UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2016
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File Number 0-13814
CORTLAND BANCORP
(Exact Name of Registrant as Specified in its Charter)
Ohio
(State or Other Jurisdiction
of Incorporation or Organization)
194 West Main Street, Cortland, Ohio
(Address of Principal Executive Offices)
34-1451118
(I.R.S. Employer
Identification No.)
44410
(Zip Code)
Registrant’s telephone number, including area code: (330) 637-8040
Securities registered pursuant to Section l2(b) of the Act: None
Securities registered pursuant to Section l2(g) of the Act:
Common Stock, no par value
(Title of Class)
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes No
Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section l3 or l5(d) of the Securities Exchange Act of l934
during the preceding l2 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing
requirements for the past 90 days. Yes No
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File
required to be submitted an posted pursuant to Rule405 of Regulation S-T(§232.405 of this chapter) during the preceding 12 months (or for such
shorter period that the registrant was required to submit and post such files). Yes No
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§232.405 of this chapter) is not contained herein,
and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of
the Form 10-K or any amendment to this Form 10-K.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company.
See the definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer
(Do not check if a smaller reporting company)
Non-accelerated filer
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes No
Smaller reporting company
Accelerated filer
Based upon the closing price of the registrant’s common stock on June 30, 2016, the aggregate market value of the voting stock held by non-affiliates
of the registrant was approximately $60,002,632. For purposes of this response, directors and executive officers are considered the affiliates of the
issuer at that date.
The number of shares outstanding of the issuer’s classes of common stock as of March 15, 2017: 4,420,255 shares
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the 2017 Annual Meeting of Shareholders to be held on May 23, 2017 are incorporated by reference into Part III.
Form 10-K for the Year Ended December 31, 2016
Table of Contents
Item 1.
Item 1A.
Item 1B.
Item 2.
Item 3.
Item 4.
PART I
Business .......................................................................................................................................................
Risk Factors .................................................................................................................................................
Unresolved Staff Comments ........................................................................................................................
Properties .....................................................................................................................................................
Legal Proceedings .......................................................................................................................................
Mine Safety Disclosures ..............................................................................................................................
PART II
Item 5.
Item 6.
Item 7.
Item 7A.
Item 8.
Item 9.
Item 9A.
Item 9B.
Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity
Securities .....................................................................................................................................................
Selected Financial Data ...............................................................................................................................
Management’s Discussion and Analysis of Financial Condition and Results of Operations ......................
Quantitative and Qualitative Disclosures About Market Risk .....................................................................
Financial Statements and Supplementary Data ...........................................................................................
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure ......................
Controls and Procedures ..............................................................................................................................
Other Information ........................................................................................................................................
PART III
Directors, Executive Officers and Corporate Governance ..........................................................................
Executive Compensation .............................................................................................................................
Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters ....
Certain Relationships and Related Transactions, and Director Independence ............................................
Principal Accounting Fees and Services .....................................................................................................
PART IV
Item 15.
Exhibits and Financial Statement Schedules ...............................................................................................
SIGNATURES ...........................................................................................................................................................................
EXHIBIT INDEX ......................................................................................................................................................................
Item 10.
Item 11.
Item 12.
Item 13.
Item 14.
Form 10-K
Page
3
11
17
17
17
18
18
20
21
47
47
94
94
94
94
94
94
94
95
95
96
97
Item l. Business
CORTLAND BANCORP
PART I
THE CORPORATION
Cortland Bancorp (the Company) was incorporated under the laws of the State of Ohio in 1984, as a one bank holding company
registered under the Bank Holding Company Act of 1956, as amended (BHC Act). The principal activity of the Company is to own,
manage and supervise The Cortland Savings and Banking Company (Cortland Bank or the Bank). The Company owns all of the
outstanding shares of the Bank.
The Company has made an election to be a financial holding company. The Company is regulated by the Board of Governors of the
Federal Reserve System (Federal Reserve) and the Consumer Financial Protection Bureau (CFPB). The BHC Act provides generally
for “umbrella” regulation of financial holding companies such as the Company by the Federal Reserve Board, and for functional
regulation of banking activities by bank regulators, securities activities by securities regulators, and insurance activities by insurance
regulators. The Company is also under the jurisdiction of the Securities and Exchange Commission (SEC) and is subject to the
disclosure and regulatory requirements of the Securities Act of 1933, as amended, and the Securities Exchange Act of 1934, as
amended, as administered by the SEC.
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. The Company operates as a single line of business.
NEW RESOURCES LEASING CO.
New Resources Leasing Co. was formed in December 1987 under Ohio law as a separate entity to handle the function of commercial
and consumer leasing. The wholly owned subsidiary has been inactive since incorporation.
CORTLAND BANK
Cortland Bank is a full service, state chartered bank engaged in commercial and retail banking. 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. Commercial lending includes
commercial, financial and agricultural loans, real estate construction and development loans, commercial real estate loans, small
business lending and trade financing. Consumer lending includes residential real estate, home equity and installment lending. Cortland
Bank also offers a variety of Internet and mobile banking options.
Full service banking business is conducted at a total of fourteen offices, seven of which are located in Trumbull County, Ohio. The
remaining offices are located throughout Portage, Ashtabula, Summit and Mahoning Counties in Ohio. There are also two financial
service centers located in Beachwood, Ohio, Cuyahoga County, and Fairlawn, Ohio, Summit County.
The Bank’s main administrative and banking office is located at 194 West Main Street, Cortland, Ohio.
The Bank, as a state chartered banking organization and member of the Federal Reserve, is subject to periodic examination and
regulation by the Federal Reserve, the State of Ohio Division of Financial Institutions (Ohio Division) and the CFPB. These
examinations, which include such areas as capital, liquidity, asset quality, management practices and other aspects of the Bank’s
operations, 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 Insurance Corporation (FDIC).
The Bank provides brokerage and investment services through an arrangement with LPL Financial. Under this arrangement, financial
advisors can offer customers an extensive range of investment products and services, including estate planning, qualified retirement
plans, mutual funds, annuities, life insurance, fixed income and equity securities, equity research and recommendations, and asset
management services to customers through the brand Cortland Private Wealth Management.
3
CSB MORTGAGE COMPANY, INC.
CSB Mortgage Company, Inc. (CSB) was formed as an Ohio corporation in December 2011. It is a wholly-owned subsidiary of
Cortland Bank and functioned as the originator of wholesale mortgage loans and the seller of company-wide mortgage loans in the
secondary mortgage market. It was inactive for the years ending December 31, 2016 and 2015.
COMPETITION
The Bank actively competes with state and national banks located in Northeastern Ohio and Western Pennsylvania. It also competes
for deposits, loans and other service business with a large number of other financial institutions, such as savings and loan associations,
credit unions, insurance companies, consumer finance companies and commercial 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 convenience, availability, timeliness and quality of the customer
services offered.
EMPLOYEES
As of December 31, 2016, the Company, through the Bank, employed 148 full-time and 13 part-time employees. The Company
provides its employees with a full range of benefit plans and considers its relations with its employees to be satisfactory.
GENERAL LENDING POLICY
The Bank’s lending policy is designed to provide a framework which will meet the credit needs and interests of the community and
the Bank. It is the Bank’s objective to make loans to credit-worthy customers that benefit their interests. The loans made by the Bank
are subject to the guidelines established in the loan policy that is approved by the Bank’s Board of Directors.
There are times when the Bank will go beyond its lending territory to accommodate people who have been customers of the Bank and
have moved out of the lending area. There are also times when excess funds are available and it is profitable to participate in loans
with other banks or to participate in large projects for community development.
Each lending relationship is reviewed and graded in 6 categories, which are (1) ability to pay, (2) financial condition, (3) management
ability, (4) collateral and guarantors, (5) loan structure, and (6) industry and economics.
Further information can be found in Management’s Discussion and Analysis of Financial Condition and Results of Operations, Item 7.
SUPERVISION AND REGULATION
The Company and the Bank are subject to federal and state banking laws that are intended to protect depositors and borrowers, not
shareholders. Changes in federal and state banking laws, including statutes, regulations, and policies of the bank regulatory agencies,
could have a material adverse impact on our business and prospects. Federal and state laws applicable to holding companies and their
financial institution subsidiaries regulate the range of permissible business activities, investments, reserves against deposits, capital
levels, lending activities and practices, the nature and amount of collateral for loans, establishment of branches, mergers, dividends,
and a variety of other important matters. The Company and the Bank are subject to detailed, complex, and sometimes overlapping
federal and state statutes and regulations affecting routine banking operations. These statutes and regulations include, but are not
limited to, state usury and consumer credit laws, the Truth-in-Lending Act and Regulation Z, the Equal Credit Opportunity Act and
Regulation B, the Fair Credit Reporting Act, the Truth in Savings Act, and the Community Reinvestment Act. In addition to minimum
capital requirements, federal law imposes other safety and soundness standards having to do with such things as internal controls,
information systems, internal audit systems, loan documentation, credit underwriting, interest rate risk exposure, asset growth, asset
quality, earnings, and compensation and benefits. The following discussion of bank supervision and regulation is qualified in its
entirety by reference to the statutory and regulatory provisions discussed.
The Company is a financial holding company and a bank holding company within the meaning of the BHC Act. As such, the
Company is subject to regulation, supervision, and examination by the Federal Reserve, acting primarily through the Federal Reserve
Bank of Cleveland. The Company is required to file annual reports and other information with the Federal Reserve. The Bank is
subject to regulation and supervision by the Ohio Division. As a member bank of the Federal Reserve, the Bank is also subject to
regulation and supervision by the Federal Reserve. The Bank is examined periodically by the Federal Reserve and by the Ohio
Division to test compliance with various regulatory requirements. If as a result of examination the Federal Reserve or the Ohio
Division determines that a bank’s financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or
other aspects of the bank’s operations are unsatisfactory, or that the bank or its management is in violation of any law or regulation,
4
the bank regulatory agencies may take a number of remedial actions. In addition, the Bank is subject to the regulations of the CFPB,
established by the Dodd-Frank Wall Street Reform and Consumer Protection Act enacted in July 2010 (the Dodd-Frank Act). The
CFPB has broad powers to adopt and enforce consumer protection regulations. Bank regulatory agencies make regular use of their
authority to take formal and informal supervisory actions against banks and bank holding companies for unsafe or unsound practices
in the conduct of their businesses and for violations of any law, rule, or regulation, or any condition imposed in writing by the
appropriate federal banking regulatory authority. Potential supervisory and enforcement actions include appointment of a conservator
or receiver, issuance of a cease-and-desist order that could be judicially enforced, termination of a bank’s deposit insurance,
imposition of civil money penalties, issuance of directives to increase capital, entry into formal or informal agreements, including
memoranda of understanding, issuance of removal and prohibition orders against institution- affiliated parties, and enforcement of
these actions through injunctions or restraining orders.
Regulation of bank holding companies. A bank holding company must serve as a source of financial and managerial strength for its
subsidiary banks and must not conduct operations in an unsafe or unsound manner. The Federal Reserve requires all bank holding
companies to maintain capital at or above prescribed levels. Federal Reserve policy requires that a bank holding company provide
capital to its subsidiary banks during periods of financial stress or adversity and that the bank holding company maintain the financial
flexibility and capital-raising capacity to obtain additional resources for assisting subsidiary banks. Bank holding companies may also
be required under certain circumstances to give written notice to and receive approval from the Federal Reserve before purchasing or
redeeming common stock or other equity securities or paying dividends.
Acquisitions. The BHC Act requires every bank holding company to obtain approval of the Federal Reserve to acquire ownership or
control of any voting shares of another bank or bank holding company, if after the acquisition the acquiring company would own or
control more than 5% of the shares of the other bank or bank holding company (unless the acquiring company already owns or
controls a majority of the shares); acquire all or substantially all of the assets of another bank; or merge or consolidate with another
bank holding company. The Federal Reserve will consider anticompetitive effects of the proposed transaction, capital adequacy and
other financial and managerial factors, along with the subsidiary banks’ performance under the Community Reinvestment Act of
1977. Approval of the Ohio Division is also necessary to acquire control of an Ohio-chartered bank.
The BHC Act, the Change in Bank Control Act, and the Federal Reserve Regulation Y require advance approval of the Federal
Reserve to acquire “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company
acquires 25% or more of a class of voting securities of the bank holding company. Under certain circumstances, control may also be
presumed to exist if a person acquires 10% or more, but less than 25%, of any class of voting securities.
Interstate banking and branching. Section 613 of the Dodd-Frank Act amends the interstate branching provisions of the Riegle-Neal
Interstate Banking and Branching Efficiency Act of 1994. The amendments authorize a state or national bank to open a de novo
branch in another state if the law of the state where the branch is to be located would permit a bank chartered by that state to open the
branch. Section 607 of the Dodd-Frank Act requires that a bank holding company be well capitalized and well managed as a condition
to approval of an interstate bank acquisition and that an acquiring bank be and remain well capitalized and well managed as a
condition to approval of an interstate bank merger.
Nonbanking activities. With some exceptions, the Bank Holding Company Act prohibits a bank holding company from acquiring or
retaining direct or indirect ownership or control of more than 5% of the voting shares of any company that is not a bank or bank
holding company or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, or
providing services for its subsidiaries. The principal exceptions to these prohibitions involve non-bank activities that, by statute or by
Federal Reserve regulation or order, are held to be closely related to the business of banking or of managing or controlling banks. A
bank holding company may become a financial holding company if the holding company meets “well-capitalized” and well-managed
requirements of the Federal Reserve and each of its subsidiary banks is well capitalized under the Federal Deposit Insurance
Corporation Act of 1991 prompt corrective action provisions, is well managed, and has at least a satisfactory rating under the
Community Reinvestment Act, by filing a declaration that the bank holding company elects to become a financial holding company.
The Company is a financial holding company. No regulatory approval is required for a financial holding company to acquire a
company, other than a bank or savings association, engaged in activities that are financial in nature or incidental to activities that are
financial in nature, as determined by the Federal Reserve.
Activities that are “financial in nature” include:
•
•
•
securities underwriting, dealing and market making;
sponsoring mutual funds and investment companies;
insurance underwriting and agency;
5
• merchant banking; and
•
activities that the Federal Reserve Board has determined to be closely related to banking.
If a financial holding company or a subsidiary bank fails to be both well capitalized and well managed, the financial holding company
must enter into a written agreement with the Federal Reserve to comply with all applicable capital and management requirements.
Until the Federal Reserve determines that the institution is again well capitalized and well managed, the Federal Reserve may impose
additional limitations or conditions on the conduct or activities of the financial holding company or any affiliate that the Federal
Reserve finds to be appropriate or consistent with federal banking laws. If the financial holding company does not timely correct
the capital or management deficiencies, the financial holding company may be required to divest ownership or control of all banks
owned by the financial holding company. If an insured bank subsidiary fails to maintain a satisfactory rating under the Community
Reinvestment Act, the financial holding company may not engage in activities permitted only to financial holding companies until
such time as the bank receives a satisfactory rating.
Capital. Risk-based capital requirements. Financial institutions and their holding companies are required to maintain capital as a
way of absorbing losses that can, as well as losses that cannot, be predicted. The Federal Reserve has adopted risk-based capital
guidelines for financial holding companies as well as state banks that are members of the Federal Reserve Bank. The Office of the
Comptroller of the Currency and the FDIC have adopted risk-based capital guidelines for national banks and state non-member banks,
respectively. The guidelines provide a systematic analytical framework which makes regulatory capital requirements sensitive to
differences in risk profiles among banking organizations, takes off-balance sheet exposures expressly into account in evaluating
capital adequacy and minimizes disincentives to holding liquid, low-risk assets. Capital levels as measured by these standards are also
used to categorize financial institutions for purposes of certain prompt corrective action regulatory provisions.
Prior to January 1, 2015, the guidelines included a minimum for the ratio of total capital to risk-weighted assets of 8%, with at least
half of the ratio composed of common shareholders’ equity, minority interests in certain equity accounts of consolidated subsidiaries
and a limited amount of qualifying preferred stock and qualified trust preferred securities, less goodwill and certain other intangible
assets (known as “Tier 1” risk-based capital). The guidelines also provided for a minimum ratio of Tier 1 capital to average assets, or
“leverage ratio,” of 3% for financial holding companies and bank holding companies that meet certain criteria, including having the
highest regulatory rating, and 4% for all other financial holding companies and bank holding companies.
The risk-based capital guidelines adopted by the federal banking agencies are based on the “International Convergence of Capital
Measurement and Capital Standard” (Basel I), published by the Basel Committee on Banking Supervision (the “Basel Committee”) in
1988. In 2004, the Basel Committee published a new capital adequacy framework (Basel II) for large, internationally active banking
organizations, and in December 2010 and January 2011, the Basel Committee issued an update to Basel II (“Basel III”). The Basel
Committee frameworks did not become applicable to banks supervised in the United States until adopted into United States law or
regulations. Although the United States banking regulators imposed some of the Basel II and Basel III rules on banks with $250
billion or more in assets or $10 billion of on-balance sheet foreign exposure, it was not until July 2013 that the United States banking
regulators issued final (or, in the case of the FDIC, interim final) new capital rules applicable to smaller banking organizations which
also implement certain of the provisions of the Dodd-Frank Act (the “Basel III Capital Rules”). Community banking organizations,
including the Company and the Bank, began transitioning to the new rules on January 1, 2015. The new minimum capital
requirements became effective on January 1, 2015, whereas a new capital conservation buffer and deductions from common equity
capital phase in from January 1, 2016, through January 1, 2019, and most deductions from common equity tier 1 capital will phase in
from January 1, 2015, through January 1, 2019.
The new rules include (a) a new common equity tier 1 capital ratio of at least 4.5%, (b) a Tier 1 capital ratio of at least 6.0%, rather
than the former 4.0%, (c) a minimum total capital ratio that remains at 8.0%, and (d) a minimum leverage ratio of 4%.
Common equity for the common equity tier 1 capital ratio includes common stock (plus related surplus) and retained earnings, plus
limited amounts of minority interests in the form of common stock, less the majority of certain regulatory deductions.
Tier 1 capital includes common equity as defined for the common equity tier 1 capital ratio, plus certain non-cumulative preferred
stock and related surplus, cumulative preferred stock and related surplus and trust preferred securities that have been grandfathered
(but which are not permitted going forward), and limited amounts of minority interests in the form of additional Tier 1 capital
instruments, less certain deductions.
Tier 2 capital, which can be included in the total capital ratio, includes certain capital instruments (such as subordinated debt) and
limited amounts of the allowance for loan and lease losses, subject to new eligibility criteria, less applicable deductions.
The deductions from common equity tier 1 capital include goodwill and other intangibles, certain deferred tax assets, mortgage-
servicing assets above certain levels, gains on sale in connection with a securitization, investments in a banking organization’s own
6
capital instruments and investments in the capital of unconsolidated financial institutions (above certain levels). The deductions phase
in from 2015 through 2019.
For institutions with less than $250 billion in assets, the final rules also allow a one-time opportunity to permanently opt-out of a
requirement to include all components of accumulated other comprehensive income in the capital calculation. To avoid the possibility
of extreme market volatility in determining capital adequacy, the Company and the Bank have elected to opt-out.
Under the guidelines, capital is compared to the relative risk related to the balance sheet. To derive the risk included in the balance
sheet, one of several risk weights is applied to different balance sheet and off-balance sheet assets, primarily based on the relative
credit risk of the counterparty. The capital amounts and classification are also subject to qualitative judgments by the regulators about
components, risk weightings and other factors. Some of the risk weightings have been changed effective January 1, 2015.
The new rules also place restrictions on the payment of capital distributions, including dividends, and certain discretionary bonus
payments to executive officers if the company does not hold a capital conservation buffer of greater than 2.5% composed of common
equity tier 1 capital above its minimum risk-based capital requirements, or if its eligible retained income is negative in that quarter and
its capital conservation buffer ratio was less than 2.5% at the beginning of the quarter. The capital conservation buffer phases in
starting on January 1, 2016, at .625% and is currently 1.25%.
In addition to the capital requirements applicable to bank holding companies generally, the Federal Reserve requires financial holding
companies to be “well-capitalized” under Federal Reserve standards.
Pursuant to the Federal Reserve's Small Bank Holding Company Policy (SBHC Policy), however, a holding company with assets of
less than $1 billion and meeting certain other requirements is not required to comply with the consolidated capital requirements. The
Bank must, however, comply with the new capital requirements. At December 31, 2016, the Company was deemed to be a small bank
holding company under the SBHC Policy.
Prompt corrective action. In addition to the capital adequacy requirements set forth above, every insured financial institution is
classified into one of five categories based upon the institution’s capital ratios, the results of regulatory examinations of the institution
and whether the institution is subject to enforcement agreements with its regulatory authorities. The categories are “well capitalized,”
“adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.”
The capital of the Company and the Bank as of December 31, 2016 were as follows:
December 31, 2016
CET1 capital (to risk-weighted assets)
Consolidated
Bank
Tier 1 capital (to risk-weighted assets)
Consolidated
Bank
Total capital (to risk-weighted assets)
Consolidated
Bank
Tier 1 capital (to average assets)
Consolidated
Bank
Actual
Amount
Ratio
(Amounts in thousands)
Minimum required for capital
adequacy purposes (1)
Ratio
Amount
To be well-capitalized under
prompt corrective action
regulations
Amount
Ratio
$
60,631
56,720
12.97 %
12.23 %
$
21,033
20,874
4.5 %
4.5 %
$
N/A
30,151
65,631
56,720
14.04 %
12.23 %
28,044
27,832
6.0 %
6.0 %
N/A
37,109
70,583
67,672
15.10 %
14.59 %
37,392
37,109
8.0 %
8.0 %
N/A
46,387
65,631
56,720
10.46 %
9.10 %
25,086
24,938
4.0 %
4.0 %
N/A
31,172
N/A
6.5 %
N/A
8.0 %
N/A
10.0 %
N/A
5.0 %
(1) Currently not required for the Company as a small bank holding company under the SBHC Policy.
A bank with a capital level that might qualify for well capitalized or adequately capitalized status may nevertheless be treated as
though the bank is in the next lower capital category if the bank’s primary federal banking supervisory authority determines that an
unsafe or unsound condition or practice warrants that treatment. A bank’s operations can be significantly affected by its capital
classification under the prompt corrective action rules. For example, a bank that is not well capitalized generally is prohibited from
accepting brokered deposits and offering interest rates on deposits higher than the prevailing rate in its market without advance
7
regulatory approval. These deposit-funding limitations can have an adverse effect on the bank’s liquidity. At each successively lower
capital category, an insured depository institution is subject to additional restrictions. Undercapitalized banks are required to take
specified actions to increase their capital or otherwise decrease the risks to the federal deposit insurance fund. Bank regulatory
agencies generally are required to appoint a receiver or conservator within 90 days after a bank becomes critically undercapitalized,
with a leverage ratio of less than 2%. Section 38(f)(2)(I) of the Federal Deposit Insurance Act provides that a federal bank regulatory
authority may require a bank holding company to divest itself of an undercapitalized bank subsidiary if the agency determines that
divestiture will improve the bank’s financial condition and prospects.
Effective January 1, 2015, in order to be “well-capitalized,” a bank must have a common equity tier 1 capital ratio of at least 6.5%, a
total risk-based capital ratio of at least 10%, a Tier 1 risk-based capital ratio of at least 8% and a leverage ratio of at least 5%, and the
bank must not be subject to any written agreement, order, capital directive or prompt corrective action directive to meet and maintain a
specific capital level or any capital measure. The Company’s management believes that the Bank meets the ratio requirements to be
deemed “well-capitalized” according to the guidelines described above.
Federal deposit insurance. Deposits in the Bank are insured by the FDIC up to applicable limits through the Deposit Insurance Fund.
Insured banks must pay deposit insurance premiums assessed semiannually and paid quarterly. The general insurance limit is
$250,000 per separately insured depositor. This insurance is backed by the full faith and credit of the United States Government.
As insurer, the FDIC is authorized to conduct examinations of and to require reporting by insured institutions, including the Bank, to
prohibit any insured institution from engaging in any activity the FDIC determines to pose a threat to the deposit insurance fund, and
to take enforcement actions against insured institutions. The FDIC may terminate insurance of deposits of any institution if it finds
that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition or has violated any applicable
law, regulation, rule, order or condition imposed by the FDIC or other regulatory agency.
The FDIC assesses a quarterly deposit insurance premium on each insured institution based on risk characteristics of the institution
and may also impose special assessments in emergency situations. The premiums fund the Deposit Insurance Fund ("DIF"). Pursuant
to the Dodd-Frank Act, the FDIC has established 2.0% as the designated reserve ratio ("DRR"), which is the amount in the DIF as a
percentage of all DIF insured deposits. In March 2016, the FDIC adopted final rules designed to meet the statutory minimum DRR of
1.35% by September 30, 2020, the deadline imposed by the Dodd-Frank Act. The Dodd-Frank Act requires the FDIC to offset the
effect on institutions with assets of less than $10 billion of the increase in the statutory minimum DRR to 1.35% from the former
statutory minimum of 1.15%. Although the FDIC's new rules reduced assessment rates on all banks, they imposed a surcharge on
banks with assets of $10 billion or more to be paid until the DRR reaches 1.35%. The rules also provide assessment credits to banks
with assets of less than $1 billion for the portion of their assessments that contribute to the increase of the DRR to 1.35%. The rules
further changed the method of determining risk-based assessment rates for established banks with less than $10 billion in assets to
better ensure that banks taking on greater risks pay more for deposit insurance than banks that take on less risk.
In addition, all FDIC-insured institutions are required to pay assessments to fund interest payments on bonds issued by the Financing
Corporation, which was established by the government to recapitalize a predecessor to the DIF. These assessments will continue until
the Financing Corporation bonds mature in 2019.
The FDIC may terminate the deposit insurance of any insured depository institution if the FDIC determines that the institution has
engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order, or any condition imposed in writing by or written agreement with the FDIC.
Selected regulations. Transactions with affiliates. The Bank must comply with section 23A and section 23B of the Federal Reserve
Act, establishing rules for transactions by member banks with affiliates. These provisions protect banks from abuse in financial
transactions with affiliates. Generally, section 23A and section 23B of the Federal Reserve Act (1) limit the extent to which a bank or
its subsidiaries may lend to or engage in various other kinds of transactions with any one affiliate to an amount equal to 10% of the
institution’s capital and surplus (2) limit the aggregate of covered transactions with all affiliates to 20% of capital and surplus,
(3) impose strict collateral requirements on loans or extensions of credit by a bank to an affiliate, (4) impose restrictions on
investments by a subsidiary bank in the stock or securities of its holding company, (5) impose restrictions on the use of a holding
company’s stock as collateral for loans by the subsidiary bank, and (6) require that affiliate transactions be on terms substantially the
same as those provided to a non-affiliate.
Loans to insiders. The authority of the Bank to extend credit to insiders –meaning executive officers, directors, and greater than 10%
shareholders – or to entities those persons control, is subject to section 22(g) and section 22(h) of the Federal Reserve Act and
Regulation O of the Federal Reserve. These laws require that insider loans be made on terms substantially similar to those offered to
unaffiliated individuals, place limits on the amount of loans a bank may make to insiders based in part on the bank’s capital position,
and require specified approval procedures. Loans to an individual insider may not exceed the general legal limit on loans to any one
borrower. The aggregate of all loans to all insiders may not exceed the bank’s unimpaired capital and surplus. Insider loans exceeding
8
the greater of 5% of capital or $25,000 must be approved in advance by a majority of the board, with any interested director not
participating in the voting. Loans to executive officers are subject to additional limitations based on the purpose of the loan. A
violation of these restrictions could result in the assessment of substantial civil money penalties, the imposition of a cease-and-desist
order, or other regulatory sanctions.
Loans to one borrower. Under Ohio law, the total loans and extensions of credit by an Ohio-chartered bank to a person outstanding at
any time generally may not exceed 15% of the bank’s unimpaired capital, plus 10% of unimpaired capital for loans and extensions of
credit fully secured by readily marketable collateral.
Dividends and Distributions. Current federal banking regulations impose restrictions on the Bank's ability to pay dividends to the
Company. These restrictions include a limit on the amount of dividends that may be paid in a given year without prior approval of the
Federal Reserve and a prohibition on paying dividends that would cause the Bank's total capital to be less than the required minimum
levels under the capital requirements imposed by the Federal Reserve. The new capital rules also limit the payment of dividends if the
Bank does not maintain the capital conservation buffer. Ohio law also limits the amount of dividends that may be paid in any given
year without prior approval of the Ohio Superintendent of Financial Institutions. The Bank's regulators may prohibit the payment of
dividends at any time if the regulators determine the dividends represent unsafe and/or unsound banking practices, or reduce the
Bank's total capital below adequate levels.
The Company's ability to pay dividends to its shareholders may also be restricted. Current Federal Reserve policy requires a financial
holding company to act as a source of financial strength to each of its banking subsidiaries. Under this policy, the Federal Reserve
may require the Company to commit resources or contribute additional capital to the Bank, which could restrict the amount of cash
available for dividends.
The Federal Reserve has also issued a policy statement with regard to the payment of cash dividends by financial holding companies
and other bank holding companies. The policy statement provides that, as a matter of prudent banking, a financial holding company
or bank holding company should not maintain a rate of cash dividends unless its net income available to common shareholders has
been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears to be consistent with the financial
holding company's or bank holding company's capital needs, asset quality and overall financial condition. Accordingly, a financial
holding company or bank holding company should not pay cash dividends that exceed its net income or can only be funded in ways
that weaken the holding company's financial health, such as by borrowing.
Executive and incentive compensation. In June 2010, the federal banking regulatory agencies issued joint interagency guidance on
incentive compensation policies (the Joint Guidance) intended to ensure that the incentive compensation policies of banking
organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. This principles-
based guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either
individually or as part of a group, is based upon the key principles that a banking organization's incentive compensation arrangements
should: (1) provide incentives that do not encourage risk-taking beyond the organization's ability to effectively identify and manage
risk; (2) be compatible with effective internal controls and risk management; and (3) be supported by strong corporate governance,
including active and effective oversight by the organization's board of directors. The Federal Reserve reviews the incentive
compensation arrangements of financial institutions as part of its examination process and includes findings in examination reports.
