company sold fewer residential mortgage loans under the service release sales pro gram but originated and retained approximately $1.5 miUion more in portfolio loans in comparision to 2006 totals. Mortgage loan originations are typi cally qualified for sale to investors in the secondary market, but are occasionally retained in portfolio when requested by a customer or to enhance account relationship for certain customers. The mix of port folio retained to those sold to investors will vary from year to year. The Bank is also active in home equity financing. Home Equity term loans and credit lines remain popular with consumers wishing to finance home improvements, educational costs, vacations and con sumer goods purchased at favorable interest rates. In order to improve customer retention and provide better overall balance, management also will con tinue to revamp and reposition the Company's In- Portfolio product offerings during 2008. The balance of the commercial loan portfolio as of December 31, 2007 was $135,931, an increase of $12,266 from the balance of $123,665 recorded at term, asset based December 31, 2006. Short commercial loans including lines of credit decreased by $2,524. Commercial real estate loans increased by $14,790 during the same period. The increase in these loans has primarily resulted from a marketing cam paign and an aggressive calling program designed to increase market share for commercial and small business loans secured by real estate. rate commercial real estate products Management in recent years has offered longer term fixed to qualifying customers in an effort to establish new business relationships and capture additional market share. Loan personnel will continue to aggressively pursue both commercial and small business oppor incentives and tunities supported by product Q CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) marketing efforts. The Bank's lending function con tinues to provide business services to a wide array of medium and small businesses, including but not lim ited to commercial and residential real estate build trucking ers, automobile dealers, manufacturers, companies, nursing homes, physicians and medical groups, funeral homes, general contractors, service contractors, retailers, wholesalers, as well as area educational institutions and other political subdivisions. restaurants, hotels/motels, Small business loans are originated by loan personnel assigned to the Community Bank offices. These loans are processed in accordance with established busi ness loan underwriting standards and practices. The following table provides an overview of com mercial loans by various business sectors reflecting the areas of largest concentration. It should be noted that these are open balances and do not reflect exist ing commitments that may be currently outstanding but unfunded. Commercial Loan Concentrations Sector Non Residential Building/ Apartment Building Hotels/Motels Real Property Lessors Eating Places Steel Related Industries 2007 % of 2006 % of Balances Portfolio Balances Portfoho $25,879 23,608 19.36%) 17.66 %c $17,963 14.82% 12,374 10.21% 7.175 6,925 5.31% 5.18 %c 8,315 7,575 6.86% 6.25% 5,268 3.94 %c 5,200 4.29% The single largest customer balance at year end had a balance of $7,047 in 2007 compared to $4,900 in 2006. This balance represented approximately 5.2% of the total commercial portfolio, compared to 4.0% in 2006. In the consumer lending area, the Company provides financing for a variety of consumer purchases: fixed rate amortizing mortgage products that consumers utilize for home improvements; the purchase of con sumer goods of all types; education, travel and other personal expenditures. The consolidation of credit card and other existing debt into term payout m continues to remain a popular financing option among consumers. Additional information regarding the loan portfolio can be found in the Notes to the Consolidated Finan cial Statements (NOTES 1, 3, 9, 12 and 14). INVESTMENT SECURITIES In accordance with Statement of Financial Account ing Standards No. 115 (SFAS 115), "Accounting for Certain Investments in Debt and Equity Securities," investment securities are segregated into three sepa rate portfolios: held to maturity, available for sale, and trading. Each portfolio type has its own method of accounting. Held to maturity securities are recorded at historical cost, adjusted for amortization of premiums and accretion of discounts. Trading securities are marked-to-market, with any gain or loss reflected in the determination of income. Securities designated as available for sale are similarly carried at their fair market value. However, any unrealized gain or loss (net of tax) is recorded as an adjustment to share holders' equity as a component of Other Compre hensive Income. One effect of SFAS 115 is to expose shareholders' equity