Any deficiencies can affect the financial institution's supervisory ratings, which can affect the institution's ability to engage in
acquisitions and activities, and can result in enforcement actions.
In May 2016, the federal bank regulatory agencies approved a second joint notice of proposed rules (the Second Proposed Joint Rules)
designed to prohibit incentive-based compensation arrangements that encourage inappropriate risks at financial institutions. The
Second Proposed Joint Rules would apply to covered financial institutions with total assets of $1 billion or more. The requirements of
the Second Proposed Joint Rules would differ for each of three categories of financial institutions, based on their asset sizes. Based on
the Bank's current asset size, the Second Proposed Joint Rules would not apply to the Bank.
Consumer protection laws and regulations. Banks are subject to regular examination to ensure compliance with federal statutes and
regulations applicable to their business, including consumer protection statutes and implementing regulations. Potential penalties
under these laws include, but are not limited to, fines. The Dodd-Frank Act established the CFPB, which has extensive regulatory and
enforcement powers over consumer financial products and services. The CFPB has adopted numerous rules with respect to consumer
protection laws, amending some existing regulations and adopting new ones. It has also commenced enforcement actions. The
following are just some of the consumer protection laws applicable to the Bank:
• Community Reinvestment Act of 1977: imposes a continuing and affirmative obligation to fulfill the credit needs of its
entire community, including low- and moderate-income neighborhoods.
9
• Equal Credit Opportunity Act: prohibits discrimination in any credit transaction on the basis of any of various criteria.
• Truth in Lending Act: requires that credit terms are disclosed in a manner that permits a consumer to understand and
compare credit terms more readily and knowledgeably.
• Fair Housing Act: makes it unlawful for a lender to discriminate in its housing-related lending activities against any person
on the basis of any of certain criteria.
• Home Mortgage Disclosure Act: requires financial institutions to collect data that enables regulatory agencies to determine
whether the financial institutions are serving the housing credit needs of the communities in which they are located.
• Real Estate Settlement Procedures Act: requires that lenders provide borrowers with disclosures regarding the nature and
cost of real estate settlements and prohibits abusive practices that increase borrowers' costs.
• Privacy provisions of the Gramm-Leach-Bliley Act: requires financial institutions to establish policies and procedures to
restrict the sharing of non-public customer data with non-affiliated parties and to protect customer information from
unauthorized access.
Monetary policy. The earnings of financial institutions are affected by the policies of regulatory authorities, including monetary
policy of the Federal Reserve. An important function of the Federal Reserve is regulation of aggregate national credit and money
supply, relying on measures such as open market transactions in securities, establishment of the discount rate on bank borrowings, and
changes in reserve requirements against bank deposits. These methods are used in varying combinations to influence overall growth
and distribution of financial institutions’ loans, investments, and deposits, and they also affect interest rates charged on loans or paid
on deposits. Monetary policy is influenced by many factors, including inflation, unemployment, short-term and long-term changes in
the international trade balance, and fiscal policies of the United States government. Federal Reserve Board monetary policy has had a
significant effect on the operating results of financial institutions in the past and it will continue to influence operating results in the
future.
Anti-money laundering and anti-terrorism legislation. The Bank Secrecy Act of 1970 requires financial institutions to maintain
records and report transactions to prevent the financial institutions from being used to hide money derived from criminal activity and
tax evasion. The Bank Secrecy Act establishes (a) record-keeping requirements to assist government enforcement agencies with
tracing financial transactions and flow of funds, (b) reporting requirements for Suspicious Activity Reports and Currency Transaction
Reports to assist government enforcement agencies with detecting patterns of criminal activity, (c) enforcement provisions authorizing
criminal and civil penalties for illegal activities and violations of the Bank Secrecy Act and its implementing regulations, and (d) safe
harbor provisions that protect financial institutions from civil liability for their cooperative efforts.
The Treasury’s Office of Foreign Asset Control administers and enforces economic and trade sanctions against targeted foreign
countries, entities, and individuals based on U.S. foreign policy and national security goals. As a result, financial institutions must
scrutinize transactions to ensure that they do not represent obligations of or ownership interests in entities owned or controlled by
sanctioned targets.
The USA PATRIOT Act of 2001 requires financial institutions to establish due diligence policies, procedures, and controls reasonably
designed to detect and report money laundering through correspondent accounts and private banking accounts, share information with
law enforcement about individuals, entities, and organizations engaged in or suspected of engaging in terrorist acts or money
laundering activities, and comply with regulations setting forth minimum standards regarding customer identification. These
regulations require financial institutions to implement reasonable procedures for verifying the identity of any person seeking to open
an account, maintain records of the information used to verify the person’s identity, and consult lists of known or suspected terrorists
and terrorist organizations provided to the financial institution by government agencies.
10
Volcker Rule. In December 2013, five federal agencies adopted a final regulation implementing the Volcker Rule provision of
the Dodd-Frank Act (the “Volcker Rule”). The Volcker Rule places limits on the trading activity of insured depository institutions
and entities affiliated with a depository institution, subject to certain exceptions. The trading activity includes a purchase or sale as
principal of a security, derivative, commodity future or option on any such instrument in order to benefit from short-term price
movements or to realize short-term profits. The Volcker Rule exempts specified U.S. Government, agency and/or municipal
obligations, and it excepts trading conducted in certain capacities, including as a broker or other agent, through a deferred
compensation or pension plan, as a fiduciary on behalf of customers, to satisfy a debt previously contracted, repurchase and securities
lending agreements and risk-mitigating hedging activities.
The Volcker Rule also prohibits a banking entity from having an ownership interest in, or certain relationships with, a hedge fund or
private equity fund, with a number of exceptions. Included among those prohibited investments are certain collateralized debt
obligations (CDOs) collateralized by trust preferred securities (TruPS). While the five regulatory agencies issued an Interim Final
Rule on January 14, 2014, granting relief from the prohibition against holding certain CDOs secured by TruPS issued by bank or thrift
holding companies, the relief does not extend to CDOs collateralized by TruPS issued by insurance companies (iTruPS). The
Company maintained a position in nine iTruPS, which were sold in early 2014.
The Company has no other investments prohibited by the Volcker Rule and does not engage in any of the trading activities governed
by the Volcker Rule.
AVAILABLE INFORMATION
The Company files an annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K and amendments to
those reports with the SEC pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 Amended. The Company’s website
is www.cortlandbank.com. The Company makes available through its website, free of charge, the reports filed with the SEC, as soon
as reasonably practicable after such material is electronically filed, or furnished to, the SEC. The SEC also maintains a website that
contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at
www.sec.gov. The public may read and copy any materials filed with the Commission at the SEC’s Public Reference Room at 100 F
Street, NE, Washington, DC 20549, on official business days during the hours of 10:00 am to 3:00 pm. The public may obtain
information on the operation of the Public Reference Room by calling the Commission at 1-800-SEC-0330.
Item 1A. Risk Factors
Like all financial companies, the Company’s business and results of operations are subject to a number of risks, many of which are
outside of our control. In addition to the other information in this report, readers should carefully consider that the following important
factors could materially impact our business and future results of operations.
Changes in economic and political conditions could adversely affect our earnings through declines in deposits, loan demand, the
ability of its customers to repay loans and the value of the collateral securing its loans.
Our success depends, in part, on economic and political conditions, local and national, as well as governmental fiscal and monetary
policies. Conditions such as inflation, recession, unemployment, changes in interest rates, fiscal and monetary policy and other factors
beyond the Company’s control may adversely affect its deposit levels and composition, demand for loans, the ability of its borrowers
to repay their loans and the value of the collateral securing the loans it makes. The recent election of a new United States President is
widely expected to result in substantial, unpredictable changes in economic and political conditions for the United States and the
remainder of the world. Economic turmoil in Europe and Asia and changes in oil production in the Middle East affect the economy
and stock prices in the United States, which can affect our earnings and capital and the ability of its customers to repay loans. Because
the Company has a significant amount of real estate loans, decreases in real estate values could adversely affect the value of property
used as collateral and our ability to sell the collateral upon foreclosure.
The enactment of new legislation or regulations may significantly affect our financial condition and results of operations.
The Company is subject to regulations and supervision of the Federal Reserve, and the Bank is subject to regulation and supervision
by the ODFI, the Federal Reserve, the FDIC and the CFPB. The regulations are designed to protect customers and the Deposit
Insurance Fund. Regulations governing financial institutions are constantly undergoing change. New regulations or amendments
could adversely affect the Company's business. Regulatory agencies have great discretion in connection with their supervisory and
enforcement activities, including the imposition of restrictions on the operation of an institution, the classification of assets held by an
institution and the appropriateness of an institution's allowance for loan losses. In addition, actions by regulatory agencies could cause
the Company to devote significant time and resources to compliance and defense of its business and may lead to penalties that
materially affect the Company.
11
In recent years, Congress and the banking regulators have increased their focus on the financial services industry. The laws and
regulations adopted have subjected the Company and the Bank to additional restrictions, oversight and costs that may have an impact
on the financial condition and results of operations of the Company. In 2013, the Company's and the Bank's primary federal regulator
established a new comprehensive capital framework for U.S. banking organizations. The new capital rules became effective for the
Bank on January 1, 2015, subject to a phase-in period. Although the implementation of the new rules is not expected to have a
material impact on the Bank's capital ratios when fully phased in, any future changes to capital requirements may have such an effect.
The election of a new President of the United States may result in substantial changes to laws and regulations applicable to financial
institutions, including the Company and the Bank. Even the reduction of regulatory restrictions could have an adverse effect on the
Company and the Bank and the Company's shareholders if such lessening of restrictions increases competition within the financial
services industry or the Company's market area.
Further information about government regulation of the Company and the Bank may be found under the heading, "SUPERVISION
AND REGULATION" in "ITEM 1. BUSINESS" of this Form 10-K.
Adverse changes in the financial markets may adversely impact our results of operations.
While we generally invest in securities issued by U.S. government agencies and sponsored entities and U.S. state and local
governments with limited credit risk, certain investment securities we hold possess higher credit risk since they represent beneficial
interests in structured investments collateralized by residential mortgages, debt obligations and other similar asset-backed assets.
Regardless of the level of credit risk, all investment securities are subject to changes in market value due to changing interest rates,
implied credit spreads and credit ratings.
We may be compelled to seek additional capital in the future but may not be able to access capital when needed.
Federal banking agencies have adopted extensive changes to their capital requirements, including raising required amounts and
eliminating inclusion of certain instruments from the calculation of capital. Should we experience significant loan losses, we may need
additional capital. In addition, we may elect to raise additional capital to support our business, to finance acquisitions, if any, or for
other purposes. Our ability to raise additional capital, if needed, will depend on our financial performance, conditions in the capital
markets, economic conditions and a number of other factors, many of which are outside of our control. There can be no assurance,
therefore, that we can raise additional capital at all or on terms acceptable to us. If we cannot raise additional capital when needed or
desired, it may have a material adverse effect on our financial condition, results of operations and prospects.
A default by another larger financial institution could adversely affect financial markets generally.
The commercial soundness of many financial institutions may be closely interrelated as a result of relationships between the
institutions. As a result, concerns about, or a default or threatened default by, one institution could lead to significant market-wide
liquidity and credit problems, losses or defaults by other institutions. This “systemic risk” may adversely affect our business.
Changes in national and local economic and political conditions could adversely affect our earnings, as our borrowers’ ability to
repay loans and the value of the collateral securing our loans decline and as loans and deposits decline.
There are inherent risks associated with our lending activities, including credit risk, which is the risk that borrowers may not repay
outstanding loans or the value of the collateral securing loans will decrease. Conditions such as inflation, recession, unemployment,
changes in interest rates and money supply and other factors beyond our control may adversely affect the ability of our borrowers to
repay their loans and the value of collateral securing the loans, which could adversely affect our earnings. Recent changes in
government, particularly the change in the U.S. President, could bring changes in all of such factors. Because we have a significant
amount of real estate loans, a decline in the value of real estate could have a material adverse effect on us. As of December 31, 2016,
79.8% of our loan portfolio consisted of commercial, commercial real estate, real estate construction and installment, all of which are
generally viewed as having more risk of default than residential real estate loans and all of which, with the exception of installment
loans, are typically larger than residential real estate loans. Residential real estate loans held in the portfolio are typically originated
using conservative underwriting standards that do not include sub-prime lending. We attempt to manage credit risk through a program
of underwriting standards, the review of certain credit decisions and an on-going process of assessment of the quality of the credit
already extended. Economic and political changes could also adversely affect our deposits and loan demand, which could adversely
affect our earnings and financial condition. Since substantially all of our loans are to individuals and businesses in Ohio, any decline
in the economy of this market area could have a materially adverse effect on our credit risk and on our deposit and loan levels.
12
Changes in interest rates could adversely affect our financial condition and results of operations.
Our results of operations depend substantially on our net interest income, which is the difference between (i) the interest earned on
loans, securities and other interest-earning assets and (ii) the interest paid on deposits and borrowings. These rates are highly sensitive
to many factors beyond our control, including general economic conditions, inflation, recession, unemployment, money supply and
the policies of various governmental and regulatory authorities. If the interest we pay on deposits and other borrowings increases at a
faster rate than the interest we receive on loans and other investments, our net interest income and therefore earnings, could be
adversely affected. Earnings could also be adversely affected if the interest we receive on loans and other investments falls more
quickly than the interest we pay on deposits and borrowings. While we have taken measures intended to manage the risks of operating
in a changing interest rate environment, there can be no assurance that these measures will be effective in avoiding undue interest rate
risk.
Increases in interest rates also can affect the value of loans and other assets, including our ability to realize gains on the sale of assets.
We originate loans for sale and for our portfolio. Increasing interest rates may reduce the origination of loans for sale and
consequently the fee income we earn on such sales. Further, increasing interest rates may adversely affect the ability of borrowers to
pay the principal or interest on loans and leases, resulting in an increase in non-performing assets and a reduction of income
recognized.
Increases in FDIC insurance premiums may have a material adverse effect on our earnings.
We are generally unable to control the amount of premiums that we are required to pay for FDIC insurance. If there are a significant
number of financial institution failures or changes in the method of calculating premiums, we may be required to pay higher FDIC
premiums. Increases in FDIC insurance premiums may materially adversely affect our results of operations and our ability to continue
to pay dividends on our common shares at the current rate or at all.
Our allowance for loan losses may be insufficient.
We maintain an allowance for loan losses to provide for probable loan losses based on management’s quarterly analysis of the loan
portfolio. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the
United States (GAAP) requires management to make significant estimates that affect the financial statements. One of our most critical
estimates is the level of the allowance for loan losses. Due to the inherent nature of these estimates, we cannot provide absolute
assurance that we will not be required to charge earnings for significant unexpected loan losses. For more information on the
sensitivity of these estimates, refer to the discussion of our “Critical Accounting Policies” in this report.
We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses within the loan
portfolio. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of
our borrowers and the value of the real estate and other assets serving as collateral for the repayment of loans. In deciding whether to
extend credit or enter into other transactions with customers and counterparties, we may rely on information provided to us by
customers and counterparties, including financial statements and other financial information. We may also rely on representations of
customers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on
reports of independent auditors. For example, in deciding whether to extend credit to a business, we may assume that the customer’s
audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of
operations and cash flows of the customer. We may also rely on the audit report covering those financial statements. Our financial
condition, results of operations and cash flows could be negatively impacted to the extent that we rely on financial statements that do
not comply with GAAP or on financial statements and other financial information that are materially misleading.
Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan
losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and
performance of customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in
economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may
exceed current estimates. We cannot fully predict the amount or timing of losses or whether the loss allowance will be adequate in the
future. If our assumptions prove to be incorrect, our allowance for loan losses may not be sufficient to cover losses inherent in our
loan portfolio, resulting in additions could have a material adverse impact on our financial condition and results of operations. In
addition, federal and state regulators periodically review our allowance for loan losses as part of their examination process and may
require management to increase the allowance or recognize further loan charge-offs based on judgments different than those of
management. Any increase in the provision for loan losses would decrease our pretax and net income.
13
If we foreclose on collateral property and own the underlying real estate, we may be subject to the increased costs associated with
the ownership of real property, resulting in reduced revenues.
We may have to foreclose on collateral property to protect our investment and may thereafter own and operate such property, in which
case we will be exposed to the risks inherent in the ownership of real estate. The amount that we, as a mortgagee, may realize after a
default is dependent upon factors outside of our control, including, but not limited to: (i) general or local economic conditions;
(ii) neighborhood values; (iii) interest rates; (iv) real estate tax rates; (v) operating expenses of the mortgaged properties; (vi) supply of
and demand for rental units or properties; (vii) ability to obtain and maintain adequate occupancy of the properties; (viii) zoning laws;
(ix) governmental rules, regulations and fiscal policies; and (x) acts of God. Certain expenditures associated with the ownership of real
estate, principally real estate taxes and maintenance costs, may adversely affect the income from the real estate. Therefore, the cost of
operating a real property may exceed the rental income earned from such property, and we may have to advance funds in order to
protect our investment, or we may be required to dispose of the real property at a loss. The foregoing expenditures and costs could
adversely affect our ability to generate revenues, resulting in reduced levels of profitability.
Environmental liability associated with commercial lending could have a material adverse effect on our business, financial
condition and results of operations.
In the course of our business, we may acquire, through foreclosure, commercial properties securing loans that are in default. There is a
risk that hazardous substances could be discovered on those properties. In this event, we could be required to remove the substances
from and remediate the properties at our cost and expense. The cost of removal and environmental remediation could be substantial.
We may not have adequate remedies against the owners of the properties or other responsible parties and could find it difficult or
impossible to sell the affected properties. These events could have a material adverse effect on our financial condition and results of
operation.
The loss of key members of our senior management team could adversely affect our business.
We believe that our success depends largely on the efforts and abilities of our senior management. Their experience and industry
contacts significantly benefit us. In addition, our success depends in part upon senior management’s ability to implement our business
strategy. The competition for qualified personnel in the financial services industry is intense, and the loss of services of any of our
senior executive officers or an inability to continue to attract, retain and motivate key personnel could adversely affect our business.
We cannot assure you that we will be able to retain our existing key personnel or attract additional qualified personnel.
Loss of key employees may disrupt relationships with certain customers.
Our business is primarily relationship-driven in that many of our key employees have extensive customer relationships. Loss of a key
employee with such customer relationships may lead to the loss of business if the customers were to follow that employee to a
competitor. While we believe our relationships with our key producers is good, we cannot guarantee that all of our key personnel will
remain with our organization. Loss of such key personnel, should they enter into an employment relationship with one of our
competitors, could result in the loss of some of our customers.
The Bank may be required to repurchase loans it has sold or indemnify loan purchasers under the terms of the sale agreements,
which could adversely affect the Company's liquidity, results of operations and financial condition.
When the Bank sells a mortgage loan, it may agree to repurchase or substitute a mortgage loan if it is later found to have breached any
representation or warranty the Bank made about the loan or if the borrower is later found to have committed fraud in connection with
the origination of the loan. The Bank's underwriting policies and procedures may not prevent every breach or fraud. Repurchases or
indemnifications may have an adverse effect on the Company's financial condition and results of operations.
The Company has operational risk.
The Company has many types of operational risk, including those discussed in more detail in this Risk Factors section, such as cyber-
related risks, insufficient allowances for loan losses, errors in estimates in the preparation of financial statements, and risks related to
future expansion. The Company also has reputational risk, legal and compliance risk, the risk of fraud or theft by employees or
outsiders and unauthorized transactions by employees, and operational errors, including clerical or record-keeping errors and errors
resulting from faulty or disabled computer or telecommunications systems.
The Company's operations may be disrupted by events beyond our control, including spikes in transaction volume or customer activity,
electrical or telecommunications outages or natural disasters. If our policies and systems designed to mitigate such problems fail to
operate well, such failures could result in reputational damage, regulatory intervention and civil litigation, leading to financial loss or
liability. Negative public opinion could result from the Company's actual or alleged conduct with respect to a variety of its activities,
14
including lending practices, corporate governance and acquisitions. Negative public opinion can adversely affect the Company's
ability to attract and keep customers.
The Company relies on vendors for certain processes. The Company is exposed to the risk that its vendors may be unable to fulfill
their contractual obligations or will suffer from the same risks as the Company has and that their business continuity systems may be
inadequate, resulting in damage to the Company's reputation, loss of business, regulatory enforcement actions and civil litigation.
We operate in an extremely competitive market, and our business will suffer if we are unable to compete effectively.
In our market area, we encounter significant competition from other banks, savings and loan associations, credit unions, mortgage
banking firms, securities brokerage firms, asset management firms and insurance companies. The increasingly competitive
environment is a result primarily of changes in regulation and the accelerating pace of consolidation among financial service
providers. The Company is smaller than many of our competitors. Many of our competitors have substantially greater resources and
lending limits than we do and may offer services that we do not or cannot provide.
Our ability to pay cash dividends is limited.
We are dependent primarily upon the earnings of our operating subsidiaries for funds to pay dividends on our common shares. The
payment of dividends by us and our subsidiaries is subject to certain regulatory restrictions. As a result, any payment of dividends in
the future will be dependent, in large part, on our ability to satisfy these regulatory restrictions and our subsidiaries’ earnings, capital
requirements, financial condition and other factors. Although our financial earnings and financial condition have allowed us to declare
and pay periodic cash dividends to our shareholders, there can be no assurance that our dividend policy or size of dividend distribution
will continue in the future.
The preparation of financial statements requires management to make estimates about matters that are inherently uncertain.
Management’s accounting policies and methods are fundamental to how we record and report our financial condition and results of
operations. Our management must exercise judgment in selecting and applying many of these accounting policies and methods in
order to ensure that they comply with generally accepted accounting principles and reflect management’s judgment as to the most
appropriate manner in which to record and report our financial condition and results of operations. One of the most critical estimates is
the level of the allowance of loan losses. Due to the inherent nature of these estimates, we cannot provide absolute assurance that we
will not significantly increase the allowance for loan losses or sustain loan losses that are significantly higher than the provided
allowance.
Material breaches in security of our systems or those of third-party service providers may have a significant effect on our business.
We collect, process and store sensitive consumer data by utilizing computer systems and telecommunications networks operated by
both us and third-party service providers. We have security and backup and recovery systems in place, as well as a business continuity
plan, to ensure the computer systems will not be inoperable, to the extent possible. We also have implemented security controls to
prevent unauthorized access to the computer systems and require our third-party service providers to maintain similar controls.
However, management cannot be certain that these measures will be successful. A security breach of the computer systems and loss of
confidential information, such as customer account numbers and related information, could result in a loss of customers’ confidence
and, thus, loss of business. In addition, unauthorized access to or use of sensitive data could subject us to litigation and liability and
costs to prevent further such occurrences.
The Bank’s necessary dependence upon automated systems to record and process the bank’s transaction volumes poses the risk that
technical system flaws or employee errors, tampering or manipulation of those systems will result in losses and may be difficult to
detect. The Bank may also be subject to disruptions of the operating system arising from events that are beyond the bank’s control (for
example, computer viruses, cyber attacks preventing customer access, electrical or telecommunications outages, natural disasters,
terrorism or international hostilities). The Bank is further exposed to the risk that the third-party service providers may be unable to
fulfill their contractual obligations (or will be subject to the same risks as the Bank). These disruptions may interfere with service to
the Bank’s customers, cause additional regulatory scrutiny and result in a financial loss or liability.
Further, we may be affected by data breaches at retailers and other third parties who participate in data interchanges with us and our
customers that involve the theft of customer credit and debit card data, which may include the theft of our debit card PIN numbers and
commercial card information used to make purchases at such retailers and other third parties. Such data breaches could result in us
incurring significant expenses to reissue debit cards and cover losses, which could result in a material adverse effect on our results of
operations.
15
Our assets at risk for cyber-attacks include financial assets and non-public information belonging to customers. We use several third-
party vendors who have access to our assets via electronic media. Certain cyber security risks arise due to this access, including cyber
espionage, blackmail, ransom, and theft. As cyber and other data security threats continue to evolve, we may be required to expend
significant additional resources to continue to modify and enhance our protective measures or to investigate and remediate any
security vulnerabilities.
Trading in our common shares is very limited, which may adversely affect the time and the price at which you can sell your
Company common shares.
Although the common shares of the Company are quoted on the OTC Market, trading in the Company’s common shares is not active,
and the spread between the bid and the asked price is often wide. As a result, you may not be able to sell your shares on short notice,
and the sale of a large number of shares at one time could temporarily depress the market price. The price at which you may be able to
sell your common shares may be significantly lower than the price at which you could buy the Company’s common shares at that
time.
Our organizational documents may have the effect of discouraging a third party from acquiring us.
Our articles of incorporation and code of regulations contain provisions, including a staggered board of directors and a supermajority
vote requirement, that make it more difficult for a third party to gain control or acquire us without the consent of the board of
directors. These provisions could also discourage proxy contests and may make it more difficult for dissident shareholders to elect
representatives as directors and take other corporate actions.
Future expansion may adversely affect our financial condition and results of operations.
We may acquire other financial institutions or parts of institutions in the future and may open new branches. We also may consider
and enter into new lines of business or offer new products or services. Expansions of our business involve a number of expenses and
risks, including:
the time and costs associated with identifying and evaluating potential acquisitions;
the potential inaccuracy of estimates and judgments used to evaluate credit, operations, management and market risk with
respect to the target institutions;
the time and costs of evaluating new markets, hiring local management and opening new offices, and the delay between
commencing these activities and the generation of profits from the expansion;
our ability to finance an acquisition or other expansion and the possible dilution to our existing shareholders;
the diversion of management’s attention to the negotiation of a transaction and the integration of the operations and
personnel of the combining businesses;
entry into unfamiliar markets;
the introduction of new products and services into our existing business;
the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects
on our results of operations; and
the risk of loss of key employees and customers.
We may incur substantial costs to expand, and we can give no assurance that such expansion will result in the levels of profits we
expect. Neither can we assure that integration efforts for any future acquisitions will be successful. We may issue equity securities in
connection with acquisitions, which could dilute the economic and voting interests of our existing shareholders.
Changes in accounting standards could materially impact the Company’s consolidated financial statements.
The Company’s accounting policies and methods are fundamental to how our financial condition and results of operations are
recorded and reported. The accounting standard setters, including the Financial Accounting Standards Board, the SEC, and other
regulatory bodies, from time to time may change the financial accounting and reporting standards that govern the preparation of the
Company’s consolidated financial statements. These changes can be hard to predict and can materially impact how the Company
records and reports financial condition and results of operations. In some cases, the Company could be required to apply a new or
revised standard retroactively, resulting in changes to previously reported financial results, or a cumulative charge to retained
earnings. Management may be required to make difficult, subjective, or complex judgments about matters that are uncertain.
Materially different amounts could be reported under different conditions or using different assumptions.
16
The Company undertakes no obligation and disclaims any intention to publish revised information or updates to forward-looking
statements contained in the above risk factors or in any other statement made at any time by any director, officer, employee or other
representative of the Company unless and until any such revisions or updates are required to be disclosed by applicable securities laws
or regulations.
Changes in tax laws could adversely affect our performance.
We are subject to extensive federal, state and local taxes, including income, excise, sales/use, payroll, franchise, withholding and ad
valorem taxes. Changes to our taxes could have a material adverse effect on our results of operations. In addition, our customers are
subject to a wide variety of federal, state and local taxes. Changes in taxes paid by our customers, including changes in the
deductibility of mortgage loan related expenses, may adversely affect their ability to purchase homes or consumer products, which
could adversely affect their demand for our loans and deposit products. In addition, such negative effects on our customers could
result in defaults on the loans we have made and decrease the value of mortgage-backed securities in which we have invested.
Item 1B. Unresolved Staff Comments — Not applicable to the Company because it is a smaller reporting company.
Item 2. Properties
The Company’s operations are conducted at 194 West Main Street, Cortland, Ohio.
Full service banking business is conducted at a total of fourteen offices, including:
BOARDMAN
Victor Hills Plaza
6538 South Avenue
Boardman, Ohio 44512
330-629-9151
BRISTOL
6090 State Route 45
Bristolville, Ohio 44402
330-889-3062
BROOKFIELD
7202 Warren-Sharon Road
Brookfield, Ohio 44403
330-448-6814
CANFIELD
3615 Boardman-Canfield Road
Canfield, Ohio 44406
330-941-5867
CORTLAND
194 West Main Street
Cortland, Ohio 44410
330-637-8040
HUBBARD
890 West Liberty Street
Hubbard, Ohio 44425
330-534-2265
HUDSON
75 S. Main St.
Hudson, OH 44236
330-342-1100
MANTUA
11661 State Route 44
Mantua, Ohio 44255
330-274-3111
NILES PARK PLAZA
815 Youngstown-Warren Road
Suite 1
Niles, Ohio 44446
330-652-8700
NORTH LIMA
9001 Market Street
North Lima, Ohio 44452
330-758-5884
VIENNA
4434 Warren-Sharon Road
Vienna, Ohio 44473
330-394-1438
WARREN
2935 Elm Road
Warren, Ohio 44483
330-372-1520
WILLIAMSFIELD
5917 U.S. Route 322
Williamsfield, Ohio 44093
440-293-7502
WINDHAM
8950 Maple Grove Road
Windham, Ohio 44288
330-326-2340
The Bank’s main and administrative office is located at 194 West Main Street, Cortland, Ohio. The Bank leases two financial service
centers in Beachwood, Ohio and Fairlawn, Ohio. The Hubbard, Niles Park Plaza, Hudson and Boardman offices are leased, while all
of the other offices are owned by the Bank.
Item 3. Legal Proceedings
The Bank is involved from time to time in legal actions arising in the ordinary course of the Bank’s business. In the opinion of
management, the outcomes from such legal proceedings, either individually or in the aggregate, are not expected to have any material
effect on the Company.
17
Item 4. Mine Safety Disclosures – Not applicable
Executive Officers of the Registrant
The names, ages and positions of the executive officers as of March 23, 2017 are as follows:
Name
James M. Gasior
Timothy Carney
David J. Lucido
Stanley P. Feret
Age
57
51
59
56
Position Held
President, Chief Executive Officer and Director
Executive Vice President, Chief Operations Officer and Director
Senior Vice President and Chief Financial Officer
Senior Vice President and Chief Lending Officer
Principal Occupation and Business Experience of Executive Officers
During the past five years the business experience of each of the executive officers has been as follows:
Mr. Gasior has been President and Chief Executive Officer of the Company and the Bank since November 2, 2009. Mr. Gasior is a
director of the Company and the Bank since November 2005.
Mr. Carney has been Executive Vice President and Chief Operating Officer of the Company and the Bank since November 2, 2009.
Mr. Carney is a director of the Company and the Bank since November 2009.
Mr. Lucido was appointed Senior Vice President and Chief Financial Officer of the Company and the Bank on January 18, 2010.
Mr. Feret was appointed Senior Vice President and Chief Lending Officer of the Company and the Bank on March 10, 2010.
PART II
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities
The following is information regarding market information, holders and dividends.
The Company files quarterly reports on Form 10-Q, an annual report on Form 10-K, current reports on Form 8-K, and proxy
statements, as well as any amendments to those reports and statements, with the SEC pursuant to section 13(a) or (15)d of the
Exchange Act. In 2017, the Company’s quarterly reports will be filed within 45 days of the end of each quarter, and the Company’s
annual report will be filed within 90 days of the end of the year. Any person may access these reports and statements free of charge, as
soon as reasonably practicable after such material is electronically filed with or furnished to the SEC, by visiting our web site at
www.cortlandbank.com or by writing to:
Deborah L. Eazor
Cortland Bancorp
194 West Main Street
Cortland, Ohio 44410
The SEC also maintains a website at www.sec.gov where our filings and other information may be obtained free of charge.
The Company’s common shares trade on the OTCQX under the symbol CLDB. The following brokerage firm is known to be
relatively active in trading the Company’s common shares:
Boenning & Scattergood
9922 Brewster Lane
Powell, OH 43065
Telephone: 866-326-8113
18
The following table shows the dividends declared during the periods indicated and the prices at which the common shares of the
Company have actually been purchased and sold in market transactions. The range of market prices is compiled from data available
from the OTCQX, a financial marketplace for 10,000 U.S. and global securities that recently expanded to include financial institutions
that meet the capital requirements and disclosure commitments as established by the OTC. The data may not necessarily represent all
transactions. As of March 15, 2017, the Company had approximately 1,299 shareholders of record.
2016
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
2015
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
2014
Fourth Quarter
Third Quarter
Second Quarter
First Quarter
High
Price Per Share
Low
Close
Cash Dividends
Declared Per Share
$
$
$
17.70 $
16.00
15.80
16.55
15.90 $
15.00
15.60
16.00
15.95 $
13.85
13.00
11.00
15.36 $
14.76
14.45
15.30
14.31 $
13.00
14.15
15.16
13.50 $
11.80
10.51
10.25
17.50 $
15.61
15.00
15.40
15.90 $
14.31
14.15
15.30
15.75 $
13.50
11.90
10.60
0.07
0.07
0.07
0.07
0.06
0.06
0.06
0.06
0.05
0.05
0.05
0.03
For current share prices, please access our website at www.cortlandbank.com.
The Bank is subject to a dividend restriction that generally limits the amount of dividends that can be paid by an Ohio state-chartered
bank. Under the Ohio Banking Code, cash dividends may not exceed net profits as defined for that year combined with retained net
profits for the two preceding years less any required transfers to surplus. Under this formula, the amount available for payment of
dividends in 2017 is $5.0 million plus 2017 profits retained up to the date of the dividend declaration.
For the convenience of shareholders, the Company has established a plan whereby shareholders may have their dividends
automatically reinvested in the common shares of the Company. Participation in the plan is completely voluntary and shareholders
may withdraw at any time.
Shareholder and General Inquiries
Cortland Bancorp
194 West Main Street
Cortland, Ohio 44410
(330) 637-8040
Attention: Deborah L. Eazor
Vice President
DEazor@cortlandbank.com
Transfer Agent
American Stock Transfer & Trust Company, LLC
6201 15th Avenue
Brooklyn, NY 11219
(888) 509-4619
Please contact our transfer agent directly for assistance in changing your address, elimination of duplicate mailings, transferring shares
or replacing lost, stolen or destroyed share certificates. Other questions regarding your status as a shareholder of the Company may be
addressed to the Company as indicated above.
The Company did not repurchase any of its common shares during 2016 or sell any of its shares without registration during 2016,
2015 or 2014.
19
Item 6. Selected Financial Data
SUMMARY OF OPERATIONS
Total interest income
Total interest expense
Net interest income (NII)
Provision for loan losses
NII after loss provision
Investment security gains (losses), including impairment losses
Mortgage banking gains
Other income
Total non-interest income
Total non-interest expenses
Income before tax expense (benefit)
Federal income tax expense (benefit)
Net income
PER COMMON SHARE DATA (1)
Earnings per share, basic and diluted
Cash dividends declared per share
Book value
BALANCE SHEET DATA
Assets
Investment securities
Loans held for sale
Loans
Allowance for loan losses
Deposits
Borrowings
Subordinated debt
Shareholders’ equity
AVERAGE BALANCES
Assets
Investment securities
Loans
Loans held for sale
Deposits
Borrowings
Subordinated debt
Shareholders’ equity
ASSET QUALITY RATIOS
Loan charge-offs
Recoveries on loans
Net charge-offs
Net charge-offs as a percentage of average total loans
Loans 30+ days delinquent as a percentage of total loans
Nonperforming loans
Nonperforming securities
Other real estate owned
Total nonperforming assets
Allowance for loan losses as a percentage of non-performing loans
Nonperforming 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 asset ratio
Tangible equity ratio
Cash dividend payout ratio
Net interest margin
(In thousands of dollars, except for ratios and per share amounts)
Years Ended December 31,
2016
2015
2014
2013
2012
$
$
$
$
$
$
$
$
$
22,555
2,918
19,637
50
19,587
419
1,248
2,930
4,597
18,186
5,998
1,127
4,871
1.11
0.28
13.05
655,184
179,219
4,554
419,768
4,868
539,850
43,202
5,155
57,670
608,298
166,690
385,667
4,506
496,917
36,292
5,155
58,923
(614 )
238
(376 )
0.10 %
1.04 %
8,286
825
—
9,111
58.75 %
1.39 %
14.57
13.88
8.27 %
0.80
18.79
9.69
10.46
25.23
3.63
$
$
$
$
$
$
$
$
$
21,113 $
2,607
18,506
455
18,051
64
785
3,060
3,909
16,363
5,597
1,219
4,378
$
20,665 $
2,884
17,781
1,638
16,143
915
440
2,772
4,127
15,499
4,771
902
3,869
$
20,060 $
3,404
16,656
650
16,006
(1,234 )
1,491
2,488
2,745
16,879
1,872
88
$
1,784
21,015
4,071
16,944
3,020
13,924
(157 )
1,772
2,573
4,188
15,357
2,755
(158 )
2,913
0.97 $
0.24
12.87
0.85 $
0.18
12.33
0.39 $
0.12
10.94
0.64
0.03
10.93
612,443 $
162,035
4,033
394,254
5,194
496,404
44,499
5,155
56,684
568,897 $
166,155
356,105
2,504
454,920
43,761
5,155
56,625
(723 ) $
260
(463 ) $
0.13 %
1.80 %
11,542 $
778
61
12,381 $
568,932 $
170,108
632
360,185
5,202
456,761
44,759
5,155
55,852
542,542 $
175,000
325,747
814
428,468
46,886
5,155
53,648
(594 ) $
394
(200 ) $
0.06 %
2.22 %
9,237 $
779
40
10,056 $
556,918 $
168,133
656
346,833
3,764
448,669
46,404
5,155
49,535
540,510 $
181,051
306,411
12,003
435,550
44,127
5,155
49,449
(1,022 ) $
311
(711 ) $
0.23 %
0.54 %
6,120 $
1,203
33
7,356 $
582,240
184,646
24,756
317,282
3,825
476,901
46,051
5,155
49,452
528,075
183,514
287,723
13,311
424,337
44,054
5,155
48,598
(2,415 )
162
(2,253 )
0.78 %
0.94 %
5,668
674
145
6,487
45.00 %
56.32 %
61.50 %
67.48 %
2.02 %
20.01
19.99
7.73 %
0.77
21.78
9.95
10.62
24.74
3.65
1.77 %
16.47
17.13
7.21 %
0.71
18.91
9.89
10.66
21.18
3.67
1.32 %
13.80
13.39
3.61 %
0.33
4.70
9.15
10.35
30.77
3.41
1.11 %
12.16
12.01
5.99 %
0.55
(5.74 )
9.20
9.63
4.69
3.58
(1)
Basic earnings per common share are based on weighted average shares outstanding. Diluted earnings per share is after consideration of common stock equivalent. Cash
dividends per common share are based on actual cash dividends declared. Book value per common share is based on shares outstanding at each period end.
For more information see Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and
Item 8, Financial Statements and Supplementary Data.
20
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations
The following schedules show average balances of interest-earning 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.
Interest-earning assets:
Interest-earning deposits and other earning assets
Available-for-sale securities (Note 1, 2, 3):
U.S. Treasury and other U.S. Government agencies
and corporations
States of the U.S. and political subdivisions -
taxable
States of the U.S. and political subdivisions -
nontaxable
U.S. Government mortgage-backed pass through
certificates
U.S. Government-guaranteed small business
administration pools
Other securities
Total available-for-sale securities
Trading securities (Note 1, 2, 3)
Loans (Note 1, 2, 3, 4)
Total interest-earning assets
Noninterest-earning assets:
Cash and due from banks
Premises and equipment
Other assets
Total assets
Interest-bearing liabilities:
Deposits:
Interest-bearing demand deposits
Savings
Time
Total interest-bearing deposits
Borrowings:
Securities sold under agreement to repurchase
Subordinated debt
Federal Home Loan Bank advances - short term
Federal Home Loan Bank advances - long term
Total borrowings
Total interest-bearing liabilities
Noninterest-bearing liabilities:
Demand deposits
Other liabilities
Shareholders' equity
Total liabilities and shareholders' equity
Net interest income
Net interest rate spread (Note 5)
Net interest margin (Note 6)
(Fully taxable equivalent basis in thousands of dollars)
Average
Balance
Outstanding
2016
Interest
Earned
or Paid
Yield or
Rate
2015
2014
Average
Balance
Outstanding
Interest
Earned
or Paid
Yield
or
Rate
Average
Balance
Outstanding
Interest
Earned
or Paid
Yield
or
Rate
$
8,233 $
44
0.54 %
$
5,930 $
19 0.32 %
$
6,686 $
21 0.31 %
3,703
98
2.63 %
11,356
301 2.65 %
9,004
210 2.33 %
1,757
65
3.69 %
4,665
162 3.47 %
4,779
165 3.45 %
58,387 2,647
4.53 %
45,169 2,211 4.90 %
44,157 2,182 4.94 %
85,448 1,647
1.93 %
91,017 1,836 2.02 %
103,228 2,230 2.16 %
9,040
4,326
166
145
162,661 4,768
94
390,173 18,570
565,096 $ 23,476
4,029
1.84 %
3.35 %
2.93 %
2.33 %
4.76 %
4.15 %
1,248
4,702
18 1.44 %
153 3.25 %
158,157 4,681 2.96 %
362 4.53 %
358,609 16,933 4.72 %
530,694 $ 21,995 4.14 %
7,998
— — —
6,200
197 3.18 %
167,368 4,984 2.98 %
397 5.20 %
326,561 16,154 4.95 %
508,247 $ 21,556 4.24 %
7,632
7,844
9,038
26,320
$ 608,298
7,399
7,165
23,639
$ 568,897
7,229
6,553
20,513
$ 542,542
435
$ 137,505 $
113,125
78
134,523 1,580
385,153 2,093
0.32 %
0.07 %
1.17 %
0.54 %
269 0.24 %
$ 110,130 $
113,272
66 0.06 %
133,490 1,333 1.00 %
356,892 1,668 0.47 %
$
178 0.19 %
92,338 $
114,408
66 0.06 %
130,792 1,450 1.11 %
337,538 1,694 0.50 %
2,249
5,155
13,550
20,493
41,447
7
112
73
633
825
426,600 $ 2,918
0.31 %
2.13 %
0.54 %
3.09 %
1.99 %
0.68 %
4,082
5,155
14,674
25,005
48,916
4 0.10 %
91 1.75 %
40 0.27 %
804 3.22 %
939 1.92 %
405,808 $ 2,607 0.64 %
4,141
3 0.07 %
5,155
88 1.70 %
17,541
156 0.89 %
943 3.74 %
25,204
52,041 1,190 2.29 %
389,579 $ 2,884 0.74 %
111,764
11,011
58,923
$ 608,298
98,028
8,436
56,625
$ 568,897
90,930
8,385
53,648
$ 542,542
$ 20,558
$ 19,388
$ 18,672
3.47 %
3.63 %
3.50 %
3.65 %
3.50 %
3.67 %
Note 1 – Includes both taxable and tax exempt securities and loans.
Note 2 – The amounts are presented on a fully taxable equivalent basis using the statutory rate of 34%, and have been adjusted to
reflect the effect of disallowed interest expenses related to carrying tax-exempt assets. The tax equivalent income adjustment
for loans and investments available-for-sale and trading was $16,000 and $905,000, respectively, for December 31, 2016;
$24,000 and $858,000, respectively, for December 31, 2015; and $34,000 and $857,000, respectively, for December 31,
2014.
Note 3 – Average balance outstanding includes the average amount outstanding of all non-accrual investment securities and loans.
Investment securities consist of average total principal adjusted for amortization of premium and accretion of discount and
include both taxable and tax-exempt securities. Loans consist of average total loans, including loans held for sale, less
average unearned income.
21
Note 4 – Interest earned on loans includes net loan fees of $684,000 in 2016, $486,000 in 2015 and $487,000 in 2014.
Note 5 – Net interest rate spread represents the difference between the yield on earning assets and the rate paid on interest-bearing
liabilities.
Note 6 – Net interest margin is calculated by dividing the net interest income by total interest-earning assets.
FINANCIAL REVIEW
The following is management’s discussion and analysis of the financial condition and results of operations of the Company. The
discussion should be read in conjunction with the Consolidated Financial Statements and related notes and summary financial
information included elsewhere in this annual report.
NOTE REGARDING FORWARD-LOOKING STATEMENTS
The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. In addition to historical
information, certain information included in this discussion and other materials filed or to be filed by the Company with the SEC
(as well as information included in oral statements or other written statements made or to be made by the Company) may contain
forward-looking statements that involve risks and uncertainties. The words “believes,” “expects,” “may,” “will,” “should,” “projects,”
“contemplates,” “anticipates,” “forecasts,” “intends,” or similar terminology identify forward-looking statements. These statements
reflect management’s beliefs and assumptions, and are based on information currently available to management.
Economic circumstances, the Company’s operations and actual results could differ significantly from those discussed in any forward-
looking statements. Some of the factors that could cause or contribute to such differences are changes in the economy and interest
rates either nationally or in the Company’s market area, including the impact of the impairment of securities; political actions,
including failure of the United States Congress to raise the federal debt ceiling or the imposition of changes in the federal budget;
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;
changes in assumptions underlying the establishment of reserves for possible loan losses, reserves for repurchase of mortgage loans
sold and other estimates; and risks associated with other global economic, political and financial factors.
While actual results may differ significantly from the results discussed in the forward-looking statements, the Company undertakes no
obligation to update publicly any forward-looking statement for any reason, even if new information becomes available.
CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The discussion and analysis of the Company’s financial condition and results of operation are based upon the Consolidated Financial
Statements, which have been prepared in accordance with U.S. Generally Accepted Accounting Principles (GAAP). The preparation
of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of
assets and liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities at the date of the Company’s
consolidated financial statements. Actual results may differ from these estimates under different assumptions or conditions.
Certain accounting policies involve significant judgments and assumptions by management which has a material impact on the
carrying value of certain assets and liabilities; management considers such accounting policies to be critical accounting policies. The
judgments and assumptions used by management are based on historical experience and other factors, which are believed to be
reasonable under the circumstances.
Management believes the following are critical accounting policies that require the most significant judgments and estimates used in
the preparation of the Company’s consolidated financial statements.
22
Accounting for the Allowance for Loan Losses
The determination of the allowance for loan losses and the resulting amount of the provision for loan losses charged to operations
reflects management’s current judgment about the credit quality of the loan portfolio and takes into consideration changes in lending
policies and procedures, changes in economic and business conditions, changes in the nature and volume of the portfolio and, in the
terms of loans, changes in the experience, ability and depth of lending management, changes in the volume and severity of past due,
non-accrual and adversely classified or graded loans, changes in the quality of the loan review system, changes in the value of
underlying collateral for collateral-dependent loans, the existence and effect of any concentrations of credit and the effect of
competition, legal and regulatory requirements and other external factors. The nature of the process by which we determine the
appropriate allowance for loan losses requires the exercise of considerable judgment. While management utilizes its best judgment and
information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond our control, including the
performance of the loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan
classifications. The allowance is increased by the provision for loan losses and decreased by charge-offs when management believes
the uncollectibility of a loan is confirmed. Subsequent recoveries, if any, are credited to the allowance. A weakening of the economy
or other factors that adversely affect asset quality could result in an increase in the number of delinquencies, bankruptcies or defaults
and a higher level of non-performing assets, net charge offs, and provision for loan losses in future periods.
The Company’s allowance for loan losses methodology consists of three elements: (i) specific valuation allowances based on probable
losses on specific loans; (ii) valuation allowances based on historical loan loss experience for similar loans with similar characteristics
and trends; and (iii) general valuation allowances based on general economic conditions and other qualitative risk factors both internal
and external to the Company. These elements support the basis for determining allocations between the various loan categories and the
overall adequacy of our allowance to provide for probable losses inherent in the loan portfolio.
With these methodologies, a general allowance is established for each loan type based on historical losses for each loan type in the
portfolio. Additionally, management allocates a specific allowance for “Impaired Credits,” which is based on current information and
events, if it is probable the Company will not collect all amounts due according to the original contractual terms of the loan agreement.
The level of the general allowance is established to provide coverage for management’s estimate of the credit risk in the loan portfolio
by various loan segments not covered by the specific allowance. Additional information regarding allowance for credit losses can be
found in Item 8, Note 3 to the Consolidated Financial Statements and elsewhere in this Management’s Discussion and Analysis.
Investment Securities and Impairment
The classification and accounting for investment securities is discussed in detail in Item 8, Notes 1 and 2 to the Consolidated Financial
Statements. Investment securities must be classified as held-to-maturity, available-for-sale, or trading. The appropriate classification is
based partially on the Company’s ability to hold the securities to maturity and largely on management’s intentions, if any, with respect
to either holding or selling the securities. The classification of investment securities is significant since it directly impacts the
accounting for unrealized gains and losses on securities. Unrealized gains and losses on trading securities, if any, flow directly through
earnings during the periods in which they arise, whereas available-for-sale securities are recorded as a separate component of
shareholders’ equity (accumulated other comprehensive income or loss) and do not affect earnings until realized. The fair values of the
Company’s investment securities are generally determined by reference to quoted market prices and reliable independent sources. At
each reporting date, the Company assesses whether there is an “other-than-temporary” impairment to the Company’s investment
securities. Such impairment must be recognized in current earnings rather than in other comprehensive income (loss).
For debt securities, ASC topic 320 requires an entity to assess whether it has the intent to sell the debt security or it is more-likely-
than-not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met, an other-
than-temporary-impairment (OTTI) loss on the security must be recognized.
In instances in which a determination is made that a credit loss (defined as the difference between the present value of the cash flows
expected to be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more-
likely-than-not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost
basis (i.e., the amortized cost basis less any current-period credit loss), ASC topic 320 changes the presentation and amount of the
OTTI recognized in the income statement.
In these instances, the impairment is separated into the amount of the total impairment related to the credit loss and the amount of the
total impairment related to all other factors. The amount of the total OTTI related to the credit loss is recognized in earnings. The
amount of the total impairment related to all other factors is recognized in other comprehensive income (loss). The total OTTI is
presented in the income statement with an offset for the amount of the total OTTI that is recognized in other comprehensive income
(loss). In determining the amount of impairment related to credit loss, the Company uses a third party discounted cash flow model,
several inputs for which require estimation and judgment. Among these inputs are projected deferral and default rates and estimated
recovery rates. Realization of events different than that projected could result in a large variance in the values of the securities.
23
Additional information regarding investment securities can be found in Item 8, Notes 2 and 11 to the Consolidated Financial
Statements and elsewhere in this Management’s Discussion and Analysis.
Income Taxes
The provision for income taxes is based on income reported for financial statement purposes and differs from the amount of taxes
currently payable, since certain income and expense items are reported for financial statement purposes in different periods than those
for tax reporting purposes. Taxes are discussed in more detail in Item 8, Note 10 to the Consolidated Financial Statements. Accrued
taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, the Company
assesses the relative merits and risks of the appropriate tax treatment of transactions taking into account statutory, judicial and
regulatory guidance in the context of our tax position.
The Company accounts for income taxes using the asset and liability approach, the objective of which is to establish deferred tax
assets and liabilities for the temporary differences between the financial reporting basis and tax basis of our assets and liabilities at
enacted tax rates expected to be in effect when such amounts are realized or settled. We conduct periodic assessments of deferred tax
assets to determine if it is more-likely-than-not that they will be realized. In making these assessments, we consider taxable income in
prior periods, projected future taxable income, potential tax planning strategies and projected future reversals of deferred tax items.
These assessments involve a certain degree of subjectivity which may change significantly depending on the related circumstances.
CORPORATE PROFILE
The Company, with total assets of approximately $655.2 million at December 31, 2016, is a bank holding company headquartered in
Cortland, Ohio whose principle activity is to manage, supervise and otherwise serve as a source of strength to the Bank.
Cortland Banks is a state chartered bank engaged in commercial and retail banking services. The Bank offers a full range of financial
services to its local communities with an ongoing strategic focus on commercial banking relationships.
The Bank’s results of operations depend primarily on net interest income, which, in part, is a direct result of the market interest rate
environment. Net interest income is the difference between the interest income earned on interest-earning assets and the interest paid
on interest-bearing liabilities. Net interest income is affected by the shape of the market yield curve, the repricing of interest-earning
assets and interest-bearing liabilities and the prepayment rate of mortgage-related assets. Results of operations may be affected
significantly by general and local economic conditions, particularly those with respect to changes in market interest rates, credit
quality, governmental policies and actions of regulatory authority.
2016 OVERVIEW
In 2016, the Company’s net income was $4.9 million compared to $4.4 million in 2015. Amid more rigorous regulatory standards and
an uncertain economy, the Company continues to follow its core strategic direction. Operating results reflect its commitment to
growing loans and deposits in the markets in which it operates and in producing consistent positive earnings.
The Company’s financial results for 2016 were affected by these notable specific factors:
• Diluted earnings per share (EPS) grew 14.4% to $1.11 for the full year 2016, compared to $0.97 per diluted share for 2015.
• For 2016, net interest income grew 6.1% to $19.6 million compared to $18.5 million for 2015.
• For 2016, non-interest income, excluding investment gains, grew 8.6% to $4.2 million from $3.8 million for 2015.
• Net interest margin (“NIM”) was 3.63% for 2016 compared to 3.65% for 2015.
•
In 2016, total deposits grew 8.8% to $539.9 million from $496.4 million at December 31, 2015.
• Total loans increased 6.5%, to $419.8 million, compared to $394.3 million at December 31, 2015.
• Mortgage banking revenue grew 59.0% to $1.2 million in 2016, compared to $785,000 in 2015.
• Nonperforming assets decreased to $9.1 million, or 1.39% of total assets, at December 31, 2016, compared to $12.4
million, or 2.02% of total assets a year earlier.
24
• Allowance for loan losses as a percentage of total loans was 1.16% at December 31, 2016, compared to 1.32% at
December 31, 2015.
• The Company remained well capitalized with total risk-based capital to risk-weighted assets of 15.10% and tangible
equity to tangible assets of 8.80%.
In the midst of earnings pressures brought on by economic instability, interest rate compression and increased competition, the
Company devoted substantial attention in 2016 and 2015 to profit improvement measures and balance sheet positioning. The
Company’s management team continues to focus on measures designed to maintain capital and to provide for adequate liquidity for
lending and business development purposes. New strategies are being pursued to improve market penetration and product expansion,
with the objective of increasing both the interest income and non-interest income revenue base.
Total shareholders’ equity at December 31, 2016 was $57.7 million, representing a ratio of equity capital to total assets of 8.8%. In
comparison, total shareholders’ equity was $56.7 million at December 31, 2015, representing a ratio of equity capital to total assets of
9.3%. A component of shareholders’ equity is accumulated other comprehensive income (loss), which includes the net after-tax
impact of unrealized gains or losses on investment securities classified as available-for-sale. Net unrealized losses on available-for-
sale investment securities, net of tax, were $2.9 million at December 31, 2016, compared with net unrealized losses, net of tax, of
$147,000 at December 31, 2015. Such unrealized gains or losses represent the difference, net of applicable income tax effect, between
the estimated fair value and amortized cost of investment securities classified as available-for-sale. The post-election rise in interest
rates significantly affected securities valuations in the fourth quarter.
Return on average equity was 8.27% in 2016, compared to 7.73% in 2015, while return on average assets measured 0.80% in 2016
and 0.77% in 2015. Book value per share increased by $0.18 to $13.05 at December 31, 2016 from $12.87 at December 31, 2015. The
price of the Company’s common shares traded in a range between a low of $14.45 and a high of $17.70, closing the year at $17.50 per
share.
The Company continues to maintain capital sufficient to be deemed well capitalized under all regulatory measures. In the current
regulatory environment, regulatory oversight bodies expect banks to maintain ratios above the statutory levels as a margin of safety.
CERTAIN NON-GAAP MEASURES
Certain financial information has been determined by methods other than 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 performance
trends and financial condition. Core earnings 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 referenced as part of management’s discussion
and analysis of quarterly and year-to-date financial results of operations.
Core earnings, which exclude non-recurring items, were $4.7 million in 2016 compared to $4.4 million in 2015 and $3.7 million in
2014. Core earnings per share were $1.07 in 2016, $0.97 in 2015 and $0.83 in 2014.
The following is a reconciliation between core earnings and earnings under GAAP:
GAAP earnings
Investment gains not in the ordinary course of business (net of tax) *
Net losses from the extinguishment of debt (net of tax) **
Reversal of deferred tax valuation allowance
Core earnings
Core earnings per share
(Amounts in thousands, except per share data)
Years Ended December 31,
2016
2015
2014
$
$
$
4,871 $
(191 )
160
(93 )
4,747 $
1.07 $
4,378 $
—
—
—
4,378 $
0.97 $
3,869
(127 )
—
—
3,742
0.83
*
The gains in 2016 were harvested to offset the early payoff penalties on FHLB long-term notes. The gains in 2014 are from the
sale of securities due to the Volcker Rule.
** Loss on the early payoff of FHLB long term debt.
25
Although the provision for loan losses is considered core earnings, it is worthy of note that $1.3 million of the $1.6 million provision
in 2014 relates to a specific provision on loans to one related group of entities.
BALANCE SHEET COMPOSITION
The following table illustrates, during the years presented, the mix of the Company’s funding sources and the assets in which those
funds are invested as a percentage of the Company’s average total assets at December 31 for the periods indicated. Average assets
totaled $608.3 million in 2016 compared to $568.9 million in 2015 and $542.5 million in 2014.
Sources of Funds:
Deposits:
Non-interest bearing
Interest bearing
Long-term debt and other borrowings
Subordinated debt
Other non-interest bearing liabilities
Shareholders' equity
Total
Uses of Funds:
Loans, including loans held for sale
Investment securities
Interest-earning deposits and other earning assets
Bank-owned life insurance
Partnerships and other investments
Other non-interest earning assets
Total
2016
December 31,
2015
2014
18.4 %
63.3
6.0
0.8
1.8
9.7
100.0 %
64.1 %
27.4
1.4
2.8
1.0
3.3
100.0 %
17.2 %
62.7
7.7
0.9
1.5
10.0
100.0 %
63.0 %
29.2
1.0
3.0
1.0
2.8
100.0 %
16.8 %
62.2
8.6
1.0
1.5
9.9
100.0 %
60.2 %
32.3
1.2
3.0
0.3
3.0
100.0 %
Deposits continue to be the Company’s primary source of funding. During 2016, the relative mix of deposits has remained steady with
interest-bearing being the main source. Average non-interest bearing deposits totaled 22.5% of total average deposits in 2016,
compared to 21.6% in 2015 and 21.2% in 2014. Additional information regarding deposits can be found in Item 8, Note 5 to the
Consolidated Financial Statements and elsewhere in this Management’s Discussion and Analysis.
The Company primarily invests funds in loans and securities. Loans continue to be the focus of the Company’s asset allocation.
Average securities increased $535,000, or 0.3%, to $166.7 million during 2016 from $166.2 million in 2015, while average loans
increased by $31.6 million, or 8.8%, to $390.2 million during 2016 from $358.6 million in 2015.
ASSET QUALITY
The Company’s management regularly monitors and evaluates trends in asset quality. Loan review practices and procedures require
detailed monthly analysis of delinquencies, nonperforming assets and other sensitive credits. Loans are moved to non-accrual status
once they reach 90 days past due or when analysis of a borrower’s creditworthiness indicates the collection of interest and principal is
in doubt. Non-performing loans include loans in non-accrual status, restructured loans and real estate acquired in satisfaction of debts
previously contracted.