to fluctuations resulting from market volatility related to the available for sale portfolio. The poten tial adverse impact of this volatility is somewhat mitigated as bank regulatory agencies measure cap ital adequacy for regulatory purposes without regard to the effects of SFAS 115. Securities designated by the Company as held to maturity tend to be higher yielding but less liquid either due to maturity, size or other characteristics of the issue. The Company must have both the intent and the ability to hold such securities to maturity. Securities the Company has designated as available for sale may be sold prior to maturity in order to fund loan demand, to adjust for interest rate sensitivity, to reallocate bank resources, or to reposition the port folio to reflect changing economic conditions and shifts in the relative values of market sectors. Avail able for sale securities tend to be more liquid invest ments and generally exhibit less price volatility as interest rates fluctuate. CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) ITIAND The following table shows the book value of investment securities by type of obligation at the dates indicated: U.S. Treasury and other U.S. Government agencies and corporations U.S. Govemment mortgage-backed pass- through certificates States of the U.S. and political subdivisions Other securities 2007 2006 December 31, 2005 2004 2003 $ 83,995 $ 86,682 $ 80,053 $ 69,670 $ 62,524 83,654 73,921 82,992 91,226 92,499 32,762 38,211 $238,622 40,807 31,693 $233,103 44,714 26,893 $234,652 45,689 19,256 $225,841 53,503 14,249 $222,775 A summary of securities held at December 3 1, 2007, classified according to the earlier of next repricing or the maturity date and the weighted average yield for each range of maturities, is set forth below. Fixed rate mortgage- backed securities are classified by their estimated contractual cash flow, adjusted for current prepayment assumptions. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. Type and Maturity or Repricing Grouping December 31, 2007 Book Value Weighted Average Yield(l) U.S. Treasury and other U.S. Government agencies and corporations: Maturing or repricing within one year Maturing or repridng after one year but within five years Maturing or repricing after five years but within ten years Maturing or repricing after ten years $21,084 8,108 19,114 35,689 Total U.S. Treasury and other U.S. Government agencies and corporations . . . $83,995 U.S. Government mortgage-backed pass-through certificates, REMICS & CMO's: Maturing or repricing within one year Maturing or repricing after one year but within five years Maturing or repricing after five years but within ten years Maturing or repricing after ten years $48,570 33,670 1,414 5.484% 4.581 5.305 6.104 5.620% 5.271% 4.963 4.713 Total U.S. Government mortgage-backed pass-through certificates, REMICS & CMO's $83,654 5.138% States of the U.S. and political subdivisions: Maturing or repridng within one year Maturing or repricing after one year but within five years Maturing or repricing after five years but within ten years Maturing or repricing after ten years Total States of the U.S. and political subdivisions Other securities: Maturing or repricing within one year Maturing or repridng after one year but within five years Maturing or repricing after five years but within ten years Maturing or repridng after ten years Total other securities $ 155 445 5,185 26,977 $32,762 $28,192 2,403 2,031 5,585 $38,211 8.376% 7.525 6.998 7.234 7.206% 6.953% 5.733 7.182 7.629 6.987% (1) The weighted average yield has been computed by dividing the total interest income adjusted for amortization of premium or accretion of discount over the life of the security by the amortized cost of the securities outstanding. The weighted average yield of tax-exempt obligations of states of the U.S. and political subdivisions has been calculated on a fully taxable equivalent basis. The amounts of adjustments to interest which are based on the statutory tax rate of 34%, were $5, $10, $111 and $585 for the four ranges of maturities. As of December 31, 2007, there were $42,156 in callable U.S. Government Agencies, and $9,591 in callable obligations of states and political subdivi- sions that given current and expected interest rate I CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) ASSET-LIABILITY MANAGEMENT The Company's executive management and Board of Directors routinely review the Company's balance sheet structure for stability, liquidity and capital adequacy. The Company has defined a set of key control parameters which provide various measures ofthe Company's exposure to changes in interest rates. The Company's asset- liability management goal is to produce a net interest margin that is relatively stable despite interest rate volatility while maintaining an acceptable level of earnings. Net