Additionally, as part of the Company’s loan review process, management routinely evaluates risks which could potentially affect the
ability to collect loan balances in their entirety. Reviews of individual credits, aggregate account relationships or any concentration of
credits in particular industries are subject to a detailed loan review.
Gross income that would have been recorded in 2016 on these nonperforming loans, had they been in compliance with their original
terms, was $555,000. Interest income that actually was included in income on these loans amounted to $436,000. In addition to
nonperforming loans, nonperforming assets include nonperforming investment securities. Gross income that would have been
recorded in 2016 on nonperforming investments, had they been in compliance with their original terms, was $42,000. Interest income
that actually was included in income on these investments amounted to $28,000. There are no accruing loans which are contractually
past due 90 days or more as to principal or interest payments.
26
The following table depicts the trend in these potentially problematic asset categories:
Non-accrual loans:
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total non-accrual loans
Investment securities
Other real estate owned
Troubled debt restructured loans
Nonperforming assets
Loans past due greater than 30 days
or on nonaccrual
2016
2015
(Amounts in thousands)
December 31,
2014
2013
2012
$
$
$
— $
1,458
1,265
55
—
2,778
825
—
5,508
9,111 $
1,196 $
2,176
1,252
262
—
4,886
778
61
6,656
12,381 $
1,824 $
2,247
1,331
149
6
5,557
779
40
3,680
10,056 $
98 $
1,279
481
72
16
1,946
1,203
33
4,174
7,356 $
49
2,336
489
72
27
2,973
674
145
2,695
6,487
4,533 $
7,242 $
8,201 $
2,176 $
3,248
Non-accrual loans as a percentage of total loans
Nonperforming assets as a percentage of total assets
Nonperforming assets as a percentage of equity capital
plus allowance for loan losses
2016
2015
December 31,
2014
2013
2012
0.66 %
1.39 %
1.24 %
2.02 %
1.54 %
1.77 %
0.56 %
1.32 %
0.94 %
1.11 %
14.57 %
20.01 %
16.47 %
13.80 %
12.16 %
As of December 31, 2016, there were $3.7 million in loans not included in this table where known information about borrowers’
possible credit problems caused management to have some doubts as to the ability of these borrowers to comply with present loan
payment terms and which may result in disclosure of such loans in this table.
Loans accounted for on a non-accrual basis ranged from a high of $5.6 million in 2014 to a low of $1.9 million in 2013. Non-accrual
loans in 2016 of $2.8 million is lower than the average of the past five years, which is $3.6 million. The increase in non-accrual loans
from 2013 to 2015 was mainly due to loans to one related group in both the commercial and commercial real estate categories which
were resolved favorably in 2016. The increase in residential real estate is one loan for $1.0 million. The total of all loans past due
more than 30 days or on non-accrual ranged from a low of $2.2 million in 2013 to a high of $8.2 million in 2014. Loans charged-off,
net of recoveries, was $376,000 for 2016, compared to $463,000 for 2015, $200,000 for 2014, $711,000 for 2013 and $2.3 million for
2012. The resulting ratios do not indicate any trends of concern from management’s perspective.
Troubled-debt restructured loans are loans that have been modified when economic concessions have been granted to borrowers who
have experienced or are expected to experience financial difficulties. In 2015, $3.2 million in new troubled debt restructurings were
added. There were none added in 2016 or 2014 and $2.8 million in 2013.
In 2016, the provision for loan losses was $50,000, as general economic conditions improved and the Company’s credit quality
remained strong, along with a favorable settlement of a creditor in bankruptcy. In 2015, the provision for loan losses was $455,000. In
2014, the provision for loan losses was $1.6 million with $1.3 million of the reserve in the commercial loan category relating to one
affiliated group. Additional information regarding loans can be found in Item 8, Note 3 to the Consolidated Financial Statements and
elsewhere in this Management’s Discussion and Analysis.
At December 31, 2016, there was $825,000 of the Company’s holdings in trust preferred securities considered to be in non-accrual
status. The quarterly interest payments for both of its investments in trust preferred securities had been placed in “payment in kind”
status. Payment in kind status results in a temporary delay in the payment of interest. As a result of a delay in the collection of the
interest payments, management placed these securities in non-accrual status. Current estimates indicate that the interest payment
delays may exceed ten years. In February of 2014, the Company completed the sale of 9 of the remaining 11 trust preferred securities
in response to the Volcker Rule.
27
RESULTS OF OPERATIONS
Analysis of Net Interest Income - Years Ended December 31, 2016 and 2015
Net interest income, the principal source of the Company’s earnings, is the amount by which interest and fees generated by interest-
earning assets, primarily loans and investment securities, exceed the interest cost of deposits and borrowed funds. On a fully taxable
equivalent basis, net interest income measured $20.6 million for 2016 and $19.4 million for 2015. The resulting net interest margin
was 3.63% for 2016 and 3.65% for 2015.
The increase in interest income, on a fully taxable equivalent basis, of $1.5 million is the product of a 6.5% year-over-year increase in
average earning assets along with a 1 basis point increase in yield. The increase in interest expense of $311,000 was a product of a 4
basis point increase in rates paid and a 5.1% increase in average interest-bearing liabilities. The net result was a 6.0% increase in net
interest income on a fully taxable equivalent basis, and a 2 basis point decrease in the Company’s net interest margin on a growing
asset base with a different mix.
On a fully taxable equivalent basis, income on investment securities available-for-sale and trading decreased by $181,000, or 3.6%.
The average invested balances in these securities increased by $535,000, or 0.3%, from the levels of a year ago. The increase in the
average balance of investment securities was accompanied by an 11 basis point decrease in the tax equivalent yield of the portfolio. As
the reservoir for excess liquidity, the increase in investment securities year-over-year reflects the robust deposit growth generated
during the year. The trading account was liquidated at the end of the second quarter of 2016. The Company will continue attempting
to redeploy liquidity into loans which generate greater yields than securities. Any reinvestment into the securities portfolio may serve
to decrease the yield due to the current low rate environment although many economists project a rising rate environment on the
horizon. Additional information regarding investment securities can be found in Item 8, Notes 2 and 11 to the Consolidated Financial
Statements and elsewhere in this Management’s Discussion and Analysis.
On a fully taxable equivalent basis, income on loans increased by $1.6 million, or 9.7%, for 2016 compared to the same period in
2015. Supplementing this increase was the collection of $296,000 of interest and fees on a nonperforming loan settled favorably in
bankruptcy. A $31.6 million increase in the average balance of the loan portfolio, or 8.8%, was accompanied by a 4 basis point
increase in the portfolio’s tax equivalent yield. Without the collection of the past due interest, the portfolio yield would have declined
8 basis points. New loan volume is still near historic low interest rates, while strong competition for good credits also drives rates
downward. The commercial loan portfolio housed the majority of the increase in balances. Additional information regarding loans can
be found in Item 8, Note 3 to the Consolidated Financial Statements and elsewhere in this Management’s Discussion and Analysis.
Other interest income increased by $25,000, or 131.6%, from the same period a year ago. The average balance of interest-earning
deposits increased by $2.3 million, or 38.8%. The yield increased by 22 basis points from 2015 to 2016, reflecting the December 2015
rise in the federal funds rate. Management intends to remain fully invested, minimizing on-balance sheet liquidity.
Average interest-bearing demand deposits and money market accounts increased by $27.4 million, or 24.9%, while average savings
balances decreased by $147,000, or 0.1%. Total interest paid on interest-bearing demand deposits and money market accounts was
$435,000, a $166,000 increase from last year. The yield increased 8 basis points from 2015 to 2016. Total interest paid on savings
accounts was $78,000, an $11,000 increase from last year. The average rate paid on savings accounts increased 1 basis point from
2015 to 2016. The average balance of time deposit products increased by $1.0 million, or 0.8%, as the average rate paid increased by
17 basis points, from 1.00% to 1.17%. Interest expense increased on time deposits by $247,000 from the prior year. The current low-
rate environment offers little opportunity for deposit customers, except for periodic special rates offered on a limited basis. The
Company’s offering of the Kasasa suite of accounts was a major factor in the growth of interest-bearing demand accounts. Additional
information regarding deposits can be found in Item 8, Note 5 to the Consolidated Financial Statements and elsewhere in this
Management’s Discussion and Analysis.
Average borrowings and subordinated debt decreased by $7.5 million while the average rate paid on borrowings decreased by 6 basis
points. The Company elected to pay off two of its longest maturity FHLB notes in January 2016, $4.5 million at an average rate of
4%. Of the $419,000 in securities gains, $289,000 was generated to offset the $242,000 prepayment penalty on this early payoff.
Alternative funding of $3.5 million at 1.44% was used to replace the borrowings. Annualized interest expense savings of $130,000 is
expected from the transaction. After a December 2016 maturity of $2 million at 4.07%, three long-term FHLB notes remain at an
average rate of 4.16%, all maturing by September of 2017 which is expected to reduce 2017 funding costs by $275,000. Management
continues to utilize short-term borrowings to bridge liquidity gaps. Additional information regarding FHLB Advances and Other
Borrowings and Subordinated Debt can be found in Item 8, Notes 6 and 7 to the Consolidated Financial Statements and elsewhere in
this Management’s Discussion and Analysis.
28
Analysis of Net Interest Income - Years Ended December 31, 2015 and 2014
Net interest income, the principal source of the Company’s earnings, is the amount by which interest and fees generated by interest-
earning assets, primarily loans and investment securities, exceed the interest cost of deposits and borrowed funds. On a fully taxable
equivalent basis, net interest income measured $19.4 million for 2015 and $18.7 million for 2014. The resulting net interest margin
was 3.65% for 2015 and 3.67% for 2014.
The increase in interest income, on a fully taxable equivalent basis, of $439,000 is the product of a 4.4% year-over-year increase in
average earning assets offset somewhat by a 10 basis point decrease in yield. The decrease in interest expense of $277,000 was a
product of a 10 basis point decrease in rates paid and a 4.2% increase in average interest-bearing liabilities. The net result was a 3.8%
increase in net interest income on a fully taxable equivalent basis, and a 2 basis point decrease in the Company’s net interest margin
on a growing asset base with a different mix.
On a fully taxable equivalent basis, income on investment securities available-for-sale and trading decreased by $338,000, or 6.3%.
The average invested balances in these securities decreased by $8.8 million, or 5.1%, from the levels of a year ago. The decrease in the
average balance of investment securities was accompanied by a 3 basis point decrease in the tax equivalent yield of the portfolio. The
Company continued attempting to redeploy liquidity into loans which generate greater yields than securities. Any reinvestment into
the securities portfolio may serve to decrease the yield due to the current low rate environment. Additional information regarding
investment securities can be found in Item 8, Notes 2 and 11 to the Consolidated Financial Statements and elsewhere in this
Management’s Discussion and Analysis.
On a fully taxable equivalent basis, income on loans increased by $779,000, or 4.8%, for 2015 compared to the same period in 2014.
A $32.0 million increase in the average balance of the loan portfolio, or 9.8%, was accompanied by a 23 basis point decrease in the
portfolio’s tax equivalent yield. Likewise, new loan volume was at historic low interest rates and strong competition for good credits
also drove rates downward. The commercial loan portfolio housed the majority of the increase in balances. Additional information
regarding loans can be found in Item 8, Note 3 to the Consolidated Financial Statements and elsewhere in this Management’s
Discussion and Analysis.
Other interest income decreased by $2,000, or 9.5%, from the same period a year ago. The average balance of interest-earning
deposits decreased by $756,000, or 11.3%. The yield increased by 1 basis point from 2014 to 2015. Management intended to remain
fully invested, minimizing on-balance sheet liquidity.
Average interest-bearing demand deposits and money market accounts increased by $17.8 million, or 19.3%, while average savings
balances decreased by $1.1 million, or 0.9%. Total interest paid on interest-bearing demand deposits and money market accounts was
$269,000, a $91,000 increase from last year. The yield increased 5 basis points from 2014 to 2015. Total interest paid on savings
accounts was $67,000, which is unchanged from 2014. The average rate paid on savings accounts remained the same at 0.06%. The
average balance of time deposit products increased by $2.6 million, or 2.0%, as the average rate paid decreased by 11 basis points,
from 1.11% to 1.00%. Interest expense decreased on time deposits by $117,000 from the prior year. As time deposits matured, the
balances were reinvested at the lower current rates. After an extended period of declining average rates paid on deposits, the Company
experienced a flattening on a linked quarter basis. Additional information regarding deposits can be found in Item 8, Note 5 to the
Consolidated Financial Statements and elsewhere in this Management’s Discussion and Analysis.
Average borrowings and subordinated debt decreased by $3.1 million while the average rate paid on borrowings decreased by 37 basis
points. Management refinanced $4.0 million of long-term borrowings at their respective 2015 maturity dates at substantially lower
rates and continued to utilize short-term borrowings to bridge liquidity gaps. Additional information regarding FHLB Advances and
Other Borrowings and Subordinated Debt can be found in Item 8, Notes 6 and 7 to the Consolidated Financial Statements and
elsewhere in this Management’s Discussion and Analysis.
29
The following table provides a detailed analysis of changes in net interest income on a tax equivalent basis, 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.
Increase (decrease) in interest income:
Interest-earning deposits and other money markets
Investment securities available-for-sale:
U.S. Government agencies and corporations
Obligations of states and political subdivisions
Mortgage-backed and related securities
U.S. Government-guaranteed small business
administration pools
Other securities
Trading securities
Loans
Total interest income change
Increase (decrease) in interest expense:
Interest-bearing demand deposits
Savings deposits
Time deposits
Securities sold under agreements to repurchase
FHLB advances - short term
FHLB advances - long term
Subordinated debt
Total interest expense change
Increase (decrease) in net interest income on a
taxable equivalent basis
2016 Compared to 2015
Rate
Volume
Total
Volume
2015 Compared to 2014
Rate
Total
(Amounts in thousands)
$
9 $
16 $
25 $
(2 ) $
— $
(2 )
(203 )
470
(109 )
142
(12 )
(136 )
1,501
1,662
76
—
17
(2 )
(3 )
(140 )
—
(52 )
—
(131 )
(80 )
6
4
(132 )
136
(181 )
90
12
230
5
36
(31 )
21
363
(203 )
339
(189 )
60
43
(253 )
148
(8 )
(268 )
1,637
1,481
18
(49 )
18
1,536
1,371
166
12
247
3
33
(171 )
21
311
38
(1 )
29
—
(22 )
(7 )
—
37
31
(17 )
(141 )
—
5
(53 )
(757 )
(932 )
53
1
(146 )
1
(94 )
(132 )
3
(314 )
91
26
(394 )
18
(44 )
(35 )
779
439
91
0
(117 )
1
(116 )
(139 )
3
(277 )
$
1,714 $
(544 ) $
1,170 $
1,334 $
(618 ) $
716
PROVISION FOR LOAN LOSSES, NON-INTEREST INCOME, NON-INTEREST EXPENSE & FEDERAL INCOME TAX
During 2016, 2015 and 2014, the amount charged to operations as a provision for loan loss was adjusted to account for charge-offs
against the allowance, as well as an increase in loan balances recorded in the portfolio, expected losses on specific problem loans and
several qualitative factors, including factors specific to the local economy and to industries operating in the local market. The
Company has allocated a portion of the allowance to a number of specific problem loans through 2016, but has not experienced
significant deterioration in any loan type, including the residential real estate portfolios or the commercial real estate loan portfolio,
and accordingly has not added any special provision for these loan types. For the year ended December 31, 2016, the provision for
loan losses was $50,000, with net charge-offs of $376,000. The lower provision in 2016 was because of a favorable outcome of a
credit relationship that had a specific reserve in place that was removed. There was a favorable ruling in a bankruptcy court
surrounding the eventual sale of a business to which the Company lent funds, $2.1 million of which was included in nonaccrual loans.
The company resolved a substantial portion of the delinquent loan, allowing the portion of the allowance for loan losses allocated to
this credit to be used for other problem loans. For the year ended December 31, 2015, the provision for loan losses was $455,000,
which was fairly close to net charge-offs of $463,000. For the year ended December 31, 2014, the provision for loan losses was $1.6
million, with net charge-offs of $200,000. Added to the nonperforming commercial loan portfolio in 2014 was $1.3 million relating to
the previously mentioned affiliated group. Provision expense levels are in recognition of loan growth and a changing composition of
the loan portfolio as the Company takes aim at managing its balance sheet with a commercially-oriented focus.
30
The following table provides a detailed analysis of non-interest income:
Fees for customer services
Mortgage banking gains, net
Earnings on bank-owned life insurance
Wealth management income
Other non-interest income
Non-interest income, excluding investment gains
Investment securities available-for-sale gains, net
Trading securities (losses) gains, net
Total non-interest income
(Amounts in thousands)
December 31,
2015
2014
2016
$
$
2,103 $
1,248
328
95
404
4,178
466
(47 )
4,597
$
2,019 $
785
338
435
268
3,845
75
(11 )
3,909
$
2,007
440
336
313
116
3,212
588
327
4,127
Total non-interest income, excluding investment gains, increased by $333,000, or 8.7%, for 2016 compared to an increase of
$633,000, or 19.7%, for 2015. After gains on investment securities and impairment losses, non-interest income increased by $688,000,
or 17.6%, in 2016 compared to a decrease of $218,000, or 5.3%, in 2015.
Fees for customer services increased by $84,000, or 4.2% in 2016, compared to an increase of $12,000, or 0.6%, in the prior year
driven by customer transactions on deposit accounts.
Mortgage banking gains totaled $440,000 in 2014, $785,000 in 2015 and $1.2 million in 2016 reflecting the increase in mortgage loan
originations spurred by the improving housing market, low interest rates, and the Company’s geographic expansion.
Wealth management income of $95,000 was recorded in 2016, compared to $435,000 in 2015 and $313,000 in 2014. The Bank, which
had operated a non-deposit investment services program, launched its new Cortland Private Wealth Management program, which
offers a full suite of program options, including private asset management, financial and estate planning, retirement plans, insurance
and advisory services. The new program, which was introduced in late January 2016, under a new platform, will ramp up in 2017,
adding contributions from both investment and advisory services.
Net gains on the sale of available-for-sale investment securities increased by $391,000 in 2016 from year ago levels. Included in the
total is $289,000 of gains generated to offset losses from the extinguishment of debt. Consistent with the balance sheet strategy, the
Company reviewed its investment portfolio in 2014 to clean up odd-lot securities and to reduce interest rate risk. Recent government
programs, such as the Home Affordable Refinance Program (HARP), promote prepayment activities in mortgage backed securities,
thus cutting short the intended investment performance. Proactively removing the securities with higher prepayment risk allowed the
Company to reinvest into securities that produce consistent cash flows. Trust preferred securities held at the beginning of 2014 were
among those considered disallowed under the revised final Volcker Rule, which originated from the Dodd-Frank Act. In February
2014, the Company completed the sale of all nine of the disallowed investments along with one other permissible holding. This
resulted in a gain of approximately $200,000. In 2016, trading securities losses increased by $36,000, reflective of the decline in the
secondary market activity for municipal securities in which the trading account operated. At the end of June the trading account was
liquidated. Additional information regarding investment securities can be found in Item 8, Notes 2 and 11 to the Consolidated
Financial Statements and elsewhere in this Management’s Discussion and Analysis.
The following table provides a summary of non-interest expenses:
Salaries and employee benefits
Net occupancy and equipment expense
State and local taxes
FDIC insurance expense
Professional fees
Advertising and marketing expenses
Net losses from the extinguishment of debt
Other non-interest expense
Total non-interest expenses
(Amounts in thousands)
December 31,
2015
2014
2016
$
$
10,169 $
2,151
455
251
882
527
242
3,509
18,186
$
9,311 $
2,019
389
304
830
454
—
3,056
16,363
$
9,147
1,912
341
309
815
277
—
2,698
15,499
31
Total non-interest expenses increased by $1.8 million, or 11.1%, in 2016. This compares to an increase of $864,000, or 5.6%, in 2015.
During 2016, expenditures for salaries and employee benefits increased by $858,000, or 9.2%, and in 2015 increased by $164,000, or
1.8%. The personnel increase was primarily due to the new branch opened in September 2015 and initiatives to geographically expand
mortgage origination, commercial lending and private banking. The increase was partially offset by compensation relative to wealth
management decreasing commensurate to the decreased revenues. Full-time equivalent employment averaged 163 in 2016 compared
to 152 in 2015 and 153 in 2014.
Salaries and employee benefits represent 55.9% of all non-interest expenses in 2016, 56.9% in 2015 and 59.0% in 2014. The
following table details components of these increases and decreases.
Salaries
Employee benefits
Deferred loan origination costs
Total
Amounts (in thousands)
December 31,
2015
2016
2014
2016
Percentages
December 31,
2015
$
$
813 $
115
928
(70 )
858 $
176 $
132
308
(144 )
164 $
(550 )
(164 )
(714 )
17
(697 )
11.2 %
4.7
9.6
19.6
9.2 %
2.5 %
5.7
3.3
67.3
1.8 %
2014
(7.2 )%
(6.7 )
(7.1 )
(7.4 )
(7.1 )%
Salary expense per employee averaged $49,000 in 2016 and $48,000 in 2015 and $46,000 in 2014. Average earning assets per
employee measured approximately $3.8 million in 2016 and $3.5 million in 2015 and $3.3 million in 2014.
Charges for insurance premiums paid to the FDIC decreased from 2015 and 2014 balances because of a reduction in assessment rates
effective September 30, 2016. Deposits are insured by the FDIC up to a maximum amount, which is generally $250,000 per depositor
subject to aggregation rules. As an FDIC-insured institution, the Bank is required to pay deposit insurance premium assessments to the
FDIC. The Company anticipates its FDIC insurance expense will decrease in 2017 with the rate decrease effective a full year. State
and local taxes increased by $66,000, or 17.0%, in 2016, compared to an increase of $48,000, or 14.1%, in 2015, reflecting the
growing shareholders’ equity on which the state tax is based. Advertising and marketing expenses increased by $73,000, or 16.1%,
from 2015 to 2016 compared to an increase of $177,000, or 63.9%, from 2014 to 2015. The increase in 2016 is due to the initiative to
rebrand the Bank, increased community support and advertising and promoting the new Kasasa suite of products. The increase in 2015
was also due to the initiative to rebrand the Bank, advertising and promoting the new Kasasa product and also promoting the opening
of the full service branch. In 2016, there was a one-time loss from the extinguishment of debt of $242,000. This loss is related to the
early payoff of long term advances with the Federal Home Loan Bank and was offset by securities gains. Additionally, payoff of this
debt will result in annual savings in interest expense of $130,000. All other categories of non-interest expenses increased $637,000, or
10.8%, in 2016 compared to an increase of $480,000, or 8.8%, in 2015. These expense categories are subject to fluctuation due to non-
recurring items. Contributing to increased expenses in 2015 were the opening of two financial service centers and a new full-service
branch in Mahoning County. Contributing to increased expenses in 2016 are ongoing expenses relating to the new full service branch
which opened in September of 2015, and two financial service centers which opened in 2015, expenses relating to rebranding other
than marketing expense, expenses relating to the preparations of opening of a new full service branch in early January 2017, and
continued investment into information technology relative to improved security monitoring, improved operational performance and
enhanced customer account analysis.
Income before federal income tax expense amounted to $6.0 million for 2016, compared to $5.6 million and $4.8 million for 2015 and
2014, respectively. The effective tax rate was 18.8% in 2016, 21.8% in 2015 and 18.9% in 2014, resulting in income tax expense of
$1.1 million in 2016, $1.2 million in 2015 and $902,000 in 2014. The 2015 effective rate is normalized based on the current rate of
profitability and tax free components of the revenue stream. A $93,000 reversal of a deferred tax valuation reserve, recognized in
2016, contributed to the lower effective tax rate in 2016.
32
The effective federal income tax rate varies from the applicable U.S. statutory federal income tax rate of 34% due to the following
differences:
Provision at statutory rate
(Deduct) add tax effects of:
Earnings on bank-owned life insurance-net
Non-taxable interest income
Low income housing tax credits
Deferred tax valuation reversal
Non-deductible expenses
Federal income tax effective rate
2016
December 31,
2015
2014
34.00 %
34.00 %
34.00 %
(1.86 )
(10.47 )
(2.37 )
(1.55 )
1.04
18.79 %
(2.05 )
(10.72 )
(0.97 )
—
1.52
21.78 %
(2.39 )
(12.75 )
(1.09 )
—
1.14
18.91 %
Net income registered $4.9 million in 2016, $4.4 million in 2015 and $3.9 million in 2014, representing per share amounts of $1.11 in
2016, $0.97 in 2015 and $0.85 in 2014. Cash dividends of $0.28, $0.24 and $0.18 per share were paid to shareholders of record in
2016, 2015 and 2014, respectively.
The following table shows unaudited financial results by quarter:
(Amounts in thousands)
Interest income
Interest expense
Net interest income
Loan loss provision
Security gains (losses), net
Mortgage banking gains, net
Other income
Other expenses
Income before tax
Federal income tax expense
Net income
Net income per share
Net interest income (fully tax-equivalent
basis)
Net interest rate spread
Net interest margin
ALLOWANCE FOR LOAN LOSSES
Dec. 31
$ 5,762
764
4,998
—
8
93
804
4,489
1,414
273
$ 1,141
$ 0.26
For the 2016 quarter ended:
June 30
Sept. 30
$ 5,740
$ 5,660
719
743
5,021
4,917
—
50
4
83
465
341
696
696
4,734
4,479
1,452
1,508
279
313
$ 1,173
$ 1,195
$ 0.27
$ 0.27
Mar. 31
$ 5,393
692
4,701
—
324
349
734
4,484
1,624
262
$ 1,362
$ 0.31
For the 2015 quarter ended:
June 30
Sept. 30
679
631
65
47
149
754
Dec. 31
Mar. 31
$ 5,395 $ 5,295 $ 5,206 $ 5,217
648
649
4,716 4,646 4,575 4,569
160
100
8
47
185
291
862
708
4,192 3,990 4,187 3,994
1,409 1,602 1,116 1,470
321
$ 1,086 $ 1,227 $ 916 $ 1,149
$ 0.24 $ 0.27 $ 0.21 $ 0.25
130
(38 )
160
736
323
375
200
$ 5,147
$ 5,230
3.41 % 3.45 % 3.60 % 3.42 % 3.48 % 3.51 % 3.51 % 3.51 %
3.58 % 3.63 % 3.77 % 3.58 % 3.63 % 3.67 % 3.66 % 3.66 %
$ 4,927 $ 4,868 $ 4,799 $ 4,794
$ 4,919
$ 5,262
The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents
management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, with the
judgment of management, is necessary to reserve for estimated loan losses on risks inherent in the loan portfolio. Accordingly, the
methodology to establish the amount of the allowance is based on historical loss experience by type of credit and internal risk grade,
specific homogeneous risk pools, and specific loss allocations, with adjustments for current events and conditions. The Company’s
process for determining the appropriate level of the allowance for loan losses is designed to account for credit deterioration as it
occurs.
The Company’s allowance for loan loss methodology consists of three elements: (i) specific valuation allowances on probable losses
on specific loans; (ii) historical valuation allowances based on historical loan loss experience for similar loans with similar
characteristics and trends; and (iii) general valuation allowances based on general economic conditions and other qualitative risk
factors both internal and external to the Company.
33
The allowances established for probable losses on specific loans are based on recurring analyses and evaluations of classified loans.
Loans are categorized into risk grade classifications based on an internal credit risk grading process that evaluates, among other things:
(i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the
borrower operates. The Bank currently divides the loan and lease portfolio into the following major categories: 1) Pooled Loans
(unclassified) with similar risk characteristics; 2) Substandard Loans (classified) defined as being inadequately protected by current
sound net worth, paying capacity of the borrower, or pledged collateral; 3) Special Mention (classified) defined as having potential
weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may, at some future date, result
in the deterioration of the repayment prospects for the credit or the Bank’s credit position; 4) Loss or doubtful loans (classified) have
all the weaknesses of the previous classifications, with the added characteristic that the weaknesses make collection or liquidation in
full, on the basis of currently existing facts, conditions, and values highly questionable and improbable; and 5) Impaired Loans which
generally include non-accrual loans. Once a loan is assigned a risk grade of classified, the loan review officer assesses whether the
loan is to be evaluated for impairment based on the Company policy. A portion of the allowance for loan loss is specifically allocated
to those loans which are evaluated for impairment and determined to be impaired. Specific valuation allowances are determined by
analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic
conditions affecting the borrower’s industry, among other things. If after review, the loan is not considered to be impaired, the loan is
included with a pool of similar loans that is assigned a valuation allowance calculated based on the historical loss experience and
qualitative factors of the pool type. The valuation allowance is calculated based on the historical loss experience of specific types of
classified loans. The Company calculates historical loss ratios for pools of loans with similar characteristics based on the proportion of
actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are updated quarterly based on
actual charge-off experience.
A general valuation allowance is established for pools of homogeneous loans based upon the product of the historical loss ratio
adjusted for qualitative factors and the total dollar amount of the loans in the pool. Specific qualitative factors considered by
management include trends in volume or terms, changes in lending policy levels and trends in charge-offs, classification and non-
accrual loans, concentrations of credit and local and national economic factors. The Company’s pools of similar loans include
similarly risk-graded groups of commercial loans, commercial real estate loans, residential real estate loans, home equity loans and
other consumer loans. Additional factors are used on pools of loans considered special mention; specifically, levels and trends in
classification, declining trends in financial performance, structure and lack of performance measures and migration from special
mention to substandard. For loans graded as substandard, a separate historical loss rate is calculated as a percent of charge-offs net of
recoveries to the balance of substandard loans, which results in a higher historical loss factor. This is also adjusted for the qualitative
factors discussed previously.
Loans identified as losses by management, internal loan review and/or bank examiners are charged off. Furthermore, consumer loan
accounts are charged off in accordance with regulatory requirements.
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 consolidated balance sheets within other liabilities, while the corresponding
provision for these losses is recorded as a component of other non-interest expenses. At both December 31, 2016 and 2015, this
allowance was $84,000.
Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in
management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate
adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including the performance of the
Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
Although management believes the Company uses the best information available to make loan loss allowance determinations, future
adjustments could be necessary if circumstances or economic conditions differ substantially from the assumptions used in making our
initial determinations. Increased levels of job loss and high unemployment, home foreclosures and business failures could result in
increased levels of nonperforming assets and charge-offs, increased loan loss provisions and reductions in income. Additionally, as an
integral part of their examination process, bank regulatory agencies periodically review our allowance for loan losses. The banking
agencies could require the recognition of additions to the loan loss allowance based on their judgment of information available to them
at the time of their examination.
34
The following is an analysis of changes in the allowance for loan losses for the period ended:
Balance at beginning of year
Loan losses:
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total
Recoveries on previous loan losses:
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total
Net loan losses
Provision charged to operations
Balance at end of year
Ratio of net loan losses to average total loans outstanding
Ratio of loan loss allowance to total loans
$
2016
2015
(Amounts in thousands)
December 31,
2014
2013
2012
$
5,194
$
5,202 $
3,764 $
3,825 $
3,058
—
(287 )
(35 )
(144 )
(148 )
(614 )
117
35
2
23
61
238
(376 )
50
$
4,868
0.10 %
1.16 %
(470 )
(84 )
(45 )
—
(124 )
(723 )
134
10
37
17
62
260
(463 )
455
5,194 $
0.13 %
1.32 %
(123 )
(186 )
(93 )
(48 )
(144 )
(594 )
(1 )
(782 )
(81 )
(12 )
(146 )
(1,022 )
274
3
16
24
77
394
(200 )
1,638
5,202 $
0.06 %
1.44 %
167
11
26
18
89
311
(711 )
650
3,764 $
0.23 %
1.09 %
(1,937 )
(36 )
(231 )
(59 )
(152 )
(2,415 )
9
37
46
13
57
162
(2,253 )
3,020
3,825
0.78 %
1.21 %
The $470,000 commercial real estate charge-off in 2015 contains a $468,000 charge-off to an isolated credit relationship that already
had a specific reserve in place. The $782,000 commercial real estate charge-off in 2013 contains $710,000 in charge-offs to a single
borrower which had $530,000 in a related specific allowance prior to the charge-off. The $1.9 million commercial loan charge-off in
2012 related to a single borrower to which no related allowance had been previously allocated.
The following is an allocation of the year end allowance for loan losses and the percentage to total loans. The allowance has been
allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the
following categories of loans as of:
2016
2015
(Amounts in thousands)
December 31,
2014
2013
2012
Commercial
Commercial real
estate
Residential real estate
Consumer - home
equity
Consumer - other
Balance
$ 1,394
%
Balance
0.3 $ 1,977
%
Balance
0.5 $ 2,064
%
Balance
%
Balance
%
0.6 $
593
0.2 $
639
0.2
3,072
2,926
0.7
2,754
0.7
163 —
153 —
229
356
343
2,638
2,616
0.8
0.1
0.8
0.1
0.8
0.1
150
—
89 —
52
—
60
—
88
—
86 —
95 —
89 —
123
—
104 —
Total
$ 4,868
$ 5,194
$ 5,202
$ 3,764
$ 3,825
The allocations of the allowance as shown in the previous table should not be interpreted as an indication that future loan losses will
occur in the same proportions or that the allocations indicate future loan loss trends. Furthermore, the portion allocated to each loan
category is not the total amount available for future losses that might occur within such categories since the total allowance is
applicable to the entire portfolio, and allocation of a portion of the allowance to one category of loans does not preclude availability to
absorb losses in other categories.
35
LOAN PORTFOLIO
The following table represents the composition of the loan portfolio as of:
2016
2015
(Amounts in thousands)
December 31,
2014
2013
2012
Balance
%
Balance
%
Balance
%
Balance
%
Balance
%
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total loans
$ 96,281
238,692
57,008
25,061
2,726
$ 419,768
22.9 $ 84,613 21.5 $ 72,330 20.1 $ 73,643 21.2 $ 62,312 19.6
56.9 237,137 60.1 223,536 62.1 206,744 59.6 193,417 61.1
13.6 45,414 11.5 38,875 10.8 42,288 12.2 39,091 12.3
6.0 23,334 5.9 21,328 5.9 19,510 5.6 17,910 5.6
4,552 1.4
0.6
4,116 1.1
3,756 1.0
4,648 1.4
$ 394,254
$ 360,185
$ 346,833
$ 317,282
The following schedule sets forth maturities based on remaining scheduled repayments of principal or next re-pricing opportunity for
loans (excluding residential real estate, consumer- home equity and consumer-other).
Commercial
Commercial real estate
Total loans
(Amounts in thousands)
December 31, 2016
1 Year or Less
Over 1 Year
to 5 Years
Over 5 Years
Total
$
$
67,334 $
83,107
150,441 $
15,499 $
93,810
109,309 $
13,448 $
61,775
75,223 $
96,281
238,692
334,973
The following schedule sets forth loans based on next re-pricing opportunity for floating and adjustable interest rate products, and by
remaining scheduled principal payments for loan products with fixed rates of interest. Residential real estate, consumer - home equity
and consumer – other loans have again been excluded.
Floating or adjustable rates of interest
Fixed rates of interest
Total loans
(Amounts in thousands)
December 31, 2016
Over 1 Year
1 Year or Less
$
145,782 $
4,659
150,441 $
$
108,156 $
76,376
184,532 $
Total
253,938
81,035
334,973
The Company recorded an increase of $25.5 million in the loan portfolio in 2016 from the level of $394.3 million recorded at
December 31, 2015. Gross loans as a percentage of earning assets stood at 68.6% as of December 31, 2016 and 69.1% at
December 31, 2015. The loan-to-deposit ratio at December 31, 2016 was 77.8% as compared to 79.4% at December 31, 2015. Despite
the slow economic recovery in the region, the Bank posted year-over-year growth in total loans of 6.5%. As the balance sheet is
adequately structured to accommodate additional loan growth, management remains committed to fulfilling the credit needs of
creditworthy customers. Included in year-end total loans are 60-day or less loans closed in December 2016 for $29.7 million,
compared to $24.2 million in 2015. At December 31, 2016 the loan loss allowance of $4.9 million represented approximately 1.2% of
outstanding loans, and at December 31, 2015, the loan loss allowance of $5.2 million represented approximately 1.3% of outstanding
loans.
The portion of the loan portfolio represented by commercial loans (including commercial real estate) remained about the same from
81.6% in 2015 to 79.8% in 2016. Consumer loans (including home equity loans) were approximately 6.6% of the loan portfolio in
2016 and 6.9% in 2015 as the Bank remains challenged in growing these portfolios with consumers deleveraging their household since
the economic downturn of 2008-2009. Between 2015 and 2016, the balance of residential real estate loans increased slightly from
11.5% to 13.6% of the loan portfolio as the bank placed quality, non-secondary market qualified and construction loans in the
portfolio. The Bank’s majority of mortgage originations are sold to the secondary market in order to take advantage of historically low
interest rates as management does not intend to take on material long term interest rate risk within the portfolio yields.
Commercial, commercial real estate and residential real estate loans continue to comprise the largest share of the Company’s loan
portfolio. At the end of 2016, commercial, commercial real estate and residential real estate loans comprised a combined 93.4% of the
portfolio compared to 93.0% at December 31, 2012, reflecting a consistent strategy over the five-year period. The loan portfolio at
36
December 31, 2016 also included home equity loans at 6.0% and consumer installment loans at 0.6%. These percentages compare to
home equity loans at 5.6% and consumer installment loans at 1.4% on December 31, 2012.
The commercial loan portfolio, which includes both commercial and commercial real estate (CRE) loans, is $335.0 million at
December 31, 2016, an increase of $13.2 million from the balance of $321.8 million recorded at December 31, 2015, and represents a
4.1% growth. Short-term, asset-based commercial loans, including lines of credit, increased by $11.7 million, or 13.8%, during the
year and represented 22.9% of the portfolio, or a 1.4% composition increase over the prior period. CRE loans increased $1.6 million,
or 0.7%, which substantially represents investment real estate supported by third-party rents and leases along with other known Bank
concentrations such as Skilled Nursing, Assisted Living, Residential Lessors (including Multi-family) and Hotels that are classified as
non-owner occupied CRE. At December 31, 2016, the total CRE portfolio consisted of 28.5% in owner-occupied real estate and
71.5% in non-owner occupied real estate. The increase in CRE loans was a direct result of management taking strategic advantage of
competitive market conditions and the Bank’s considerable liquidity position since 2010. The CRE portfolio was also enhanced by
lending into the Skilled Nursing, Personal Health Care industries and Multi-family. In 2006, the federal banking regulatory agencies
published interagency guidance on CRE Concentration Risk Management stating that if total commercial real estate concentration
exceeded 300% of a bank’s total capital (or if the CRE portfolio increased by over 50% in the preceding 3 years), the portfolio may
represent significant concentration risk and additional monitoring may be required. The Bank’s CRE concentration, excluding owner-
occupied real estate, as of December 31, 2016 was $170.6 million, which is 252.2% of total unimpaired or risk-based capital,
compared to 264.0% for 2015 which, along with the nominal 0.7% CRE balance growth is reflecting moderate growth and less
concentration risk relative to capital. CRE reflected 15.5% growth over the past three years. Management also believes that its current
level of credit review, portfolio monitoring and stress testing adequately assures that the Bank is mitigating CRE concentration levels.
In a strategic effort to diversify, the Bank continues to develop its commercial loans and, as such, the December 31, 2016 balance of
$96.3 million represents 28.7% of the total commercial loan portfolio, which reflected a 2.4% increase from the period December 31,
2015 to December 31, 2016. However, excluding the year-end, 60-day or less, cash-secured loans that were increased by $5.5 million
from 2015 to 2016, commercial loans grew by $6.2 million, or 10.3%, from 2015 to 2016. In addition, residential loans grew by $11.6
million, or 25.5%, for the same period.
Loan personnel will continue to aggressively pursue both commercial and small business opportunities supported by product
incentives and marketing efforts. When necessary, management will continue to offer competitive fixed-rate and derivative pricing
options on commercial real estate products to qualifying customers in an effort to establish new business relationships, retain existing
relationships, and capture additional market share. The Bank’s lending function continues to provide business services to a wide array
of medium and small businesses, including but not limited to, commercial and industrial accounts such as health care facilities,
grocery stores, manufacturers, trucking companies, physicians and medical groups, service contractors, restaurants, hospitality
industry companies, retailers, wholesalers, educational institutions and other political subdivisions as well as commercial and
residential real estate lessors, developers and builders.
Commercial and small business loans are originated by commercial loan personnel and other loan personnel assigned to the Bank’s
offices within various geographical regions. These loans are all processed in accordance with established business loan underwriting
standards and practices.
The following table provides an overview of commercial loans by various business sectors reflecting the areas of largest
concentration. It should be noted that these are current loan balances including executed commitments to fund and do not reflect
existing commitments that have not been accepted or executed.
Non-residential building/apartment building
Skilled nursing
Residential real estate lessors, agents and
managers (including multi-family)
Hotels/motels
Trucking/courier services
2016
(Amounts in thousands)
December 31,
2015
2014
Balances
% of
Portfolio
Balances
% of
Portfolio
Balances
% of
Portfolio
$
70,399
29,929
21.02 $ 65,308
36,119
8.93
20.30 $ 56,731
30,239
11.23
19.17
10.22
27,016
23,285
21,329
8.07
6.95
6.37
16,032
29,215
19,941
4.98
9.08
6.20
14,245
31,151
15,670
4.81
10.53
5.30
The most substantial increase in concentrations since 2014 comes from non-residential building/apartment building, which is not
material relative to the total portfolio composition. The single largest customer relationship had an aggregate balance at year end 2016
of $11.8 million compared to $9.7 million in 2015. This balance represented approximately 3.5% of the total commercial and CRE
portfolio in 2016 and 2.8% in 2015. It is important to note that within this relationship, there is a 60-day or less note for $10.0 million
in 2016 and $6.2 million in 2015, which were fully secured by segregated deposit accounts with the Bank at the time of origination.
37
Since 2015, the price of oil declined significantly. This occurrence negatively affected several industries, particularly those whose
revenues are derived from oil and oil-related products. The Company reviewed its borrowers to identify and measure any potential
credit losses relating to oil. Nothing of significance was noted and no additional provisions are considered necessary.
The Bank continues to be active in home equity financing. Home equity term loans and credit lines (HELOCs) remain popular with
consumers wishing to finance home improvement costs, education expenses, vacations and consumer goods purchased at favorable
interest rates. In order to improve customer retention and provide better overall balance, management will continue to evaluate and
reposition the Company’s portfolio product offerings during 2016.
In the consumer lending area, the Company provides financing for a variety of consumer purchases, such as: fixed- and variable-rate
amortizing mortgage products that consumers utilize for home improvements; the purchase of consumer goods of all types; and
education, travel and other personal expenditures. The consolidation of credit card balances and other existing debt into term payouts
continues to remain a popular financing option among consumers. In an effort to increase consumer relationship banking, the
Company implemented a Private Bank product line in 2016 that focuses on high net worth and income consumers.
Additional information regarding the loan portfolio can be found in Item 8, Notes 1, 3, 8, 11 and 14 to the Consolidated Financial
Statements.
MORTGAGE BANKING
Since the May 2013 Taper Tantrum when mortgage rates rose dramatically, the Company shifted its focus from wholesale to retail
origination. With the majority of loans sold into the secondary market, the resulting gains have significantly enhanced non-interest
revenue, with growth of 59.0% over the prior year. As originators were added in the retail footprint, as well as expanding into adjacent
markets, originations grew from $18.4 million in 2014, to $61.0 million in 2016. As previously referenced, the residential portfolio
grew by $11.6 mil or 25.5% with quality, non-secondary market qualified and construction loans. The Company continues to diversify
its portfolio with expansion into new geographic markets and new personnel within its footprint.
Currently, the Company is not retaining the servicing on loans sold. Although the Company’s primary strategy is to sell long-term
residential mortgages, loans are occasionally retained in the portfolio when requested by a customer or to enhance account
relationships, and tend to be variable rate or shorter term. The mix of portfolio retained to those sold to investors will vary from year
to year.
The Company maintains reserves for mortgage loans sold to agencies and investors in the event that, either through error or
disagreement between the parties, the Company is required to indemnify the purchase. The reserves take into consideration risks
associated with underwriting, key factors in the mortgage industry, loans with specific reserve requirements, past due loans and
potential indemnification by the Company. Reserves are estimated based on consideration of factors in the mortgage industry, such as
declining collateral values and rising levels of delinquency, default and foreclosure, coupled with increased incidents of quality
reviews at all levels of the mortgage industry seeking justification for pushing back losses to loan originators and wholesalers. As of
December 31, 2016 and 2015, the Company had reserves for mortgage loans sold of $721,000 and $719,000, respectively. For both
the twelve months ended December 31, 2016 and 2015, the Company recorded $2,000 and $19,000, respectively, in provision expense
related to potential repurchase and warranties exposure. For the years ended December 31, 2016 and 2015, the Company did not
repurchase any mortgage loans sold.
INVESTMENT SECURITIES
Investment securities are segregated into three separate portfolios: available-for-sale, held-to-maturity and trading. Each portfolio type
has its own method of accounting. The Company currently does not maintain a held-to-maturity portfolio. Securities classified as
available-for-sale are those that could be sold for liquidity, investment management, or similar reasons even though management has
no present intentions to do so. Securities available-for-sale are carried at fair value using the specific identification method. Changes
in the unrealized gains and losses on available-for-sale securities are recorded net of tax effect as a component of comprehensive
income.
Held-to-maturity securities are recorded at historical cost and adjusted for amortization of premiums and accretion of discounts.
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. The Company
has no securities classified as held-to-maturity.
38
Trading securities were an investment in obligations of states and political subdivisions and a short duration bond fund. Management
had purchased these securities principally for the purpose of selling them in the near term. Trading securities were carried at fair value
with valuation adjustments included in other non-interest income. The Company no longer has any investment in trading securities.
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 portfolio to reflect changing economic conditions and shifts in
the relative values of market sectors. Available-for-sale securities tend to be more liquid investments and generally exhibit less price
volatility as interest rates fluctuate.
Securities are evaluated periodically to determine whether a decline in their value is other-than-temporary. Management utilizes
criteria such as the magnitude and duration of the decline, in addition to the reasons underlying the decline, to determine whether the
loss in value is other-than-temporary. The OTTI is not intended to indicate that the decline is permanent, but indicates that the
prospect for a near-term recovery of value is not necessarily favorable, or that there is a lack of evidence to support a realizable value
equal to or greater than the carrying value of the investment. Once a decline in value is determined to be an OTTI, the credit-related
OTTI is recognized in earnings while the non-credit related OTTI on securities not expected to be sold is recognized in other
comprehensive income (loss).
The following table shows the fair value of available-for-sale securities by type of obligation at:
U.S. Treasury and U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed and related securities
Trust preferred securities
Federal Home Loan Bank and Federal Reserve Bank stock
Total fair value of investment securities available-for-sale
(Amounts in thousands)
December 31,
2015
2016
$
$
7,988 $
66,770
101,055
825
2,581
$
179,219
12,623 $
51,405
86,046
778
3,049
$
153,901
2014
8,749
50,091
99,579
779
3,049
162,247
Impairment Analysis of Investment Securities
Item 8, Note 2 in the Notes to the Consolidated Financial Statements contains the accounting and disclosures for securities
impairment.
Fair Value
The Company owns two trust preferred securities totaling $2.0 million (original face) consisting of obligations of banks, thrifts and
insurance companies. The market for these securities at December 31, 2016 is not fully active and markets for similar securities are
also not completely active. Given conditions in the debt markets today and the absence of observable transactions in the secondary and
new issue markets, the Company determined the few observable transactions and market quotations that are available are not reliable
for purposes of determining fair value at December 31, 2016. It was decided that an income valuation approach technique (present
value technique) that maximizes the use of relevant observable inputs and minimizes the use of unobservable inputs would be more
representative of fair value than the market approach valuation technique used at measurement dates prior to 2008.
The Company enlisted the aid of an independent third party to perform the trust preferred securities valuations. The approach to
determining fair value involved the following process:
1. Estimate the credit quality of the collateral using average probability of default values for each issuer (adjusted for rating
levels).
2. Consider the potential for correlation among issuers within the same industry for default probabilities (e.g. banks with
other banks).
3. Forecast the cash flows for the underlying collateral and apply to each trust preferred security tranche to determine the
resulting distribution among the securities.
4. Discount the expected cash flows to calculate the present value of the security.
The effective discount rates on an overall basis generally range from 9.69% to 15.11% and are highly dependent upon the credit
quality of the collateral, the relative position of the tranche in the capital structure of the trust preferred securities and the prepayment
assumptions.
39
Based upon the results of the analysis, the Company currently believes that a weighted average price of approximately $0.47 per $1.00
of par value is representative of the fair value of the two trust preferred securities, with individual securities therein ranging from
$0.41 to $0.52.
The Company considered all information available as of December 31, 2016 to estimate the impairment and resulting fair value of the
trust preferred securities. These securities are supported by a number of banks and insurance companies located throughout the
country. While the number of bank failures has declined since the historically high failure rates of 2009, 2010 and 2011, there is still
the potential for troubled banks to fail. The Company did not recognize any credit related impairment during 2016 or 2015. If the
conditions of the underlying banks in the trust preferred securities worsen, there may be additional impairment to recognize in 2017 or
later.
A summary of securities held at December 31, 2016, classified according to the earlier of next re-pricing 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.
U.S. Government agencies and corporations:
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
Total U.S. Government agencies and corporations
Obligations of states and political subdivisions:
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
Total obligations of states and political subdivisions
U.S. Government mortgage-backed and related securities:
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
Total U.S. Government mortgage-backed and related securities
Other securities (2):
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
Total other securities
(Amounts in thousands)
Fair Value
Weighted
Average
Yield (1)
$
$
$
$
$
$
$
$
—
344
7,644
—
7,988
1,137
2,708
9,859
53,066
66,770
—
9,349
4,824
86,882
101,055
825
—
—
2,581
3,406
— %
2.199
2.599
—
2.582 %
4.999 %
3.898
3.255
2.756
2.915 %
— %
1.959
2.243
2.120
2.111 %
1.450 %
—
—
4.539
3.790 %
(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 and political subdivisions has been calculated on a fully taxable equivalent basis. The amount
of adjustment to interest, which is based on the statutory tax rate of 34%, was $905,000.
(2) Regulatory stock is included in the amount maturing or repricing after ten years, and although pays dividends, is not
contractually obligated.
As of December 31, 2016, there were $7.6 million in callable U.S. Government agency securities and $2.9 million in callable
obligations of states and political subdivisions that, given current and expected interest rate environments, have the possibility of being
called within the one-year time horizon. These securities are categorized according to their contractual maturities, with $1.1 million
classified as maturing or repricing within one year, $231,000 classified as maturing after one year but within five years, $9.2 million
classified as maturing after five years but within ten years and none of the callable investments were classified as maturing after 10
years.
40
As of December 31, 2016, there were no callable U.S. Government agency securities and $19.4 million in callable obligations of states
and political subdivisions that, given current and expected interest rate environments, have the possibility of being called within the
time frame defined as after one year but within five years. These securities are categorized according to their contractual maturities,
with $1.5 million maturing after one year but within five years, $7.3 million maturing after five years but within ten years and $10.6
million maturing after 10 years.
As of December 31, 2016, the carrying value of all investment securities totaled $179.2 million, an increase of $25.3 million, or 16.5%,
from the prior year. Near year-end 2015, several securities were called, in addition to some investment sales, and these proceeds were
reallocated to other funding needs, specifically commercial loan growth, thereby leaving invested balances at a low point at the end of
2015. During 2016, the trading account, consisting of $8.1 million, was liquidated and reallocated to the investments available for
sale portfolio. In addition, near year-end 2016, all excess liquidity was fully allocated to the investment portfolio, thereby leaving the
invested balances at a high point. The investment portfolio functions as the balancing factor among the sometimes volatile swings in
loans and deposits, along with short term borrowings. The investment portfolio represents 33.2% of each deposit dollar, up from 31.0%
at the prior year end. The allocation between single maturity investment securities and mortgage-backed securities shifted to a 44/56
split versus the 45/55 division of the previous year.
Holdings of obligations of states and political subdivisions increased by $15.3 million, or 29.9%. The increase was due to purchases of
$35.7 million offset by sales of $14.7 million and calls of $2.5 million.
Holdings of U.S. Government-sponsored mortgage-backed securities increased by $10.1 million, or 14.5%. This increase was
primarily the result of purchases of $45.6 million, offset by sales of $19.2 million and principal paydowns of $13.7 million.
Holdings of U.S. Government-guaranteed small business administration pools increased $9.1 million, or 320.8%. This increase was
due to purchases of $10.8 million, offset by principal paydowns of $1.2 million.
Holdings of other securities remained relatively unchanged during the year.
The current year mortgage-backed securities and related portfolio is comprised of investments in mortgage-backed securities of $79.8
million, collateralized mortgage obligations of $9.3 million and U.S. Government-guaranteed small business administration pools of
$11.9 million. The prior year mortgage-backed securities and related portfolio is comprised of investments in mortgage-backed
securities of $51.4 million, collateralized mortgage obligations of $13.5 million and U.S. Government-guaranteed small business
administration pools of $2.8 million. The current year portfolio was comprised solely of fixed rate products, while the prior year
portfolio was heavily weighted in favor of fixed-rate securities at 96.8%.
At December 31, 2016, a net unrealized loss of $2.9 million, net of tax, was included in shareholders’ equity as a component of other
comprehensive income, as compared to a net unrealized loss of $147,000, net of tax, as of December 31, 2015. Rising interest rates,
such as that occurred post-election, generally result in depreciation in the market value of debt securities, while lower interest rates
generally translate into more favorable market prices for debt securities.
The Company has $825,000 in investments considered to be structured notes as of December 31, 2016, relatively unchanged
compared to $778,000 from one year ago. The Company has no investments in other derivative products.
Additional information regarding investment securities can be found in Item 8, Notes 1 and 2 to the Consolidated Financial
Statements.
DEPOSITS
The Company’s deposits are primarily derived from the individuals and businesses located in its market area. Total deposits at year-
end exhibited an increase of 8.8% to $539.9 million at December 31, 2016, as compared to $496.4 million at December 31, 2015.
The Company’s deposit base consists of demand deposits, savings, money market and time deposit accounts. Noninterest-bearing
deposits increased 8.4% during 2016, while interest-bearing deposits increased by 8.9%.
At December 31, 2016, noninterest-bearing deposits were $117.2 million, or 21.7%, compared to $108.1 million or 21.8% of total
deposits in 2015.
Core deposits, which are deposits exclusive of certificates of deposit greater than $250,000, brokered deposits and deposits through
listed services represented 92.5% of total deposits at year-end 2016 compared to 91.0% in 2015.
41
The Company’s portfolio of certificates of deposit is sourced primarily from customers in the Bank’s immediate market area and
includes an insignificant amount of brokered deposits.
Average noninterest-bearing and interest-bearing checking accounts now comprise 30.9% of total deposits compared to 26.0% five
years ago. The largest shift, however, is the decline in CD balances of 9.8%. This is reflective of the unwillingness of customers to
commit to longer terms in the low interest rate environment, and the expectation of rising rates on the horizon. The following table
depicts how the average deposit mix has shifted during this five-year time frame.
Checking
NOW
Money market
Savings
CDs
(In percentages)
December 31,
2016
2012
22.5
8.4
19.3
22.8
27.0
18.3
7.7
11.9
25.3
36.8
Additional information regarding interest-bearing deposits can be found in Item 8, Note 5 to the Consolidated Financial Statements.
OTHER ASSETS AND OTHER LIABILITIES
Premises and equipment totaled $9.1 million at December 31, 2016, an decrease of $58,000 from $9.2 million at December 31, 2015.
Bank-owned life insurance had a cash surrender value of $17.4 million at December 31, 2016 and $17.3 million at December 31,
2015, which comprised approximately 25% of regulatory capital in both years. Management does not intend to make any significant
insurance purchases. Other assets increased to $14.7 million at December 31, 2016 from $12.3 million at December 31, 2015. Net
deferred tax assets measured $4.9 million at December 31, 2016 comparable to $3.3 million at December 31, 2015.
In 2016, a $4.2 million investment in a partnership fund is included in other assets and $3.5 million at 2015, with an offsetting $2.5
million in other liabilities in 2016 and $2.4 million in 2015, which is the commitment to fund this affordable housing investment. Also
included in other assets is an investment of $2.0 million at both 2016 and 2015 into a privately managed pooled fund of small business
administration loans. Both of these investments are intended to satisfy Community Reinvestment Act requirements.
Other liabilities measured $9.3 million at December 31, 2016 and $9.7 million at December 31, 2015. In 2015, there was a $1.0
million balance in securities to settle on investment purchases, with none at December 31, 2016. In addition to the commitment
described above other major components are accrued interest on deposits and borrowings which measured $288,000 and $255,000 in
2016 and 2015. Accrued expenses measured $4.3 million at December 31, 2016 and $3.9 million at December 31, 2015. Post-
retirement benefits is the largest accrued expense item, which measured $3.0 million at December 31, 2016 and $2.8 million at
December 31, 2015.
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 of the
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 income 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 has averaged 3.59%
ranging between 3.41% and 3.67% as depicted in the following table.
Net interest margin
2016
2015
(In percentages)
December 31,
2014
2013
2012
3.63
3.65
3.67
3.41
3.58
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 alternative asset deployment strategies, different interest rate environments, various product offerings
and changing growth patterns.
42
During 2016, the effective maturities of earning assets remained fairly stable as rates in the credit markets remained extremely low.
Federal Reserve policy makers kept the short-term rates in the range of 0.00% to 0.50% during all of 2016 in an attempt to ease strains
in the financial market, stimulate spending and help improve the recovery. The quarter point tightening in December 2016 is not
expected to affect markets significantly. During the year, management invested the excess funds, with an allocation towards municipal
bonds for yield, and mortgage-backed securities for cash flow.
The computerized simulation techniques utilized by management provide a more sophisticated measure of the degree to which the
Company’s interest sensitive 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 in an acceptable range 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 3.41% to 3.67% 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 a low of 0.00% to 0.50%, as Federal Reserve monetary policy turned from
guarding against deflation to warding off inflationary threats to attempting to recover from a recession and softening the effects of the
housing correction.
LIQUIDITY
The central role of the Company’s liquidity management is to (1) ensure sufficient liquid funds to meet the normal transaction
requirements of its customers, (2) take advantage of market opportunities requiring flexibility and speed, and (3) provide a cushion
against unforeseen liquidity needs.
Liquidity risk arises from the possibility that the Company may not be able to satisfy current or future financial commitments or may
become unduly reliant on alternative funding sources. The objective of liquidity management is to ensure the Company has the ability
to fund balance sheet growth and meet deposit and debt obligations in a timely and cost-effective manner. Management monitors
liquidity through a regular review of asset and liability maturities, funding sources, and loan and deposit forecasts. The Company
maintains strategic and contingency liquidity plans to ensure sufficient available funding to satisfy requirements for balance sheet
growth, properly manage capital markets funding sources and address unexpected liquidity requirements.
Principal sources of liquidity available to the Company include assets considered relatively liquid, such as interest-bearing deposits in
other banks, federal funds sold, and cash and due from banks, as well as cash flows from maturities and repayments of loans,
investment securities and mortgage-backed securities.
Principal repayments on mortgage-backed securities, collateralized mortgage obligations and small business administration pools,
along with investment securities maturing or called amounted to $21.2 million during 2016, representing 12.0% of the total combined
portfolio, compared to $23.7 million, or 15.4%, of the portfolio a year ago.