interest margin is the difference between total interest earned on a fully taxable equivalent basis and total interest expensed. The net interest margin ratio expresses this difference as a percentage of average earning assets. In the past five years, the net interest margin ratio has averaged 3.73% ranging between 3.45% and 3.94%. Included among the various measurement techniques used by the Company to identify and manage exposure to changing interest rates is the use of computer based simulation models. Computerized simulation techniques enable the Company to explore and measure net interest income volatility under altemative asset deployment strategies, different interest rate environments, various product offerings and changing growth patterns. GAP TABLE December 31, 2007 Maturity or Repricing 3 Months or Less 3 to 12 Months l to 5 Years Interval Non Rate Sensitive or >5 Years $ 76 91,432 65,819 155 $ 58,316 56,225 $ 78,811 89,847 $ 157,482 114,541 168,658 10,063 11,218 21,281 30,732 Total $ 76 238,622 223,109 155 461,962 30,732 $ 157,482 $114,541 $168,658 $ 52,013 $492,694 $ 23,460 19,698 74,024 18,522 26,729 4,644 594 1,175 5,155 5,500 179,501 $ $ $ 37,527 49,914 9,574 32,047 2,895 12,174 6,000 93,441 28,000 69,621 24,500 39,569 58,224 3,514 48,824 $ 23,460 19,698 74,024 68,518 120,864 4,644 594 1,175 5,155 64,000 382,132 58,224 3,514 48,824 $ 179,501 $ 93,441 $ 69,621 $ 150,131 $492,694 $ (22,019) $ 21,100 $ 99,037 ($18,288) ($22,019) ($919) $ 98,118 $ 79,830 Interest-Earning Assets Interest-Bearing Balance from Depository Institution Investments Loans & Leases Investment in Nonconsolidated Subsidiary Total Eaming Assets Other Assets Total Assets Interest-Bearing Liabilities Interest-bearing Checking Money Market Accounts Passbook Savings Time Deposits £100,000 Time Deposits < 100,000 Repurchase Agreements U.S. Treasury Demand Federal Funds Purchased Subordinated Debt Other Borrowings Total Interest-Bearing Liabilities Demand Deposits Other Liabilities Shareholders' Equity Total Liabilities & Equity Rate Sensitivity Gap Cumulative Gap Cumulative Gap to Total Assets (4.5)%. (0.2) %<, 19.9% 16.2%, B CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) The preceding Gap Table presents an analysis of the Company's earliest repricing opportunity for each of its interest-earning assets and interest-bearing liabil ities. Assets are distributed according to the earlier of interest rate repricing opportunity or expected cash flows. Time deposits and liabilities with defined maturities are distributed according to the earlier of the repricing interval or contractual maturity. Other core deposit accounts (Interest-bearing check ing. Money Market and Savings accounts) are shown as being available for repricing in the earliest time frame, although management can exert considerable influence over the timing and manner of repricing such core deposits. Therefore, these accounts may reprice in later time intervals and reflect smaller interest-eaming incremental changes assets and interest-bearing liabilities. Since manage ment may reprice these accounts at its discretion, the impact of changing rates on net interest income is likely to be considerably different than inferred by this table. than other During 2007, the effective maturities of eaming assets tended to shorten as rates in the credit markets fell sharply. Federal Reserve policy makers decreased short-term interest rates three times during the year, from 5.25% to 4.25% in an attempt to ease strains in the financial market, soften the effects of the housing cor rection and to help avoid a recession. With rates faUing during the year, the volume of investment securities eUgible to be called increased, while prepayments on similarly loans and mortgage-backed increased, causing the effective maturities of existing earning assets to shorten. Management invested excess ovemight funds (federal funds sold balances), with an increased allocation towards adjustable and floating rate corporate bonds, and U.S. Govemment agencies purchased at a discount that contain a lock-out period prior to the first caU date and mortgage-backed securities. securities While the preceding Gap Table provides a general indication of the potential effect that changing inter est rates may have on net interest income, it does not by itself present a complete picture of interest rate sensitivity. Because the repricing of the various cat to egories of assets and is subject liabilities a^IAND competitive pressures, customer preferences and other factors, such assets and liabilities may in fact reprice in different time periods and in different increments than assumed. The computerized simulation techniques utilized by management provide a more sophisticated measure of the degree to which the Company's interest sen sitive assets and liabilities may be impacted by changes in