In order to address the concern of FDIC insurance of larger depositors, the Bank is a member of the Certificate of Deposit Account
Registry Service (CDARS®) program and the Insured Cash Sweep (ICS) program. Through CDARS®, the Bank’s customers can
increase their FDIC insurance by up to $50.0 million through reciprocal certificate of deposit accounts and likewise through ICS, they
can accomplish the same through money market savings accounts. This is accomplished by the Bank entering into reciprocal
depository relationships with other member banks. The individual customer’s large deposit is broken into amounts below $250,000
and placed with other banks that are members of the network. The reciprocal member bank issues certificates of deposit or money
market savings accounts in amounts that ensure that the entire deposit is eligible for FDIC insurance. The Bank can also enter into
one-way buy or sell transactions which are not reciprocated. At December 31, 2016, the Bank had $22.3 million in deposits in the
CDARS® program, and $9.3 million of deposits in the ICS money market program. For regulatory purposes, CDARS® and ICS are
considered a brokered deposit even though reciprocal deposits are generally matched with funds from customers in the local market.
43
Along with its liquid assets, the Bank has other sources of liquidity available to it which help to ensure that adequate funds are
available as needed. These other sources include, but are not limited to, the ability to obtain deposits through the adjustment of interest
rates, the purchasing of federal funds, correspondent bank lines of credit and access to the Federal Reserve Discount Window. The
Bank is also a member of the Federal Home Loan Bank of Cincinnati, which provides its largest source of liquidity. At December 31,
2016, the Bank had approximately $15.9 million available of collateral-based borrowing capacity at FHLB of Cincinnati,
supplementing the $5.0 million of availability with the Federal Reserve Discount window. Additionally, the FHLB has committed a
$30.1 million cash management line, of which nothing has been disbursed, subject to posting additional collateral. The Bank, by
policy, has access to approximately 15% of total deposits in various forms of wholesale deposits that could be used as an additional
source of liquidity. At December 31, 2016, there was $27.8 million in outstanding balances in wholesale deposits including internet-
based deposits with access to an additional $53.3 million. The Company was also granted a total of $8.5 million in unsecured,
discretionary Federal Funds lines of credit with no funds drawn upon as of December 31, 2016. Unpledged securities of $64.3 million
are also available for borrowing under repurchase agreements or as additional collateral for FHLB lines of credit or to sell to generate
liquidity.
The Company has other more limited sources of liquidity. In addition to its existing liquid assets, it can raise funds in the securities
market through debt or equity offerings or it can receive dividends from the Bank. Generally, the Bank may pay dividends without
prior approval as long as the dividend is not more than the total of the current calendar year-to-date earnings plus any earnings from
the previous two years not already paid out in dividends, as long as the Bank remains well-capitalized after the dividend payment. The
amount available for dividends in 2017 is $5.0 million plus 2017 profits retained up to the date of the dividend declaration. Future
dividend payments by the Bank to the Company are based upon future earnings. The Company had cash of $320,000 at December 31,
2016 available to meet cash needs. It also held a $6.0 million note receivable, the cash flow from which approximates the debt service
on the Junior Subordinated Debentures. Cash is generally used by the Company to pay quarterly interest payments on the debentures,
to pay dividends to common shareholders and to fund operating expenses.
Cash and cash equivalents decreased from $18.5 million in 2015 to $15.4 million in 2016. The following table details the cash flows
from operating activities for the years ended 2016, 2015 and 2014.
Net income
Adjustments to reconcile net income to net cash flow from operating
activities:
Depreciation, amortization and accretion
Provision for loan losses
Investment securities available-for-sale gains, net
Decrease (Increase) in trading account
Originations of mortgage banking loans held for sale
Proceeds from the sale of mortgage banking loans
Mortgage banking gains, net
Earnings on bank-owned life insurance
Changes in:
Deferred taxes
Federal income tax receivable
Other assets and liabilities
Net cash flow from operating activities
$
(Amounts in thousands)
December 31,
2015
2014
2016
$
4,871 $
4,378 $
3,869
2,770
50
(466 )
8,134
(61,003 )
61,730
(1,248 )
(328 )
(129 )
281
(1,417 )
13,245 $
2,534
455
(75 )
(273 )
(39,191 )
36,575
(785 )
(338 )
303
(260 )
(1,936 )
1,387 $
2,465
1,638
(588 )
(614 )
(18,443 )
18,907
(440 )
(336 )
451
982
(685 )
7,206
Key variations stem from: 1) Provision for loan losses decreased by $405,000 in 2016 from 2015. The decreased amount in 2016 is
because of a favorable outcome on a credit relationship which the specific reserve previously set aside was able to be used for other
problem loans. $1.3 million of the provision in 2014 is related to the affiliated group.2) Gains were recognized on the sale of
available-for-sale investments of $466,000 in 2016 mainly due to sales made to offset the loss on extinguishment of debt, and $75,000
in 2015. 3) As of the end of 2016, the trading account was fully liquidated with a $8.1 million decrease compared to an increase of
$273,000 in 2015. 4) Loans held for sale increased by $521,000 in 2016 compared to an increase of $3.4 million in 2015, with
mortgage banking gains of $1.2 million in 2016 and $785,000 in 2015 due to the volume in mortgage banking. Refer to the
Consolidated Statements of Cash Flows in item 8 for a summary of the sources and uses of cash for 2016, 2015 and 2014.
44
CONTRACTUAL OBLIGATIONS AND COMMITMENTS
The Company has various obligations, including contractual obligations and commitments that may require future cash payments.
Contractual Obligations: The following table presents 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 Item 8, Notes to the Consolidated
Financial Statements.
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)
FHLB advances (a)
Average rate (b)
Subordinated debt
Average rate (b)
Operating leases
See Note
5
5
6
6
7
8
(Amounts in thousands)
December 31, 2016
Payments Due in:
Three to
Five Years
Over Five
Years
$
$
—
—
—
—
One Year or
Less
$ 117,225
291,758
One to
Three Years
—
$
—
0.22 %
Total
$ 117,225
291,758
0.22 %
79,884
15,490
22,666
12,827
130,867
0.71 %
1.76 %
2.65 %
2.20 %
1.32 %
2,702
0.33 %
—
38,500
2,000
1.70 %
—
1.17 %
—
—
—
—
206
235
105
—
2,702
0.33 %
—
40,500
5,155
2.41 %
—
1.67 %
5,155
2.41 %
546
(a) Excludes present and future accrued interest.
(b) Variable-rate obligations reflect interest rates in effect at December 31, 2016.
The Company’s operating lease obligations represent short- and long-term lease and rental payments for the Bank’s branch facilities.
The Company also has obligations under its supplemental retirement plans as described in Item 8, Note 9 to the Consolidated
Financial Statements. The postretirement benefit payments represent actuarially-determined future benefit payments to eligible plan
participants. The Company does not have any commitments or obligations to the defined contribution retirement plan (401(k) plan) at
December 31, 2016 due to the funded status of the plan. Additional information regarding benefit plans can be found in Item 8, Note 9
to the Consolidated Financial Statements.
Off-balance sheet arrangements/commitments: The following table details the amounts and expected maturities of significant off-
balance sheet commitments. Additional information regarding commitments can be found in Item 8, Note 8 to the Consolidated
Financial Statements.
(Amounts in thousands)
December 31, 2016
Three to
Five Years
One to Three
Years
One Year or
Less
Over Five
Years
Total
Commitments to extend credit:
Commercial (including commercial real estate)
Revolving home equity
Overdraft protection
Other
Residential real estate
Standby letters of credit
$ 23,251 $
18,742
9,655
978
3,756
357
528 $
—
—
—
—
55
1,245 $ 21,653 $ 46,677
20,444
9,655
978
7,786
412
1,702
—
—
4,030
—
—
—
—
—
—
Commitments to extend credit, including loan commitments, standby letters of credit, and commercial letters of credit do not
necessarily represent future cash requirements since these commitments often expire without being drawn upon.
45
CAPITAL RESOURCES
Regulatory standards for measuring capital adequacy require banks and bank holding companies to maintain capital based on “risk-
adjusted” assets so that categories of assets of potentially higher credit risk require more capital backing than assets with lower risk. In
addition, banks and bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance
sheet activities such as standby letters of credit and interest rate swaps.
The risk-based standards classify capital into two tiers. Tier 1 capital consists of common shareholders’ equity, noncumulative and
cumulative perpetual preferred stock, qualifying trust preferred securities and minority interests less intangibles, disallowed deferred
tax assets and the unrealized market value adjustment of investment securities available-for-sale. Tier 2 capital consists of a limited
amount of the allowance for loan and lease losses, perpetual preferred stock (not included in Tier 1), hybrid capital instruments, term
subordinated debt, and intermediate-term preferred stock.
The Federal Financial Institutions Examination Council (FFIEC) determines the risk weightings of direct credit substitutions that have
been downgraded below investment grade. Included in the definition of a direct credit substitute are mezzanine and subordinated
tranches of trust preferred securities and non-agency collateralized mortgage obligations. Following these guidelines results in an
increase in total risk-weighted assets with an attendant decrease in the risk-based capital and Tier 1 risk-based capital ratios.
The Company met all capital adequacy requirements to which it was subject as of December 31, 2016 and December 31, 2015.
In early September 2013, the regulatory bodies substantially revised the capital requirements for all banks, varying with the size of the
institution. The new requirements became effective January 1, 2015 and are to be phased in over four years. The Company does not
expect a material change to its excess capital position currently enjoyed.
Additional information regarding regulatory matters, including capital requirements, can be found in Item 8, Note 13 to the
Consolidated Financial Statements and in the Supervision and Regulation portion of Item 1 - Business.
INTEREST RATE RISK
Interest rate risk is measured as the impact of interest rate changes on the Company’s net interest income. Components of interest rate
risk comprise re-pricing risk, basis risk and yield curve risk. Re-pricing risk arises due to timing differences in the re-pricing of assets
and liabilities as interest rate changes occur. Basis risk occurs when re-pricing assets and liabilities reference different key rates. Yield
curve risk arises when a shift occurs in the relationship among key rates across the maturity spectrum.
The effective management of interest rate risk seeks to limit the adverse impact of interest rate changes on the Company’s net interest
margin, providing the Company with the best opportunity for maintaining consistent earnings growth. Toward this end, management
uses computer simulation to model the Company’s financial performance under varying interest rate scenarios. These scenarios may
reflect changes in the level of interest rates, changes in the shape of the yield curve, and changes in interest rate relationships.
The simulation model allows management to test and evaluate alternative responses to a changing interest rate environment. Typically
when confronted with a heightened risk of rising interest rates, the Company will evaluate strategies that shorten investment and loan
re-pricing intervals and maturities, emphasize the acquisition of floating rate over fixed rate assets, and lengthen the maturities of
liability funding sources. When the risk of falling rates is perceived, management will consider strategies that shorten the maturities of
funding sources, lengthen the re-pricing intervals and maturities of investments and loans, and emphasize the acquisition of fixed rate
assets over floating rate assets. The Company does not currently use financial derivatives, such as interest rate options, caps, floors or
other similar instruments. Interest rate swaps are currently used to accommodate large commercial borrowers desiring longer term
fixed rates.
Run-off rate assumptions for loans are based on the consensus speeds for the various loan types. Investment speeds are based on the
characteristics of each individual investment. Re-pricing characteristics are based upon actual information obtained from the Bank’s
information system data and other related programs. Actual results may differ from simulated results not only due to the timing,
magnitude and frequency of interest rate changes, but also due to changes in general economic conditions, changes in customer
preferences and behavior, and changes in strategies by both existing and potential competitors.
The following table shows the Company’s current estimate of interest rate sensitivity based on the composition of its balance sheet at
December 31, 2016. For purposes of this analysis, short-term interest rates as measured by the federal funds rate and the prime lending
rate are assumed to increase (decrease) gradually over the next twelve months reaching a level 300 basis points higher (and 100 basis
points lower) than the rates in effect at December 31, 2016. Because rates on the short end of the curve are below 3%, it is not
practical to review results to the degree of 300 basis points lower. Under both the rising rate scenario and the falling rate scenario, the
yield curve is assumed to exhibit a parallel shift.
46
During 2016, the Federal Reserve kept its target rate for overnight federal funds constant until late December. At December 31, 2016,
the difference between the yield on the ten-year Treasury and the three-month Treasury had only slightly decreased to a positive 194
from the positive 211 basis points that existed at December 31, 2015, indicating that the yield curve had remained similarly shaped. At
December 31, 2016, rates peaked at the 30-year point on the Treasury yield curve. The yield curve remains positively sloping as
interest rates continue to increase with a lengthening of maturities, with rates peaking at the long-end of the Treasury yield curve.
The base case against which interest rate sensitivity is measured assumes no change in short-term rates. The base case also assumes no
growth in assets and liabilities and no change in asset or liability mix. Under these simulated conditions, the base case projects net
interest income of $21.7 million for the year ending December 31, 2017.
Change in interest rates:
Graduated increase of +300 basis points
Short-term rates unchanged (base case)
Graduated decrease of -100 basis points
(Amounts in thousands)
December 31, 2017
Net Interest
Income
$ Change
% Change
$
23,035 $
21,656
21,060
1,379
6.4 %
(596 )
(2.8 )%
The level of interest rate risk indicated is within limits that management considers acceptable. However, given that interest rate
movements can be sudden and unanticipated and are increasingly influenced by global events and circumstances beyond the purview
of the Federal Reserve, no assurances can be made that interest rate movements will not impact key assumptions and parameters in a
manner not presently embodied by the model.
It is management’s opinion that hedging instruments currently available are not a cost effective means of controlling interest rate risk
for the Company. Accordingly, the Company does not currently use financial derivatives, such as interest rate options, swaps, caps,
floors or other similar instruments, but does utilize swaps to accommodate large commercial borrowers that desire longer term fixed
rates.
IMPACT OF INFLATION
Consolidated financial information included herein has been prepared in accordance with U.S. Generally Accepted Accounting
Principles, which require the Company to measure financial position and operating results in terms of historical dollars. Changes in
the relative value of money due to inflation are generally not considered. Neither the price, timing nor magnitude of changes directly
coincides with changes in interest rates.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk – Not applicable to the Company because it is a smaller
reporting company.
Item 8. Financial Statements and Supplementary Data
Consolidated Financial Statements included in this Annual Report:
Management’s Annual Report on Internal Control Over Financial Reporting ......................................................................
Report of Independent Registered Public Accounting Firm ..................................................................................................
Consolidated Balance Sheets as of December 31, 2016 and 2015 ........................................................................................
Consolidated Statements of Income for the Years Ended December 31, 2016, 2015 and 2014 ............................................
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2016, 2015 and 2014 ..................
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2016, 2015 and 2014 ......................
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014 .....................................
Notes to Consolidated Financial Statements .........................................................................................................................
48
49
50
51
52
53
54
55
47
MANAGEMENT’S ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING
Management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting as
defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. The Company’s internal control over financial reporting is designed
to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external
purposes in accordance with generally accepted accounting principles.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections
of any 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 procedures may deteriorate.
A material weakness is a significant deficiency (as defined in Public Company Accounting Oversight Board Auditing Standard No. 5),
or a combination of significant deficiencies, that results in there being more than a remote likelihood that a material misstatement of
the annual or interim financial statements will not be prevented or detected on a timely basis by management or employees in the
normal course of performing their assigned functions.
Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2016. In
making this assessment, management used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway
Commission (COSO) 2013 Internal Control-Integrated Framework. Based on this assessment, management believes that, as of
December 31, 2016, the Company’s internal control over financial reporting was effective.
This annual report does not include an attestation report of the Company’s independent registered public accounting firm regarding
internal control over financial reporting. Management’s report was not subject to attestation by the Company’s independent registered
public accounting firm pursuant to a provision of the Dodd-Frank Act which eliminates such requirements for “smaller reporting
companies” as defined by the Securities and Exchange Commission regulations.
/s/ James M. Gasior
James M. Gasior
President and Chief Executive Officer
(Principal Executive Officer)
Cortland, Ohio
March 23, 2017
/s/ David J. Lucido
David J. Lucido
Senior Vice President and Chief Financial Officer
(Principal Financial and Accounting Officer)
Cortland, Ohio
March 23, 2017
48
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
Cortland Bancorp
Cortland, Ohio
We have audited the accompanying consolidated balance sheet of Cortland Bancorp and subsidiaries as of December 31, 2016 and
2015, and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity and cash flows for
each of the three years in the period ended December 31, 2016. These financial statements are the responsibility of the Cortland
Bancorp’s management. Our responsibility is to express an opinion on these consolidated financial statements 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 audit to obtain reasonable assurance about whether the financial statements are free of
material misstatement. Cortland Bancorp is not required to have, nor were we engaged to perform an audit of its internal control over
financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of Cortland
Bancorp’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of
Cortland Bancorp and subsidiaries as of December 31, 2016 and 2015, and the results of their operations and their cash flows for each
of the three years in the period ended December 31, 2016, in conformity with U.S. generally accepted accounting principles.
/s/ S.R. Snodgrass, P.C.
S.R. Snodgrass, P.C.
Cranberry Township, Pennsylvania
March 23, 2017
49
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Amounts in thousands, except share data)
ASSETS
Cash and due from banks
Interest-earning deposits
Total cash and cash equivalents
Investment securities available-for-sale (Note 2)
Trading securities (Note 2)
Loans held for sale
Total loans (Note 3)
Less allowance for loan losses (Note 3)
Net loans
Premises and equipment
Bank-owned life insurance
Other assets
Total assets
LIABILITIES
Noninterest-bearing deposits
Interest-bearing deposits (Note 5)
Total deposits
Short-term borrowings
Federal Home Loan Bank advances - short term (Note 6)
Federal Home Loan Bank advances - long term (Note 6)
Subordinated debt (Note 7)
Other liabilities
Total liabilities
SHAREHOLDERS’ EQUITY
Common stock - $5.00 stated value - authorized 20,000,000 shares; issued 4,728,267
shares in 2016 and 2015; outstanding shares, 4,420,255 in 2016 and 4,404,783 in 2015
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock, at cost, 308,012 shares in 2016 and 323,484 shares in 2015
Total shareholders’ equity
Total liabilities and shareholders’ equity
December 31,
December 31,
2016
2015
$
$
$
$
7,021 $
8,330
15,351
179,219
—
4,554
419,768
(4,868 )
414,900
9,132
17,376
14,652
655,184 $
117,225 $
422,625
539,850
2,702
23,000
17,500
5,155
9,307
597,514
23,641
20,878
21,485
(2,961 )
(5,373 )
57,670
655,184 $
8,454
10,042
18,496
153,901
8,134
4,033
394,254
(5,194 )
389,060
9,190
17,328
12,301
612,443
108,144
388,260
496,404
2,499
17,000
25,000
5,155
9,701
555,759
23,641
20,833
17,851
(238 )
(5,403 )
56,684
612,443
See accompanying notes to consolidated financial statements
50
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Amounts in thousands, except per share data)
For the years ended December 31,
2015
2014
2016
$
18,554 $
16,909 $
16,120
INTEREST INCOME
Interest and fees on loans
Interest and dividends on investment securities:
Taxable interest
Nontaxable interest
Dividends
Other interest income
Total interest income
INTEREST EXPENSE
Deposits
Short-term borrowings
Federal Home Loan Bank advances - short term
Federal Home Loan Bank advances - long term
Subordinated debt
Total interest expense
Net interest income
PROVISION FOR LOAN LOSSES (Note 3)
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
NON-INTEREST INCOME
Fees for customer services
Investment securities available-for-sale gains, net
Trading security (losses) gains, net
Mortgage banking gains, net
Earnings on bank-owned life insurance
Wealth management income
Other non-interest income
Total non-interest income
NON-INTEREST EXPENSES
Salaries and employee benefits
Net occupancy and equipment
State and local taxes
FDIC insurance
Professional fees
Advertising and marketing
Net losses from the extinguishment of debt
Data processing fees
Other operating expenses
Total non-interest expenses
INCOME BEFORE FEDERAL INCOME TAX EXPENSE
Federal income tax expense (Note 10)
NET INCOME
EARNINGS PER SHARE BASIC AND DILUTED (Note 1)
CASH DIVIDENDS DECLARED PER SHARE
$
$
$
2,026
1,814
117
44
22,555
2,093
7
73
633
112
2,918
19,637
50
19,587
2,103
466
(47 )
1,248
328
95
404
4,597
10,169
2,151
455
251
882
527
242
250
3,259
18,186
5,998
1,127
4,871 $
1.11 $
0.28 $
2,343
1,716
126
19
21,113
1,668
4
40
804
91
2,607
18,506
455
18,051
2,019
75
(11 )
785
338
435
268
3,909
9,311
2,019
389
304
830
454
—
263
2,793
16,363
5,597
1,219
4,378 $
0.97 $
0.24 $
2,677
1,721
126
21
20,665
1,694
3
156
943
88
2,884
17,781
1,638
16,143
2,007
588
327
440
336
313
116
4,127
9,147
1,912
341
309
815
277
—
200
2,498
15,499
4,771
902
3,869
0.85
0.18
See accompanying notes to consolidated financial statements
51
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
Net income
Other comprehensive (loss) income:
Securities available for sale:
For the years ended December 31,
2016
2015
2014
$
4,871
$
4,378
$
3,869
Unrealized holding (losses) gains on available-for-sale securities
Tax effect
Reclassification adjustment for net gains realized in net income
Tax effect
Total securities available-for-sale
Change in post-retirement obligations
Total other comprehensive (loss) income
Total comprehensive income
(3,719 )
1,265
(466 )
158
(2,762 )
39
(2,723 )
2,148 $
(692 )
235
(75 )
26
(506 )
(108 )
(614 )
3,764 $
5,465
(1,858 )
(588 )
200
3,219
45
3,264
7,133
$
See accompanying notes to consolidated financial statements
52
Total
Shareholders'
Equity
Treasury
Stock
(3,553 ) $ 49,535
3,869
3,264
(816 )
55,852
4,378
(614 )
(1,082 )
—
—
—
(3,553 )
—
—
—
(2,888 ) $
—
3,264
—
376
—
(614 )
—
—
(238 )
—
(2,723 )
—
—
(2,961 ) $
(1,850 )
(5,403 )
—
—
—
30
(1,850 )
56,684
4,871
(2,723 )
(1,237 )
75
(5,373 ) $ 57,670
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(Amounts in thousands, except per share data)
Common
Stock
Additional
Paid-in
Capital
Retained
Earnings
Accumulated Other
Comprehensive (Loss)
Income
Balance at December 31, 2013
Net income
Other comprehensive income
Cash dividend declared ($0.18 per share)
Balance at December 31, 2014
Net income
Other comprehensive loss
Cash dividend declared ($0.24 per share)
Treasury shares purchased net of 1 share
reissued (123,065 shares)
Balance at December 31, 2015
Net income
Other comprehensive loss
Cash dividend declared ($0.28 per share)
Equity compensation
Balance at December 31, 2016
—
—
—
—
—
—
$ 23,641 $ 20,833 $ 11,502 $
3,869
—
(816 )
23,641 20,833 14,555
4,378
—
(1,082 )
—
—
—
—
—
—
—
—
—
23,641 20,833 17,851
4,871
—
(1,237 )
—
$ 23,641 $ 20,878 $ 21,485 $
—
—
—
45
—
—
—
—
See accompanying notes to consolidated financial statements
53
CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Net cash flow from operating activities
Net income
Adjustments to reconcile net income to net cash flow from operating activities:
For the years ended December 31,
2015
2014
2016
$
4,871 $
4,378 $
3,869
Depreciation, amortization and accretion
Provision for loan losses
Investment securities available-for-sale gains, net
Originations of mortgage banking loans held for sale
Proceeds from the sale of mortgage banking loans
Mortgage banking gains, net
Decrease (increase) in trading account
Earnings on bank-owned life insurance
Changes in:
Interest receivable
Interest payable
Deferred taxes
Federal income tax receivable
Other assets and liabilities
Net cash flow from operating activities
Cash deficit from investing activities
Purchases of available-for-sale securities
Proceeds from sale of available-for-sale securities
Proceeds from call, maturity and principal payments on available-for-sale
securities
Net increase in loans made to customers
Proceeds from sale of other real estate
Proceeds from or (purchases) of bank-owned life insurance
Purchases of premises and equipment
Net cash deficit from investing activities
Cash flow from financing activities
Net increase in deposit accounts
Net change in short-term borrowings
Net change in Federal Home Loan Bank advances - short term
Proceeds from Federal Home Loan Bank advances - long term
Repayments of Federal Home Loan Bank advances - long term
Dividends paid
Treasury shares purchased
Net cash flow from financing activities
Net change in cash and cash equivalents
Cash and cash equivalents
Beginning of period
End of period
Supplemental disclosures:
Cash paid during the period for:
Income taxes
Interest
Transfer of loans to other real estate owned
$
$
$
$
2,770
50
(466 )
(61,003 )
61,730
(1,248 )
8,134
(328 )
(401 )
33
(129 )
281
(1,049 )
13,245
(103,032 )
50,862
21,203
(25,937 )
121
280
(799 )
(57,302 )
43,446
203
6,000
2,000
(9,500 )
(1,237 )
—
40,912
(3,145 )
2,534
455
(75 )
(39,191 )
36,575
(785 )
(273 )
(338 )
83
7
303
(260 )
(2,026 )
1,387
(29,055 )
12,291
23,708
(34,594 )
41
—
(2,302 )
(29,911 )
39,643
(1,760 )
1,500
4,000
(4,000 )
(1,082 )
(1,850 )
36,451
7,927
18,496
15,351
$
10,569
18,496
$
2,465
1,638
(588 )
(18,443 )
18,907
(440 )
(614 )
(336 )
(48 )
(42 )
451
982
(595 )
7,206
(52,515 )
32,733
22,137
(13,649 )
99
(1,605 )
(1,864 )
(14,664 )
8,092
455
7,400
3,000
(12,500 )
(816 )
—
5,631
(1,827 )
12,396
10,569
625 $
2,886 $
47 $
1,010 $
2,600 $
62 $
320
2,926
97
See accompanying notes to consolidated financial statements
54
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
The accounting and financial reporting policies of Cortland Bancorp (the Company), and its bank subsidiary, The Cortland Savings
and Banking Company (the Bank), 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 the Company and its wholly-owned
subsidiaries, the Bank, CSB Mortgage Company, Inc. 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 the 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. Based on the analysis performed by the Company, management has determined that the Company only
has one operating segment, which is commercial banking. The chief operating decision-makers use consolidated results to make
operating and strategic decisions, and therefore are not required to disclose any additional segment information.
Use of Estimates: The preparation of financial statements in conformity with U.S. 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 of the Consolidated Balance Sheet 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 and amounts due from banks, both interest and non-interest bearing, but
excludes the liquid portion of the securities trading account. The Company reports net cash flows for customer loan transactions,
deposit transactions and deposits made with other financial institutions.
Investment Securities: Investments in debt and equity securities are classified as held-to-maturity, available-for-sale or trading.
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 classified as trading are those that management has bought principally for
the purpose of selling in the near term. The Company currently has no securities classified as held-to-maturity or trading.
Available-for-sale securities, other than regulatory stock, are carried at fair value with unrealized gains and losses recorded as a
separate component of shareholders’ equity, net of tax. 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 income includes amortization of purchase
premium or discount and is amortized on the level-yield method without anticipating payments, except for U.S. Government
mortgage-backed and related securities where twelve months of historical prepayments are taken into consideration. Trading securities
are carried at fair value with valuation adjustments included in non-interest income.
The regulatory stock is carried at cost (its redeemable value) and the Company is required to hold such investments as a condition of
membership in order to transact business with the Federal Home Loan Bank (FHLB) of Cincinnati and the Federal Reserve Bank
(FRB). The stock is bought from and sold based upon its par value. The stock cannot be traded or sold in any market and as such is
classified as restricted stock, carried at cost (its redeemable value) and evaluated by management. The stock’s value is determined by
the ultimate recoverability of the par value rather than by recognizing temporary declines. The determination of whether the par value
will ultimately be recovered is influenced by criteria such as the following: (a) the significance of the decline in net assets of the
FHLB and FRB as compared to the capital stock amount and the length of time this situation has persisted, (b) commitments by the
FHLB and FRB to make payments required by law or regulation and the level of such payments in relation to the operating
performance, (c) the impact of legislative and regulatory changes on the customer base of the FHLB and FRB and (d) the liquidity
position of the FHLB and FRB. The Company does not consider these investments to be other-than-temporarily impaired at December
31, 2016.
Other-than-Temporary Investment Security Impairment: Securities are evaluated periodically to determine whether a decline in value
is other-than-temporary. Management utilizes criteria such as the magnitude and duration of the decline, along with the reasons
underlying the decline, to determine whether the loss in value is other-than-temporary. The term “other-than-temporary” is not
intended to indicate that the decline in value is permanent, but indicates that the prospect for a near-term recovery of value is not
necessarily favorable and that there is a lack of evidence to support a realizable value equal to or greater than the carrying value of the
investment. Unrealized losses on available-for-sale investments have not been recognized into income. However, once a decline in
value is determined to be other-than-temporary, the credit related other-than-temporary impairment (OTTI) is recognized in earnings
55
while the non-credit related OTTI on securities not expected to be sold is recognized in other comprehensive income (loss).
Unrealized losses on trading securities are recognized in the Consolidated Statements of Income.
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 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
accrual of interest is discontinued on a loan when management determines that the collection of interest is doubtful. Generally, a loan
is placed on non-accrual status once the borrower is 90 days past due on payments, or whenever sufficient information is received to
question the collectability of the loan or any time legal proceedings are initiated involving a loan. Interest income accrued up to the
date a loan is placed on non-accrual is reversed through interest income. Cash payments received while a loan is classified as non-
accrual are recorded as a reduction to principal or reported as interest income according to management’s judgment as to the
collectability of principal. A loan is returned to accrual status when either all of the principal and interest amounts contractually due
are brought current and future payments are, in management’s judgment, 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.
The same treatment is applied to impaired loans, which means that it is probable that all amounts will not be collected according to the
contractual terms of the loan agreement.
Loans Held for Sale: The Company originates certain residential mortgage loans for sale in the secondary mortgage loan market. The
Company concurrently sells the rights to service the related loans. These loans are classified as loans held for sale, and carried at the
estimated fair value based on secondary market prices. Adjustments to the fair value of loans held for sale are included in “mortgage
banking gains” in the Consolidated Statements of Income. Deferred fees and costs related to loans held for sale are not amortized, but
included in the cost basis at the time of sale.
Allowance for Loan Losses (ALLL) and Allowance for Losses on Lending Related Commitments: Management establishes the
allowance for loan losses based upon its evaluation of the pertinent factors underlying the types and quality of loans in the portfolio.
Commercial loans and commercial real estate loans are reviewed on a regular basis with a focus on larger loans, along with loans
which have experienced past payment or financial deficiencies. Larger commercial loans and commercial real estate loans are
evaluated for impairment in accordance with the Bank’s loan review policy. These loans are analyzed to determine if they are
impaired. All loans that are delinquent 90 days and are placed on non-accrual status are evaluated on an individual basis. Allowances
for loan losses on impaired loans are determined using the estimated future cash flows of the loan, discounted to their present value
using the loan’s effective interest rate, or in most cases, the estimated fair value of the underlying collateral. If the analysis indicates a
collection shortfall, a specific reserve is allocated to loans on an individual basis which are reviewed for impairment. The remaining
loans are evaluated and classified as groups of loans with similar risk characteristics.
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. Estimates of credit losses should
reflect consideration of all significant factors that affect collectability of the portfolio. While historical loss experience provides a
reasonable starting point, historical losses, or even recent trends in losses are not, by themselves, a sufficient basis to determine the
appropriate level for the ALLL. Management will also consider any factors that are likely to cause estimated credit losses associated
with the Bank’s current portfolio to differ from historical loss experience. Factors include, but are not limited to, changes in lending
policies and procedures, including underwriting standards and collection, charge-offs, and recovery practices; changes in economic
trends; changes in the nature and volume of the portfolio; changes in the experience and ability of lending management and the depth
of staff; changes in the trend, volume and severity of past-due and classified loans, and trends in the volume of non-accrual loans; the
existence and effect of any concentrations of credit and changes in the level of such concentrations; levels and trends in classification;
declining trends in performance; structure and lack of performance measures and migration between risk classifications.
Key risk factors and assumptions are updated to reflect actual experience and changing circumstances. While management may
periodically allocate portions of the ALLL for specific problem loans, the entire ALLL is available for any charge-offs that occur.
Certain collateral dependent loans are evaluated individually for impairment, based on management’s best estimate of discounted cash
repayments and the anticipated proceeds from liquidating collateral. The actual timing and amount of repayments and the ultimate
realizable value of the collateral may differ from management’s estimates.
The expected loss for certain other commercial credits utilizes internal risk ratings. These loss estimates are sensitive to changes in the
customer’s risk profile, the realizable value of collateral, other risk factors and the related loss experience of other credits of similar
risk. Consumer credits generally employ statistical loss factors, adjusted for other risk indicators, applied to pools of similar loans
stratified by asset type. These loss estimates are sensitive to changes in delinquency status and shifts in the aggregate risk profile.
56
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 Consolidated Balance Sheets within other liabilities, while the corresponding
provision for these losses is recorded as a component of other operating expense.
Loan Charge-off Policies: Consumer loans are generally fully or partially charged down to the fair value of collateral securing the
asset prior to the loan becoming 180 days past due, unless the loan is well secured and in the process of collection. All other loans are
generally charged down to the net realizable value when the loan is 90 days past due.
Troubled Debt Restructurings (TDR): A loan is classified as a TDR when management grants a concession for other than an
insignificant period of time to the borrower that would not otherwise be considered, except in situations of economic difficulties.
Management strives to identify borrowers in financial difficulty early and work with them to modify to more affordable terms before
their loan reaches non-accrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance
and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where
borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on
the restructuring as noted above for impaired loans. In addition to the allowance for the pooled portfolios, management has developed
a separate allowance for loans that are identified as impaired through a TDR. These loans are excluded from pooled loss forecasts and
a separate reserve is provided under the accounting guidance for loan impairment.
Premises and Equipment: Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation.
Depreciation is computed generally on the straight-line method over the estimated useful lives (5 to 40 years) 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 on the
Consolidated Balance Sheets. Such real estate is carried at 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 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.
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 of the policies, as well as its share of insurance
proceeds received, are recorded in noninterest income, and are not subject to income taxes. The cash surrender value of the policies is
included on the Consolidated Balance Sheets. 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 I Capital. The
Company has purchased BOLI to provide a long-term asset to offset long-term benefit liabilities, while generating competitive
investment yields.
Endorsement Split-Dollar Life Insurance Arrangement: The Company maintains a liability for the death benefit promised under split-
dollar life insurance arrangements.
Derivative Instruments and Hedging Activities: To mitigate interest rate risk associated with commitments made to borrowers for
mortgage loans that have not yet closed and that are intended for sale in the secondary markets, the Company may enter into
commitments to sell loans or mortgage-backed securities, considered to be derivatives, to limit exposure to potential movements in
market interest rates. The Company also enters into contracts for the future delivery of residential mortgage loans when interest rate
locks are entered into in order to economically hedge potential adverse effects of changes in interest rates. These contracts are also
derivative instruments. All derivative instruments are recognized as either other assets or other liabilities at fair value in the
Consolidated Balance Sheets. Gains or losses are recorded as part of mortgage banking gains on the Consolidated Statements of
Income.
Advertising and Marketing: The Company expenses advertising and marketing costs as incurred.
Income Taxes: A deferred tax liability or asset is determined at each balance sheet date. It is measured by applying currently enacted
tax laws to future amounts that result from differences in the financial statement and tax bases of assets and liabilities.
Other Comprehensive (Loss) Income: Accumulated other comprehensive (loss) income for the Company is comprised of unrealized
holding (losses) gains on available-for-sale securities, net of tax, and post-retirement obligations.
57
Per Share Amounts: Earnings per share is computed by dividing net income available to common shareholders by the weighted
average number of shares of common outstanding stock, net of any treasury shares, during the period. Diluted earnings per share is
calculated by dividing net income available to common shareholders by the weighted average number of shares of common stock
outstanding, net of any treasury shares, after consideration of the potential dilutive effect of common stock equivalents, based upon the
treasury stock method using an average market price for the period. The common stock equivalents are comprised of the restricted
share awards.
The following table sets forth the computation of basic earnings per common share:
Net income (amounts in thousands)
Weighted average common shares outstanding
Net effect of dilutive common share equivalents
Adjusted average shares outstanding - dilutive
Basic earnings per share
Dilutive earnings per share
Years ended December 31,
2016
2015
4,871 $
4,406,005
1,264
4,407,269
4,378 $
4,497,825
—
4,497,825
2014
3,869
4,527,848
—
4,527,848
1.11 $
1.11 $
0.97 $
0.97 $
0.85
0.85
$
$
$
Off-Balance Sheet Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to
make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the
exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are
funded.
Reclassifications: Certain items in the financial statements for 2015 and 2014 have been reclassified to conform to the 2016
presentation. Such reclassifications did not affect net income or shareholders’ equity.
Authoritative Accounting Guidance:
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (a new revenue recognition standard). The
Update’s core principle is that a company will recognize revenue to depict the transfer of goods or services to customers in an amount
that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. In addition, this
Update specifies the accounting for certain costs to obtain or fulfill a contract with a customer and expands disclosure requirements for
revenue recognition. This Update is effective for annual reporting periods beginning after December 15, 2016, including interim
periods within that reporting period. The Company is currently evaluating the impact the adoption of the standard will have on the
Company’s financial position or results of operations. In August 2015, the FASB issued ASU 2015-14, Revenue from Contracts with
Customers (Topic 606). The amendments in this Update defer the effective date of ASU 2014-09 for all entities by one year. Public
business entities, certain not-for-profit entities, and certain employee benefit plans should apply the guidance in ASU 2014-09 to
annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. All
other entities should apply the guidance in ASU 2014-09 to annual reporting periods beginning after December 15, 2018, and interim
reporting periods within annual reporting periods beginning after December 15, 2019. This Update is not expected to have a
significant impact on the Company’s financial statements.
In September 2015, the FASB issued ASU 2015-16, Business Combinations (Topic 805). The amendments in this Update require that
an acquirer recognizes adjustments to provisional amounts that are identified during the measurement period in the reporting period in
which the adjustment amounts are determined. The amendments in this Update require that the acquirer record, in the same period's
financial statements, the effect on earnings of changes in depreciation, amortization, or other income effects, if any, as a result of the
change to the provisional amounts, calculated as if the accounting had been completed at the acquisition date. The amendments in this
Update require an entity to present separately on the face of the income statement or disclose in the notes the portion of the amount
recorded in current-period earnings by line item that would have been recorded in previous reporting periods if the adjustment to the
provisional amounts had been recognized as of the acquisition date. For public business entities, the amendments in this Update are
effective for fiscal years beginning after December 15, 2015, including interim periods within those fiscal years. For all other entities,
the amendments in this Update are effective for fiscal years beginning after December 15, 2016, and interim periods within fiscal
years beginning after December 15, 2017. This Update is not expected to have a significant impact on the Company’s financial
statements.
58
In January 2016, the FASB issued ASU 2016-01, Financial Instruments – Overall (Subtopic 825-10): Recognition and Measurement
of Financial Assets and Financial Liabilities. This Update applies to all entities that hold financial assets or owe financial liabilities
and is intended to provide more useful information on the recognition, measurement, presentation, and disclosure of financial
instruments. Among other things, this Update (a) requires equity investments (except those accounted for under the equity method of
accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in
net income; (b) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a
qualitative assessment to identify impairment; (c) eliminates the requirement to disclose the fair value of financial instruments
measured at amortized cost for entities that are not public business entities; (d) eliminates the requirement for public business entities
to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial
instruments measured at amortized cost on the balance sheet; (e) requires public business entities to use the exit price notion when
measuring the fair value of financial instruments for disclosure purposes; (f) requires an entity to present separately in other
comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific
credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial
instruments; (g) requires separate presentation of financial assets and financial liabilities by measurement category and form of
financial asset (that is, securities or loans and receivables) on the balance sheet or the accompanying notes to the financial statements;
and (h) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale
securities in combination with the entity’s other deferred tax assets. For public business entities, the amendments in this Update are
effective for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. For all other entities
including not-for-profit entities and employee benefit plans within the scope of Topics 960 through 965 on plan accounting, the
amendments in this Update are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years
beginning after December 15, 2019. All entities that are not public business entities may adopt the amendments in this Update earlier
as of the fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The Company is
currently evaluating the impact the adoption of the standard will have the Company’s financial position or results of operations.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The standard requires lessees to recognize the assets and
liabilities that arise from leases on the balance sheet. A lessee should recognize in the statement of financial position a liability to
make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. A
short-term lease is defined as one in which (a) the lease term is 12 months or less and (b) there is not an option to purchase the
underlying asset that the lessee is reasonably certain to exercise. For short-term leases, lessees may elect to recognize lease payments
over the lease term on a straight-line basis. For public business entities, the amendments in this Update are effective for fiscal years
beginning after December 15, 2018, and interim periods within those years. For all other entities, the amendments in this Update are
effective for fiscal years beginning after December 15, 2019, and for interim periods within fiscal years beginning after
December 15, 2020. The amendments should be applied at the beginning of the earliest period presented using a modified
retrospective approach with earlier application permitted as of the beginning of an interim or annual reporting period. This Update is
not expected to have a significant impact on the Company’s financial statements.
In March 2016, the FASB issued ASU 2016-05, Derivatives and Hedging (Topic 815). The amendments in this Update apply to all
reporting entities for which there is a change in the counterparty to a derivative instrument that has been designated as a hedging
instrument under Topic 815. The standards in this Update clarify that a change in the counterparty to a derivative instrument that has
been designated as the hedging instrument under Topic 815 does not, in and of itself, require designation of that hedging relationship
provided that all other hedge accounting criteria continue to be met. For public business entities, the amendments in this Update are
effective for financial statements issued for fiscal years beginning after December 15, 2016, and interim periods within those fiscal
years. For all other entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after
December 15, 2017, and interim periods within fiscal years beginning after December 15, 2018. An entity has an option to apply the
amendments in this Update on either a prospective basis or a modified retrospective basis. Early adoption is permitted, including
adoption in an interim period. This Update is not expected to have a significant impact on the Company’s financial statements.
In March 2016, the FASB issued ASU 2016-06, Derivatives and Hedging (Topic 815). The amendments apply to all entities that are
issuers of or investors in debt instruments (or hybrid financial instruments that are determined to have a debt host) with embedded call
(put) options. The amendments in this Update clarify the requirements for assessing whether contingent call (put) options that can
accelerate the payment of principal on debt instruments are clearly and closely related to their debt host. An entity performing the
assessment under the amendments in this Update is required to assess the embedded call (put) options solely in accordance with the
four-step decision sequence. For public business entities, the amendments in this Update are effective for financial statements issued
for fiscal years beginning after December 15, 2016, and interim periods within those fiscal years. For entities other than public
business entities, the amendments in this Update are effective for financial statements issued for fiscal years beginning after December
15, 2017, and interim periods within fiscal years beginning after December 15, 2018. Early adoption is permitted, including adoption
in an interim period. This Update is not expected to have a significant impact on the Company’s financial statements.
59
In March 2016, the FASB issued ASU 2016-09, Compensation – Stock Compensation (Topic 718). The amendments in this Update
affect all entities that issue share-based payment awards to their employees. The standards in this Update provide simplification for
several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of
awards as with equity or liabilities, and classification on the statement of cash flows. Some of the areas for simplification apply only to
nonpublic entities. In addition to those simplifications, the amendments eliminate the guidance in Topic 718 that was indefinitely
deferred shortly after the issuance of FASB Statement No. 123 (revised 2004), Share-Based Payment. This should not result in a
change in practice because the guidance that is being superseded was never effective. For public business entities, the amendments in
this Update are effective for annual periods beginning after December 15, 2016, and interim periods within those annual periods. For
all other entities, the amendments are effective for annual periods beginning after December 15, 2017, and interim periods within
annual periods beginning after December 15, 2018. Early adoption is permitted for any entity in any interim or annual period. This
Update is not expected to have a significant impact on the Company’s financial statements.
In May 2016, the FASB issued ASU 2016-11, Revenue Recognition (Topic 605) and Derivative and Hedging (Topic 815), which
rescinds SEC paragraphs pursuant to two SEC Staff Announcements at the March 3, 2016, Emerging Issues Task Force meeting. This
Update did not have a significant impact on the Company’s financial statements
In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses: Measurement of Credit Losses on Financial
Instruments (“ASU 2016-13”), which changes the impairment model for most financial assets. This Update is intended to improve
financial reporting by requiring timelier recording of credit losses on loans and other financial instruments held by financial
institutions and other organizations. The underlying premise of the Update is that financial assets measured at amortized cost should
be presented at the net amount expected to be collected, through an allowance for credit losses that is deducted from the amortized
cost basis. The allowance for credit losses should reflect management’s current estimate of credit losses that are expected to occur
over the remaining life of a financial asset. The income statement will be effected for the measurement of credit losses for newly
recognized financial assets, as well as the expected increases or decreases of expected credit losses that have taken place during the
period. ASU 2016-13 is effective for annual and interim periods beginning after December 15, 2019, and early adoption is permitted
for annual and interim periods beginning after December 15, 2018. With certain exceptions, transition to the new requirements will be
through a cumulative effect adjustment to opening retained earnings as of the beginning of the first reporting period in which the
guidance is adopted. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s
financial position or results of operations. We expect to recognize a one-time cumulative effect adjustment to the allowance for loan
losses as of the beginning of the first reporting period in which the new standard is effective, but cannot yet determine the magnitude
of any such one-time adjustment or the overall impact of the new guidance on the consolidated financial statements.
In August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and
Cash Payments (“ASU 2016-15”), which addresses eight specific cash flow issues with the objective of reducing diversity in practice.
Among these include recognizing cash payments for debt prepayment or debt extinguishment as cash outflows for financing activities;
cash proceeds received from the settlement of insurance claims should be classified on the basis of the related insurance coverage; and
cash proceeds received from the settlement of bank-owned life insurance policies should be classified as cash inflows from investing
activities while the cash payments for premiums on bank-owned policies may be classified as cash outflows for investing activities,
operating activities, or a combination of investing and operating activities. The amendments in this Update are effective for public
business entities for fiscal years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities,
the amendments are effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning
after December 15, 2019. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the
amendments in an interim period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim
period. An entity that elects early adoption must adopt all of the amendments in the same period. The amendments in this Update
should be applied using a retrospective transition method to each period presented. If it is impracticable to apply the amendments
retrospectively for some of the issues, the amendments for those issues would be applied prospectively as of the earliest date
practicable. The Company is currently evaluating the impact the adoption of the standard will have on the Company’s statement of
cash flows.
In October 2016, the FASB issued ASU 2016-18, Statement of Cash Flows (Topic 230) (“ASU 2016-18”), which requires that a
statement of cash flows explains the change during the period in the total of cash, cash equivalents, and amounts generally described
as restricted cash or restricted cash equivalents. Therefore, amounts generally described as restricted cash and restricted cash
equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total
amounts shown on the statement of cash flows. The amendments in this Update are effective for public business entities for fiscal
years beginning after December 15, 2017, and interim periods within those fiscal years. For all other entities, the amendments are
effective for fiscal years beginning after December 15, 2018, and interim periods within fiscal years beginning after December 15,
2019. Early adoption is permitted, including adoption in an interim period. If an entity early adopts the amendments in an interim
period, any adjustments should be reflected as of the beginning of the fiscal year that includes that interim period. The amendments in
60
this Update should be applied using a retrospective transition method to each period presented. The Company is currently evaluating
the impact the adoption of the standard will have on the Company’s statement of cash flows.
In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805), Clarifying the Definition of a Business “ASU
2017-01”, which provides a more robust framework to use in determining when a set of assets and activities (collectively referred to as
a “set”) is a business. The screen requires that when substantially all of the fair value of the gross assets acquired (or disposed of) is
concentrated in a single identifiable asset or a group of similar identifiable assets, the set is not a business. This screen reduces the
number of transactions that need to be further evaluated. Public business entities should apply the amendments in this Update to
annual periods beginning after December 15, 2017, including interim periods within those periods. All other entities should apply the
amendments to annual periods beginning after December 15, 2018, and interim periods within annual periods beginning after
December 15, 2019. The amendments in this Update should be applied prospectively on or after the effective date. This Update is not
expected to have a significant impact on the Company’s financial statements.
In January 2017, the FASB issued ASU 2017-03, Accounting Changes and Error Corrections (Topic 250) and Investments—Equity
Method and Joint Ventures (Topic 323), Amendments to SEC Paragraphs Pursuant to Staff Announcements at the September 22, 2016
and November 17, 2016 EITF Meetings. This ASU adds an SEC paragraph to the Codification following an SEC Staff Announcement
about applying Staff Accounting Bulletin (SAB) Topic 11.M. Specifically this announcement applies to ASU No. 2014- 09, Revenue
from Contracts with Customers (Topic 606); ASU No. 2016-02, Leases (Topic 842); and ASU No. 2016-13, Financial Instruments—
Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. A registrant should evaluate ASUs that have not
yet been adopted to determine the appropriate financial statement disclosures about the potential material effects of those ASUs on the
financial statements when adopted. If a registrant does not know or cannot reasonably estimate the impact that adoption of the ASUs
referenced in this announcement are expected to have on the financial statements, then in addition to making a statement to that effect,
that registrant should consider additional qualitative financial statement disclosures to assist the reader in assessing the significance of
the impact that the standard will have on the financial statements of the registrant when adopted. In this regard, the SEC staff expects
the additional qualitative disclosures to include a description of the effect of the accounting policies that the registrant expects to apply,
if determined, and a comparison to the registrant’s current accounting policies. Also, a registrant should describe the status of its
process to implement the new standards and the significant implementation matters yet to be addressed. The amendments in this
Update are effective immediately.
61
NOTE 2 - INVESTMENT SECURITIES
The following is a summary of investment securities available-for-sale:
December 31, 2016
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed securities
U.S. Government-sponsored collateralized mortgage obligations
U.S. Government-guaranteed small business administration pools
Trust preferred securities
Total debt securities
Federal Home Loan Bank (FHLB) stock
Federal Reserve Bank (FRB) stock
Total regulatory stock
Total investment securities available-for-sale
$
December 31, 2015
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed securities
U.S. Government-sponsored collateralized mortgage obligations
U.S. Government-guaranteed small business administration pools
Trust preferred securities
Total debt securities
Federal Home Loan Bank (FHLB) stock
Federal Reserve Bank (FRB) stock
Total regulatory stock
Total investment securities available-for-sale
$
(Amounts in thousands)
Gross
Unrealized
Gains
Gross
Unrealized
Losses
3 $
582
32
—
1
—
618
—
—
—
618 $
180 $
2,031
1,546
155
317
795
5,024
—
—
—
5,024 $
(Amounts in thousands)
Gross
Unrealized
Gains
Gross
Unrealized
Losses
136 $
1,386
165
—
—
—
1,687
—
—
—
1,687 $
68 $
120
679
135
46
862
1,910
—
—
—
1,910 $
Fair Value
7,988
66,770
79,767
9,349
11,939
825
176,638
2,355
226
2,581
179,219
Fair Value
12,623
51,405
69,679
13,530
2,837
778
150,852
2,823
226
3,049
153,901
Amortized Cost
$
8,165 $
68,219
81,281
9,504
12,255
1,620
181,044
2,355
226
2,581
183,625 $
Amortized Cost
$
12,555 $
50,139
70,193
13,665
2,883
1,640
151,075
2,823
226
3,049
154,124 $
Trading securities historically have been an investment in obligations of states and political subdivisions, government and agency
bonds, short-term government bonds and included cash equivalent investments for trading liquidity. In the second quarter,
management decided to cease its trading activities and liquidated the investments that were in the trading account. The current interest
rate and economic environment mitigated the opportunities to generate revenues with a trading strategy. At December 31, 2016, there
were no trading securities and at December 31, 2015 trading securities were $8.1 million. Both realized and unrealized gains and
losses are included in the Consolidated Statements of Income.
Unrealized gains
Unrealized losses
Net unrealized gains
Net realized (losses) gains
Trading securities (losses) gains, net
2016
2015
2014
(Amounts in thousands)
$
$
— $
—
—
(47 )
(47 ) $
7 $
(3 )
4
(15 )
(11 ) $
39
(4 )
35
292
327
62
The amortized cost and fair value of debt securities at December 31, 2016, 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.
Due in one year or less
Due after one year through five years
Due after five years through ten years
Due after ten years
Total
U.S. Government-sponsored mortgage-backed and related securities
Total debt securities
(Amounts in thousands)
Amortized Cost
Fair Value
$
$
— $
1,360
18,457
70,442
90,259
90,785
181,044 $
—
1,391
18,530
67,601
87,522
89,116
176,638
The following table sets forth the proceeds, gains and losses realized on securities sold or called for each of the years ended
December 31:
Proceeds on securities sold
Gross realized gains
Gross realized losses
2016
(Amounts in thousands)
2015
2014
$
50,862 $
725
259
12,291 $
135
60
32,733
1,170
582
Investment securities with a carrying value of approximately $111.5 million at December 31, 2016 and $108.2 million at
December 31, 2015 were pledged to secure deposits and for other purposes. The remaining securities provide an adequate level of
liquidity.
The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at
December 31, 2016:
Less than 12 Months
(Amounts in thousands)
12 Months or More
Total
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed
securities
U.S. Government-sponsored collateralized
mortgage obligations
U.S. Government-guaranteed small business
administration pools
Trust preferred securities
Total
Fair Value
$
7,643 $
41,668
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
180 $
2,031
— $
—
— $
—
7,643 $
41,668
180
2,031
68,386
1,487
2,044
59
70,430
1,546
9,350
155
—
—
9,350
155
8,757
—
$ 135,804 $
317
—
4,170 $
—
825
2,869 $
8,757
—
795
825
854 $ 138,673 $
317
795
5,024
The above table represents 122 investment securities where the fair value is less than the related amortized cost.
63
The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at
December 31, 2015:
Less than 12 Months
(Amounts in thousands)
12 Months or More
Total
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed
securities
U.S. Government-sponsored collateralized
mortgage obligations
U.S. Government-guaranteed small business
administration pools
Trust preferred securities
Total
Fair Value
$
1,974 $
5,439
Unrealized
Losses
Fair Value
Unrealized
Losses
Fair Value
Unrealized
Losses
25 $
61
1,947 $
2,125
43 $
59
3,921 $
7,564
68
120
35,081
315
16,575
364
51,656
679
13,530
135
—
—
13,530
135
2,837
—
$ 58,861 $
46
—
—
778
582 $ 21,425 $
—
862
2,837
778
1,328 $ 80,286 $
46
862
1,910
The above table represents 34 investment securities where the current value is less than the related amortized cost.
The trust preferred securities with an unrealized loss represent pools of trust preferred debt issued primarily by bank holding
companies. The unrealized losses on the Company’s investment in U.S. Government agencies and corporations, obligations of states
and political subdivisions, U.S. Government-sponsored-mortgage-backed securities, U.S. Government-sponsored collateralized
mortgage obligations, and U.S. Government-guaranteed small business administration pools were caused by changes in market rates
and related spreads. The significant increase in unrealized losses in 2016 is a direct result of the spike in interest rates immediately
following the election results. It is expected that the securities would not be settled at less than the amortized cost of the Company’s
investment because the decline in fair value is attributable to changes in interest rates and relative spreads and not credit quality. Also,
except for the securities described below, the Company does not intend to sell those investments and it is not more-likely-than-not that
the Company will be required to sell the investments before recovery of its amortized cost basis less any current period credit loss.
The Company does not consider these investments to be other-than-temporarily impaired at December 31, 2016.
Securities Deemed to be Other-Than-Temporarily Impaired
The Company reviews investment debt securities on an ongoing basis for the presence of other-than-temporary impairment (OTTI)
with formal reviews performed quarterly.
For debt securities in an unrealized loss position, management assesses whether (a) it has the intent to sell the debt security or (b) it is
more-likely-than-not that it will be required to sell the debt security before its anticipated recovery. If either of these conditions is met,
an OTTI on the security must be recognized.
In instances in which a determination is made that a credit loss (defined as the difference between the present value of the cash flows
expected to be collected and the amortized cost basis) exists but the entity does not intend to sell the debt security and it is not more-
likely-than-not that the entity will be required to sell the debt security before the anticipated recovery of its remaining amortized cost
basis (i.e., the amortized cost basis less any current-period credit loss), the Company presents the amount of the OTTI recognized in
the Consolidated Statements of Income.
In these instances, the impairment is separated into (a) the amount of the total impairment related to the credit loss, and (b) the amount
of the total impairment related to all other factors. The amount of the total OTTI related to the credit loss is recognized in earnings.
The amount of the total impairment related to all other factors is recognized in other comprehensive income. The total other-than-
temporary impairment is presented in the Consolidated Statements of Income with an offset for the amount of the total other-than-
temporary impairment that is recognized in other comprehensive income.
As more fully disclosed in Note 11, the Company assessed the impairment of certain securities currently in an illiquid market. The
Company records impairment credit losses in earnings (before tax) and non-credit impairment losses in other comprehensive (loss)
income (before tax). Through the impairment assessment process, there was no impairment loss recognized in the years ended
December 31, 2016, 2015 or 2014.
64
The following provides a cumulative roll forward of credit losses recognized in earnings for trust preferred securities held for the years
ended:
Beginning balance
Reduction for debt securities for which other-than-temporary impairment has
been previously recognized and there is no related other comprehensive
income
Credit losses on debt securities for which other-than-temporary impairment
has not been previously recognized
Additional credit losses on debt securities for which other-than-temporary
impairment was previously recognized
Sale of debt securities
Ending balance
(Amounts in thousands)
December 31,
2015
2014
2016
$
140 $
140 $
2,305
—
—
—
—
—
—
$
140 $
140 $
—
—
—
(2,165 )
140
In January 2014, the Company determined that its portfolio of insurance trust preferred collateralized debt obligations, commonly
known as iTruPS securities, were considered disallowed investments under the final rule implementing Section 619 of the Dodd-Frank
Wall Street Reform and Consumer Protection Act, commonly referred to as the Volcker Rule, which was originally released jointly by
five regulatory agencies on December 10, 2013, and further clarified with the release of the Interim Final Rule on January 14, 2014.
The final rule requires banking entities to divest disallowed securities by July 21, 2015, unless, upon application, the Federal Reserve
grants extensions to July 21, 2017.
With the release of the Interim Final Rule on January 14, 2014, the joint agencies granted relief by permitting financial institutions to
retain their interests in certain collateralized debt obligations, but limited that provision to those collateralized by issuances prior to
May 2010 from bank or thrift holding companies with less than $15 billion in consolidated assets. The Interim Final Rule did not
contain a provision for issuances by insurance companies, which comprises the various iTruPS securities owned by the Company.
The disallowed iTruPS consisted of nine positions with an amortized cost of $10.5 million at December 31, 2013. Because the
Company could no longer hold the securities until their anticipated recovery, an OTTI had to be recognized for the entire amount of
unrealized loss as of December 31, 2013. The fair value of the iTruPS as determined by the discounted cash flow model used by the
Company aggregated to $8.5 million. The resulting OTTI charge of approximately $2.0 million was included in the Consolidated
Statements of Income in 2013. In February 2014, the Company completed the sale of all nine of the disallowed investments.