the general level of interest rates. These analyses show the Company's net interest income remaining relatively neutral within the economic and interest rate scenarios anticipated by management. As previously noted, the Company's net interest margin has remained in the range of 3.45% to 3.94% over the past five years, a period characterized by significant shifts in the mix of earning assets and the direction and level of interest rates. The targeted federal funds rate during that period ranged from 1.00% to 5.25%, as Federal Reserve monetary policy tumed from guarding against deflation to warding off inflationary threats and now back to attempting to avoid a recession. NET INTEREST MARGIN RATIO (In Percentages) 3.67 3.83 3.74 3.94 ^ ^m ^m M • •• — 2007 2006 2005 2004 2003 5.0 4.5 4.0 3.5 3.0 2.5 2.0 LIQUIDITY The central role of the Company's liquidity manage ment 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 M CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) 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. Consolidated Statements of Cash Flows for a sum mary of the sources and uses of cash for 2007, 2006 and 2005. The following table details the cash flows from operating activities. December 31, Net income Adjustments to reconcile net income to net cash flows from operating activities: Depreciation, amortization and accretion Provision for loan loss Investment securities gains Other real estate losses Impact of loans held for sale Changes in: Securities to settie and securities sold to setde Purchase of insurance contracts Other assets and liabilities 2006 2007 2005 $4,350 $4,576 $ 4,334 $ 4,843 $ 5,484 2003 2004 775 991 1,469 2,176 2,382 40 225 545 415 240 (77) (18) (308) (1,052) (946) 1 47 3 171 109 (109) 103 1,919 (1,270) 1,270 (128) (500) (2,500) (189) (502) (498) (44) 469 Net cash flows from operating activities $5,009 $5,082 $ 4,275 $ 7,382 $ 7,048 CONTRACTUAL OBLIGATIONS AND COMMITMENTS The Corporation has various obligations, including contractual obUgations and commitments that may require future cash payments. Contractual Obligations: The following table pre sents, as of December 31, 2007, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements. Anticipated principal repayments on mortgage- backed securities along with investment securities maturing, repricing, or expected to be called in one year or less amounted to $149,748 at December 31, 2007, representing 62.8% ofthe total combined port foUo, as compared to $77,463 or 33.2% of the port folio a year ago. Along with its liquid assets, the Company has other sources of liquidity avaUable 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, and access to the Federal Reserve Discount Window. The Company is also a member ofthe Federal Home Loan Bank of Cincinnati, which provides yet another source of liquidity. Cash and cash equivalents decreased from $19,237 in 2005 to $14,375 in 2006, then to $9,441 in 2007. Operating activities provided cash of $5,009 in 2007, $5,082 in 2006 and $4,275 in 2005. Key differences stem mainly from: 1) a decrease in net income of $226 between 2007 and 2006 and a $242 increase between 2005 and 2006; 2) there were no loans held for sale at December 31, 2007 and 2005 and $109 at 2006; 3) gains on the sale of investments, was $308 at December 31, 2005, $18 at December 31, 2006 and $77 in 2007; 4) amortization on securities was $199 in 2007 compared to $506 in 2006 and $872 in 2005 ; 5) loss on the sale of other real estate totaled $47 in 2006 and $3 in 2005 compared to $1 in 2007; 6) the purchase ofan additional $128 of insurance contracts on the lives of participants in the supplemental post retirement benefit plan in 2006 and none in 2007 or 2005; 7) a liability for securities purchased yet to settie totaled $ 1,270 at December 31,2004, with none at December 31, 2005, 2006 or 2007. Refer to the M CORTLAND BANCORP AND SUBSIDIARIES MANAGEMENT'S DISCUSSION AND ANALYSIS (In thousands of dollars, except for per share amounts) IIAND Contractual Obligations as of December 31, 2007 Payments Due in Three to Five Years One to Three Years Over Five Years One Year or Less 5 58,224 117,182 1.33% Total & 58,224 117,182 1.33% 124,637 29,772 18,989 15,984 189,382 4.69% 4.63% 5.01% 4.63% 4.71% 5,819 3.80% 594 3.59% 6,000 5.24% 24,000 5.50% 9,500 5.09% 131 168 45 5,819 3.80% 594 3.59% 24,500 64,000 4.13% 5,155 6.44% 4.89% 5,155 6.44% 344 Sec Note 6 6 7 7 7 8 9 Non-interest bearing deposits Interest bearing deposits(a) Average Rate(b) Certificates of deposit(a) Average Rate(b) Federal funds purchased and security repurchase agreements(a) Average Rate(b) U.S. Treasury interest-bearing demand note(a) Average Rate(b) Federal Home Loan Bank advances(a) Average Rate(b) Subordinated debt Average Rate(b) Operating leases (a) Excludes present and future accrued interest. (b) Variable rate obligations reflect interest rates in effect at December 31, 2007. The Corporation's operating lease obligations repre sent short and long-term lease and rental payments for the subsidiary bank's branch facilities. The Corporation also has obUgations under its sup plemental retirement plans as described in Note 10 to the consolidated financial statements. The postretire ment benefit payments represent actuarially deter to eligible plan mined future benefit payments participants. The Corporation does not have any commitments or obligations to the defined contribu tion retirement plan (401(k) plan) at December 31, 2007 due to the funded status ofthe plan. (See further discussion in Note 10.) table details Commitments: The the following amounts and expected maturities of significant com mitments as ofDecember 31, 2007. (Further discus sion of these commitments is included in Note 9 to the consolidated financial statements.) Expected Maturities of Commitments as of December 31, 2007 One Year or Less One to Three Years Tiiree to Five Years Over Five Years Total Commitments to extend credit: Commercial $ 8,672 $1,522 $348 $16,007 $26,549 Residential real estate 224 Revolving home equity 11,468 Overdraft protection 11,698 Ottier Standby letters of credit 460 1,179 224 11,468 11,698 460 1,179 Commitments to extend credit, including loan com mitments, standby letters of credit, and commercial letters of credit do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon. B THE CORTLAND SAVINGS AND BANKING COMPANY TLAND BOARD OF DIRECTORS JERRYA. CARLETON President, Carleton Enterprises Inc. DAVID C. COLE Partner and President Cole Valley Motor Company LAWRENCE A. FANTAUZZI President and Chief Executive Officer JAMES M. GASIOR Senior Vice President, Chief Financial Officer and Secretary GEORGE E. GESSNER Attorney JAMES E. HOFFMAN III Attomey NEIL J. KABACK Partner, Cohen & Company K. RAY MAHAN President, Mahan Packing Co. and Chairman of the Board RICHARD B. THOMPSON Executive, Therm-O-Link, Inc. TIMOTHY K. WOOFTER President, Stan-Wade Metal Products WILLIAM A. HAGOOD Director Emeritus RODGER W. PLATT Director Emeritus OFFICERS LAWRENCE A. FANTAUZZI President and Chief Executive Officer JAMES M. GASIOR Senior Vice President, Chief Financial Officer and Secretary STEPHEN A. TELEGO, SR. Senior Vice President and Director of Human Resources and Corporate Administration TIMOTHY CARNEY Senior Vice President & Chief Operations Officer CRAIG M. PHYTHYON Senior Vice President, Chief Investment Officer and Treasurer DANNY L. WHITE Senior Vice President and Chief Lending Officer CHARLES J. COMMONS Vice President MARLENE LENIO Vice President M EMMA JEAN WOLLAM Vice President ROBERT J. HORVATH Vice President JUDY RUSSELL Vice President JAMES DUFF Vice President KEITH MROZEK Vice President DEBORAH L. EAZOR Vice President KAREN GLOWER Vice President GREG YURCO Group-Vice President JOAN M. FRANGIAMORE Vice President BARBARA R. SANDROCK Vice President WILLIAM J. HOLLAND Group-Vice President MICHAEL MATTOCKS Group-Vice President DEAN S. EVANS Vice President MARCEL R ARNAL Assistant Vice President GRACE J. BACOT Assistant Vice President SHIRLEY E ROOT Assistant Vice President DARLENE MACK Assistant Vice President and Trust Officer JANET K. HOUSER Assistant Vice President RUSSELL E. TAYLOR Assistant Vice President BARBARA McKENZIE Assistant Vice President JAMES HUGHES Assistant Vice President SHIRLEY A. WADE Assistant Vice President CHRISTOPHER MADURA Assistant Vice President MICHELE LEE Assistant Vice President LANA MUIR Assistant Secretary-Treasurer HEATHER J. BOWSER Assistant Secretary-Treasurer KAREN MILLER Assistant Secretary CORTLAND BANKS OFFICES AND LOCATIONS Thirteen Offices Serving These Fine Communities BOARDMAN 8580 South Avenue Youngstown, Ohio 44514 330-758-5884 CORTLAND 194 West Main Street Cortiand, Ohio 44410 330-637-8040 VIENNA 4434 Warren-Sharon Road Vienna, Ohio 44473 330-394-1438 BOARDMAN Victor Hills Plaza 6538 South Avenue Boardman, Ohio 44512 330-629-9151 BRISTOL 6090 State Route 45 Bristolville, Ohio 44402 330-889-3062 HUBBARD 890 West Liberty Street Hubbard, Ohio 44425 330-534-2265 WARREN 2935 Elm Road Warren, Ohio 44483 330-372-1520 MANTUA 11661 State Route 44 Mantua, Ohio 44255 330-274-3111 WILLIAMSFIELD 5917 U.S. Route 322 Williamsfield, Ohio 44093 440-293-7502 BROOKFIELD 7325 Warren-Sharon Road Brookfield, Ohio 44403 330-448-6814 NILES PARK PLAZA 815 Youngstown-Warren Road Suite 1 Niles, Ohio 44446 330-652-8700 WINDHAM 8950 Maple Grove Road Windham, Ohio 44288 330-326-2340 NORTH BLOOMFIELD 8837 State Route 45 North Bloomfield, Ohio 44450 440-685-4731 Member Federal Reserve System and Federal Deposit Insurance Corporation Visit US at our home page on the world wide web at www.cortland-banks.com or e-mail us at cbinfoCs'cortland-banks.com M e m b er FDIC '•"^wm^ 

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