At December 31, 2016 and December 31, 2015, there were $825,000 and $778,000, respectively, of investment securities considered
to be in non-accrual status. This balance is comprised of two trust preferred securities at December 31, 2016. As a result of the delay
in the collection of interest payments, management placed these securities in non-accrual status. Current estimates indicate that the
interest payment delays may exceed ten years.
65
NOTE 3 - LOANS AND ALLOWANCE FOR LOAN LOSSES
The Company, through the Bank, grants residential, consumer and commercial loans to customers located primarily in Northeastern
Ohio and Western Pennsylvania.
The following represents the composition of the loan portfolio for the period ending:
Commercial
Commercial real estate
Residential real estate
Consumer - home equity
Consumer - other
Total loans
(Amounts in thousands)
December 31,
2016
2015
Balance
%
Balance
%
$
$
96,281
238,692
57,008
25,061
2,726
419,768
22.9 $
56.9
13.6
6.0
0.6
$
84,613
237,137
45,414
23,334
3,756
394,254
21.5
60.1
11.5
5.9
1.0
Management has an established methodology to determine the adequacy of the allowance for loan losses that assesses the risks and
losses inherent in the loan portfolio. For purposes of determining the allowance for loan losses, the Company has segmented loans in
the portfolio by product type. Loans are segmented into the following pools: commercial loans, commercial real estate loans,
residential real estate loans and consumer loans. The Company also sub-segments the consumer loan portfolio into the following two
classes: home equity loans and other consumer loans. Historical loss percentages for each risk category are calculated and used as the
basis for calculating allowance allocations. These historical loss percentages are calculated over multiple periods for all portfolio
segments. Management evaluates these results and utilizes the most reflective period in the calculation. Certain qualitative factors are
then added to the historical allocation percentage to get the adjusted factor.
These factors include, but are not limited to, the following:
Factor Considered:
Levels of and trends in charge-offs, classifications and non-accruals
Trends in volume and terms
Changes in lending policies and procedures
Experience, depth and ability of management, including loan review function
Economic trends, including valuation of underlying collateral
Concentrations of credit
Risk Trend:
Stable
Stable
Stable
Increasing
Stable
Stable
The following factors are analyzed and applied to loans internally graded with higher risk credit in addition to the above factors for
non-classified loans:
Factor Considered:
Levels and trends in classification
Declining trends in financial performance
Structure and lack of performance measures
Migration between risk categories
Risk Trend:
Increasing
Stable
Stable
Stable
The provision charged to operations can be allocated to a loan classification either as a positive or negative value as a result of any
material changes to: net charge-offs or recovery which influence the historical allocation percentage, qualitative risk factors or loan
balances.
66
The following is an analysis of changes in the allowance for loan losses for the periods ended:
December 31, 2016
Balance at beginning of period
Loan charge-offs
Recoveries
Net loan recoveries (charge-offs)
Provision charged to operations
Balance at end of period
December 31, 2015
Balance at beginning of period
Loan charge-offs
Recoveries
Net loan recoveries (charge-offs)
Provision charged to operations
Balance at end of period
December 31, 2014
Balance at beginning of period
Loan charge-offs
Recoveries
Net loan recoveries (charge-offs)
Provision charged to operations
Balance at end of period
Commercial
$
(Amounts in thousands)
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
1,977 $
—
117
117
(700 )
1,394 $
2,926 $
(287 )
35
(252 )
398
3,072 $
153 $
(35 )
2
(33 )
43
163 $
52 $
(144 )
23
(121 )
219
150 $
86 $
(148 )
61
(87 )
90
89 $
5,194
(614 )
238
(376 )
50
4,868
Commercial
$
(Amounts in thousands)
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
2,064 $
(470 )
134
(336 )
249
1,977 $
2,754 $
(84 )
10
(74 )
246
2,926 $
229 $
(45 )
37
(8 )
(68 )
153 $
60 $
—
17
17
(25 )
52 $
95 $
(124 )
62
(62 )
53
86 $
5,202
(723 )
260
(463 )
455
5,194
Commercial
$
(Amounts in thousands)
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
593 $
(123 )
274
151
1,320
2,064 $
2,638 $
(186 )
3
(183 )
299
2,754 $
356 $
(93 )
16
(77 )
(50 )
229 $
88 $
(48 )
24
(24 )
(4 )
60 $
89 $
(144 )
77
(67 )
73
95 $
3,764
(594 )
394
(200 )
1,638
5,202
$
$
$
The total allowance reflects management’s estimate of loan losses inherent in the loan portfolio at the Consolidated Balance Sheet
date.
The following tables present a full breakdown by portfolio classification, the changes in the allowance for loan losses and the recorded
investment in loans for the periods ended December 31, 2016 and 2015:
December 31, 2016
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment
Collectively evaluated for impairment
Total ending allowance balance
Loan Portfolio:
Individually evaluated for impairment
Collectively evaluated for impairment
Total ending loan balance
Commercial
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
(Amounts in thousands)
$
$
— $
1,394
1,394 $
178 $
2,894
3,072 $
— $
163
163 $
— $
150
150 $
— $
89
89 $
178
4,690
4,868
$
106 $
6,860 $
96,175 231,832
— $
25,061
$ 96,281 $ 238,692 $ 57,008 $ 25,061 $
— $
57,008
— $
6,966
2,726 412,802
2,726 $ 419,768
67
December 31, 2015
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment
Collectively evaluated for impairment
Total ending allowance balance
Loan Portfolio:
Individually evaluated for impairment
Collectively evaluated for impairment
Total ending loan balance
Commercial
Commercial
real estate
Residential
real estate
Consumer -
home equity
Consumer -
other
Total
(Amounts in thousands)
$
$
834 $
1,143
1,977 $
178 $
2,748
2,926 $
— $
153
153 $
— $
52
52 $
— $
86
86 $
1,012
4,182
5,194
$
1,347 $
8,465 $
83,266 228,672
— $
23,334
$ 84,613 $ 237,137 $ 45,414 $ 23,334 $
— $
45,414
— $
9,812
3,756 384,442
3,756 $ 394,254
The decrease in the provision for the commercial category is primarily due to a reduction of specific reserves or $834,000 due to the
favorable settlement of a creditor in bankruptcy. The increase in the provision for commercial real estate loans is due mainly to an
increase in the historical factor along with an increase in loan charge-offs, The increase in consumer – home equity provision is due to
historical factor increase along with the related increase in net charge-offs. Along with the impact of classified loans, the amount of
net charge-offs impacts the provision charged to operations for any category of loans. Charge-offs affect the historical rate applied to
each category, and the amount needed to replenish the charge off to the provision. This impacted all categories other than commercial
loans.
The following tables represent credit exposures by internally assigned grades for years ended December 31, 2016 and 2015,
respectively. The grading analysis estimates the capability of the borrower to repay the contractual obligations of the loan agreements
as scheduled or at all. The Company’s internal credit risk grading system is based on experiences with similarly graded loans.
The Company’s internally assigned grades are as follows:
Pass – loans which are protected by the current net worth and paying capacity of the obligor or by the value of the
underlying collateral. Within this category, there are grades of exceptional, quality, acceptable and pass monitor.
Special Mention – loans where a potential weakness or risk exists, which could cause a more serious problem if not
corrected.
Substandard – loans that have a well-defined weakness based on objective evidence and are characterized by the distinct
possibility that the Bank will sustain some loss if the deficiencies are not corrected.
Doubtful – loans classified as doubtful have all the weaknesses inherent in a substandard asset but with the severity which
makes collection in full highly questionable and improbable, based on existing circumstances.
Loss – loans classified as a loss are considered uncollectible, or of such value that continuance as an asset is not
warranted. This rating does not mean that the assets have no recovery or salvage value but rather that the assets should be
charged off now, even though partial or full recovery may be possible in the future.
The following is a summary of credit quality indicators by internally assigned grade as of December 31, 2016 and 2015.
December 31, 2016
Pass
Special Mention
Substandard
Doubtful
Ending Balance
(Amounts in thousands)
Commercial
Commercial real estate
$
$
80,644 $
12,836
2,801
—
96,281 $
208,337
22,633
7,722
—
238,692
68
December 31, 2015
Pass
Special Mention
Substandard
Doubtful
Ending Balance
(Amounts in thousands)
Commercial
Commercial real estate
$
$
77,095 $
4,216
3,302
—
84,613 $
219,958
7,707
9,472
—
237,137
The Company evaluates the classification of consumer, home equity and residential loans primarily on a pooled basis. If the Company
becomes aware that adverse or distressed conditions exist that may affect a particular loan, the loan is downgraded following the
above definitions of special mention and substandard. Nonaccrual loans in these categories are evaluated for charge off or charge
down, and the remaining balance has the same allowance factor as pooled loans.
The following is a summary of consumer credit exposure as of December 31, 2016 and 2015.
December 31, 2016
Performing
Nonperforming
Total
December 31, 2015
Performing
Nonperforming
Total
Residential real
estate
(Amounts in thousands)
Consumer - home
equity
Consumer- other
$
$
55,743 $
1,265
57,008 $
25,006 $
55
25,061 $
2,726
—
2,726
Residential real
estate
(Amounts in thousands)
Consumer - home
equity
Consumer- other
$
$
44,162 $
1,252
45,414 $
23,072 $
262
23,334 $
3,756
—
3,756
Loans are considered to be nonperforming when they become 90 days past due or on nonaccrual status, though the Company may be
receiving partial payments of interest and partial repayments of principal on such loans. When a loan is placed in non-accrual status,
previously accrued but unpaid interest is recorded against interest income. Loans in foreclosure are considered nonperforming. At
December 31, 2016, there were $1.7 million of loans in the process of foreclosure.
The following is a summary of classes of loans on non-accrual status as of:
Commercial
Commercial real estate
Residential real estate
Consumer:
Consumer - home equity
Consumer - other
Total
(Amounts in thousands)
December 31,
2016
2015
$
$
— $
1,458
1,265
55
—
2,778 $
1,196
2,176
1,252
262
—
4,886
Gross income that should have been recorded in income on nonaccrual loans was $160,000, $293,000 and $351,000 for the years
ended December 31, 2016, 2015 and 2014, respectively. Actual interest included in income on these nonaccrual loans amounts to
$41,000, $26,000 and $149,000 in 2016, 2015 and 2014, respectively.
69
Troubled Debt Restructuring
Nonperforming loans also include certain loans that have been modified in troubled debt restructurings (TDRs) where economic
concessions have been granted to borrowers who have experienced or are expected to experience financial difficulties. These
concessions typically result from the Company’s loss mitigation activities and could include reductions in the interest rate, payment
extensions, forgiveness of principal, forbearance or other actions. Certain TDRs are classified as nonperforming at the time of
restructure and may only be returned to performing status after considering the borrower’s sustained repayment performance for a
reasonable period, generally six months.
None of the loans that were approved as TDRs in 2015 have subsequently defaulted in the year ended December 31, 2016. There were
no loans modified as TDRs during the years ended December 31, 2016 and 2014.
The following presents, by class, information related to loans modified in a TDR during the periods ended:
Commercial real estate
Subsequently defaulted
(Dollar amounts in thousands)
December 31, 2015
Number of
contracts
Pre-modification
recorded
investment
Post-
modification
recorded
investment
Increase in the
allowance
2 $
— $
3,154 $
3,154 $
—
—
In 2015, the two commercial real estate loans were to the same customer. There was no interest rate impact, only a change in loan
terms to six months interest only.
The following is an aging analysis of the recorded investment of past due loans as of the periods ended December 31, 2016 and 2015:
(Amounts in thousands)
December 31, 2016
Commercial
Commercial real estate
Residential real estate
Consumer:
Consumer - home equity
Consumer - other
Total
December 31, 2015
Commercial
Commercial real estate
Residential real estate
Consumer:
Consumer - home equity
Consumer - other
Total
30-59 Days
60-89 Days
Past Due
Past Due
90 Days Or
Greater
Total Past
Due
Current
Total
Loans
Recorded
Investment >
90 Days and
Accruing
$
377 $
1,189
58
— $
83
9
— $
1,347
1,184
377 $ 95,904 $ 96,281 $
2,619 236,073 238,692
1,251 55,757 57,008
—
13
$ 1,637 $
101 24,960 25,061
46
—
2,726
2,713
13
138 $ 2,586 $ 4,361 $ 415,407 $ 419,768 $
55
—
—
—
—
—
—
—
(Amounts in thousands)
30-59 Days
60-89 Days
Past Due
Past Due
90 Days Or
Greater
Total Past
Due
Current
Total
Loans
Recorded
Investment >
90 Days and
Accruing
$
$
178 $
248
163
— $ 1,196 $ 1,374 $ 83,239 $ 84,613 $
3,783 233,354 237,137
1,534 43,880 45,414
2,055
1,240
1,480
131
29
10
408 22,926 23,334
3,756
3,746
628 $ 1,728 $ 4,753 $ 7,109 $ 387,145 $ 394,254 $
262
—
117
—
10
—
—
—
—
—
—
An impaired loan is a loan on which, based on current information and events, it is probable that a creditor will be unable to collect all
amounts due (including both interest and principal) according to the contractual terms of the loan agreement. However, an
insignificant delay or insignificant shortfall in amount of payments on a loan does not indicate that the loan is impaired.
70
When a loan is determined to be impaired, impairment should be measured based on the present value of expected future cash flows
discounted at the loan’s effective interest rate. However, as a practical expedient, the Company will measure impairment based on a
loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent.
The following are the criteria for selecting individual loans / relationships for impairment analysis. Non-homogenous loans which
meet the criteria below are evaluated quarterly.
All borrowers whose loans are classified doubtful by examiners and internal loan review
All loans on non-accrual status
Any loan in foreclosure
Any loan with a specific reserve
Any loan determined to be collateral dependent for repayment
Loans classified as troubled debt restructuring
Commercial loans and commercial real estate loans evaluated for impairment are excluded from the general pool of loans in the ALLL
calculation regardless if a specific reserve was determined. If management determines that the value of the impaired loan is less than
the recorded investment in the loan (net of previous charge-offs, deferred loan fees or costs and unamortized premium or discount),
impairment is recognized through an allowance estimate or a charge-off to the allowance.
The following table presents the recorded investment and unpaid principal balances for impaired loans, excluding homogenous loans
for which impaired analyses are not necessarily performed, with the associated allowance amount, if applicable, at December 31, 2016
and 2015. Also presented are the average recorded investments in the impaired balances and interest income recognized after
impairment for the years ended December 31, 2016, 2015 and 2014.
December 31, 2016
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
December 31, 2015
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
Recorded
Investment
(Amounts in thousands)
Unpaid Principal
Balance
Related Allowance
106 $
5,681
—
1,179
106 $
6,860 $
106 $
5,789
—
1,179
106 $
6,968 $
—
—
—
178
—
178
Recorded
Investment
(Amounts in thousands)
Unpaid Principal
Balance
Related Allowance
232 $
7,222
1,115
1,243
1,347 $
8,465 $
264 $
7,424
1,552
1,243
1,816 $
8,667 $
—
—
834
178
834
178
$
$
$
$
$
$
71
December 31, 2016
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
December 31, 2015
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
December 31, 2014
With no related allowance recorded:
Commercial
Commercial real estate
With an allowance recorded:
Commercial
Commercial real estate
Total:
Commercial
Commercial real estate
NOTE 4 - PREMISES AND EQUIPMENT
The following is a summary of premises and equipment:
Land
Premises
Equipment
Leasehold improvements
Total premises and equipment
Less accumulated depreciation
Net book value
72
(Amounts in thousands)
Average Recorded
Investment
Interest Income
Recognized
146
$
6,072
279
1,209
425 $
7,281 $
8
335
—
85
8
420
(Amounts in thousands)
Average Recorded
Investment
Interest Income
Recognized
$
322
4,842
1,341
1,160
1,663 $
6,002 $
13
181
—
84
13
265
$
$
$
$
$
$
(Amounts in thousands)
Average Recorded
Investment
Interest Income
Recognized
$
$
$
$
$
257
4,069
$
311
1,430
568 $
5,499 $
17
158
—
73
17
231
(Amounts in thousands)
December 31,
2016
2015
2,746 $
9,846
9,312
222
22,126
12,994
9,132 $
2,746
9,689
8,970
222
21,627
12,437
9,190
Depreciation expense was $835,000 in 2016, $792,000 in 2015 and $715,000 in 2014.
NOTE 5 - DEPOSITS
The following is a summary of interest-bearing deposits:
Demand
Money market
Savings
Time:
In denominations $250,000 or under
In denominations of over $250,000
Total
Stated maturities of time deposits were as follows:
2017
2018
2019
2020
2021
2022 and beyond
Total
(Amounts in thousands)
December 31,
2016
2015
$
$
45,158 $
133,783
112,817
113,368
17,499
422,625 $
38,078
104,334
114,021
109,910
21,917
388,260
(Amounts in thousands)
2016
$
$
79,884
11,163
4,327
8,915
13,751
12,827
130,867
The following is a summary of time deposits of $100,000 or more by remaining maturities:
Three months or less
Three to six months
Six to twelve months
One through five years
Over five years
Total
Certificates of
Deposit
(Amounts in thousands)
December 31, 2016
Other Time
Deposits
$
$
14,502
8,881
12,591
18,468
3,022
57,464
$
$
1,471
379
167
1,869
1,624
5,510
$
$
Total
15,973
9,260
12,758
20,337
4,646
62,974
73
NOTE 6 - FEDERAL HOME LOAN BANK (FHLB) ADVANCES AND OTHER SHORT TERM BORROWINGS
The following is a summary of FHLB advances and other short term borrowings:
FHLB advances - long term:
Fixed rate payable and convertible fixed rate FHLB advances, with
monthly interest payments:
Due in 2016
Due in 2017
Due in 2018
Total FHLB advances - long term
FHLB advances - short term:
Short term
Cash management
Total FHLB advances - short term
Total FHLB advances
Other short term borrowings:
Securities sold under repurchase agreements
Total FHLB advances and other short term borrowings
The following is a summary of FHLB advances – short term:
Average balance during the year
Average interest rate during the year
Maximum month-end balance during the year
Weighted average interest rate at year end
$
$
Weighted Average
Interest Rate
(Amounts in thousands)
December 31,
2016
2015
$
3.34 %
1.17 %
3.09 %
0.65 %
0.57 %
0.59 %
1.67 %
0.33 %
1.59 % $
— $
15,500
2,000
17,500
6,000
17,000
23,000
40,500
2,702
43,202 $
5,000
18,000
2,000
25,000
8,000
9,000
17,000
42,000
2,499
44,499
2016
(Amounts in thousands)
2015
2014
13,550
$
0.54 %
$
0.59 %
23,000
14,674
$
0.27 %
$
0.37 %
23,500
17,541
0.89 %
22,500
0.25 %
At December 31, 2016, FHLB advances were collateralized by FHLB stock owned by the Bank with a carrying value of $2.4 million,
a blanket lien against the Bank’s qualified mortgage loan portfolio of $61.2 million, $16.1 million in mortgage-backed securities and
$11.9 million in U.S. Government-guaranteed small business administration pools. In comparison, in the prior year FHLB advances
were collateralized by FHLB stock owned by the Bank with a carrying value of $2.8 million, a blanket lien against the Bank’s
qualified mortgage loan portfolio of $49.2 million, $26.1 million in mortgage-backed securities and $2.8 million in U.S. Government-
guaranteed small business administration pools. Maximum borrowing capacities from FHLB totaled $56.3 million and $51.0 million
at December 31, 2016 and 2015, respectively.
At December 31, 2016, $11.5 million of the FHLB fixed rate advances were putable on or after certain specified dates at the option of
the FHLB and at December 31, 2015, $18.0 million of the FHLB fixed rate advances were putable on or after certain specified dates at
the option of the FHLB. Should the FHLB elect to exercise the put, the Company is required to pay the advance off on that date
without penalty.
The following is a summary of other short term borrowings:
Average balance during the year
Average interest rate during the year
Maximum month-end balance during the year
Weighted average interest rate at year end
2016
(Amounts in thousands)
2015
2014
$
$
$
2,249
0.31 %
$
3,608
0.33 %
4,082
$
0.10 %
7,541
$
0.11 %
4,141
0.07 %
5,795
0.07 %
Securities sold under repurchase agreements represent arrangements the Bank has entered into with certain deposit customers within
its local market areas. These borrowings are collateralized with securities. At December 31, 2016 and 2015, securities allocated for
74
this purpose, owned by the Bank and held in safekeeping accounts at independent correspondent banks, amounted to $2.9 million and
$5.8 million, respectively.
The following table provides additional detail regarding other short term borrowings:
(Amounts in thousands)
Repurchase Agreements (Sweep)
Accounted for as Secured Borrowings
At December 31, 2016
At December 31, 2015
Remaining Contractual Maturity of the Agreements
Overnight and Continuous
Overnight and Continuous
Repurchase agreements:
U.S. Government-sponsored mortgage-backed securities
U.S. Government-sponsored collateralized mortgage obligations
Total collateral carrying value
Total short-term borrowings
$
$
$
2,898 $
—
2,898 $
2,702 $
4,729
1,088
5,817
2,499
NOTE 7 - SUBORDINATED DEBT
In July 2007, a trust formed by the Company issued $5.0 million of floating rate trust preferred securities as part of a pooled offering
of such securities due December 2037. The Company owns all $155,000 of the common securities issued by the trust. The securities
bear interest at the 3-month LIBOR rate plus 1.45%. The rates at December 31, 2016 and 2015 were 2.41% and 1.96%, respectively.
The Company issued subordinated debentures to the trust in exchange for the proceeds of the trust preferred offering. The debentures
represent the sole assets of this trust. The Company may redeem the subordinated debentures, in whole or in part, at par.
The trust is not consolidated with the Company’s financial statements. Accordingly, the Company does not report the securities issued
by the trust as liabilities, but instead reports as liabilities the subordinated debentures issued by the Company and held by the trust.
The subordinated debentures qualify as Tier 1 capital for regulatory purposes in determining and evaluating the Company’s capital
adequacy.
NOTE 8 – COMMITMENTS AND CONTINGENCIES
The Bank occupies office facilities under operating leases extending to 2021. Most of these leases contain an option to renew at the
then fair rental value for periods of five and ten years. These options enable the Bank to retain use of facilities in desirable operating
areas. In most cases, management expects that in the normal course of business, leases will be renewed or replaced by other leases.
Rental and lease expense was $183,000 for 2016, $168,000 for 2015 and $139,000 for 2014.
The following is a summary of remaining future minimum lease payments under current non-cancelable operating leases for office
facilities:
Years ending:
December 31, 2017
December 31, 2018
December 31, 2019
December 31, 2020
December 31, 2021
Total
(Amounts in thousands)
$
$
206
130
105
105
53
599
At December 31, 2016, the Bank was required to maintain aggregate cash reserves amounting to $3.5 million in order to satisfy
federal regulatory requirements. The reserves are held in useable vault cash and interest-earning balances at the Federal Reserve Bank
of Cleveland.
The Bank grants commercial and industrial loans, commercial and residential mortgage loans, and consumer loans to customers in
Northeastern Ohio and Western Pennsylvania. Although the Bank has a diversified portfolio, exposure to credit loss can be adversely
impacted by downturns in local economic and employment conditions. Approximately 0.36% of total loans are unsecured at
December 31, 2016 and approximately 0.48% at December 31 2015.
75
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of
its customers. These financial instruments include commitments to extend credit, standby letters of credit and financial guarantees.
Such instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the Consolidated Balance
Sheets. The contract or notional amounts on those instruments reflect the extent of involvement the Company has in particular classes
of financial instruments.
In the event of nonperformance by the other party, the Company’s exposure to credit loss on these financial instruments is represented
by the contract or notional amount of the instrument. The Company uses the same credit policies in making commitments and
conditional obligations as it does for instruments recorded on the balance sheet. The amount and nature of collateral obtained, if any,
is based on management’s credit evaluation.
The following is a summary of such contractual commitments:
Commitments to extend credit:
Fixed rate
Variable rate
Standby letters of credit
(Amounts in thousands)
December 31,
2016
2015
$
18,709 $
57,176
412
13,311
45,929
3,508
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 Company 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 Company evaluates each customer’s creditworthiness on a case-by-case basis. The
amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit
evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment
and income-producing commercial properties. The increase in commitments is in line with the Company’s increased focus on
commercial and industrial lending, and specifically lines of credit.
The Company 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 following table is a summary of overdraft protection for the periods indicated:
Overdraft protection available on depositors' accounts
Balance of overdrafts included in loans
Average daily balance of overdrafts
Average daily balance of overdrafts as a percentage of available
(Amounts in thousands)
December 31,
2016
2015
$
$
9,655
80
105
1.09 %
9,598
80
99
1.03 %
Customer Derivatives - Interest Rates Swaps/Floors – The Company enters into interest rate swaps that allow our commercial loan
customers to effectively convert a variable-rate commercial loan agreement to a fixed-rate commercial loan agreement. Under these
agreements, the Company enters into a variable-rate loan agreement with a customer in addition to an interest rate swap agreement,
which serves to effectively swap the customer’s variable-rate into a fixed-rate. The Company then enters into a corresponding swap
agreement with a third party in order to economically hedge its exposure through the customer agreement. The interest rate swaps with
both the customers and third parties are not designated as hedges under FASB ASC 815 and are not marked to market through
earnings. As the interest rate swaps are structured to offset each other, changes to the underlying benchmark interest rates considered
in the valuation of these instruments do not result in an impact to earnings; however, there may be fair value adjustments related to
credit quality variations between counterparties, which may impact earnings as required by FASB ASC 820. There was no effect on
earnings in any periods presented. At December 31, 2016, the Company had one U.S. Government-sponsored mortgage-backed
security pledged for collateral on its interest rate swaps with the third party financial institution with a fair value $1.7 million. At
December 31, 2015, the Company had $150,000 in cash pledged for collateral on its interest rate swap with the third party financial
institution.
76
Summary information regarding these derivatives is presented below:
Notional Amount
December 31,
(Amounts in thousands)
Fair Value
December 31,
2016
2015
Interest Rate Paid
Interest Rate Received
2016
2015
2,594 $
5,630
2,178
6,150
16,552 $
2,680 1 Mo. Libor + Margin
5,921 1 Mo. Libor + Margin
— 1 Mo. Libor + Margin
— 1 Mo. Libor + Margin
8,601
Fixed
Fixed
Fixed
Fixed
$
$
15 $
101
(29 )
210
297 $
35
136
—
—
171
2,594 $
5,630
2,178
6,150
16,552 $
2,680
5,921
—
—
8,601
Fixed
Fixed
Fixed
Fixed
1 Mo. Libor + Margin $
1 Mo. Libor + Margin
1 Mo. Libor + Margin
1 Mo. Libor + Margin
$
(15 ) $
(101 )
29
(210 )
(297 ) $
(35 )
(136 )
—
—
(171 )
Customer interest rate
swap
Maturing in 2020
Maturing in 2025
Maturing in 2026
Maturing in 2027
Total
Third party interest rate
swap
Maturing in 2020
Maturing in 2025
Maturing in 2026
Maturing in 2027
Total
$
$
$
$
The following table presents the fair values of derivative instruments in the balance sheet.
Balance Sheet Location
Fair Value
Balance Sheet Location
Fair Value
Assets
Liabilities
(Amounts in thousands)
Other assets
$
297
Other liabilities
$
297
Other assets
$
171
Other liabilities
$
171
December 31, 2016
Interest rate derivatives
December 31, 2015
Interest rate derivatives
NOTE 9 – BENEFIT PLANS
The Bank has a contributory defined contribution retirement plan (401(k) plan) which covers substantially all employees. Total
expense under the plan was $349,000 for 2016, $307,000 for 2015 and $284,000 for 2014. 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 $18,000 with an
additional $6,000 catch-up deferral for plan participants over the age of 50. The Bank makes bi-weekly contributions to this plan equal
to amounts accrued for plan expense.
The Company provides 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. 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 Company accrues the cost of these
post-retirement benefits during the working careers of the officers and directors. At December 31, 2016, the accumulated liability for
these benefits totaled $2.96 million, with $2.44 million accrued for the officers’ plan and $519,000 for the directors’ plan.
77
The following table reconciles the accumulated liability for the benefit obligation of these agreements:
Beginning balance
Benefit expense
Benefit payments
Ending balance
(Amounts in thousands)
Years Ended December 31,
2015
2014
2016
$
$
2,760 $
359
(162 )
2,957 $
2,549 $
369
(158 )
2,760 $
2,396
308
(155 )
2,549
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 2017, is expected to be approximately $386,000. The benefits expected to be paid in the next year are
approximately $162,000.
The Bank has purchased insurance contracts on the lives of the participants in the supplemental retirement benefit plan and has named
the Bank as the beneficiary. Similarly, the Company 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.
The Company accrues for the monthly benefit expense of postretirement cost of insurance for split-dollar life insurance coverage. The
following table presents the changes in the accumulated liability.
Beginning balance
Expense recorded
Other comprehensive loss (income) recorded
Ending balance
NOTE 10 - FEDERAL INCOME TAXES
The composition of income tax expense is as follows:
Current
Deferred
Total
(Amounts in thousands)
December 31,
2015
2014
2016
$
$
856 $
23
(39 )
840 $
616 $
132
108
856 $
614
47
(45 )
616
(Amounts in thousands)
Years Ended December 31,
2015
2016
2014
$
$
1,256
(129 )
1,127
$
$
916
303
1,219
$
$
451
451
902
The ability to realize the benefit of deferred tax assets is dependent upon a number of factors, including the generation of future
taxable income, the ability to carry back taxes paid in previous years, the ability to offset capital losses with capital gains, the reversal
of deferred tax liabilities, and certain tax planning strategies. A valuation allowance of $94,000 had been established to offset in its
entirety the tax benefits associated with securities sold at a loss that management was able to offset in 2016.
78
The following is a summary of net deferred taxes included in other assets:
Gross deferred tax assets:
Allowance for loan and other real estate losses
Deferred loan origination cost - net
Impairment loss on securities
Deferred compensation
AMT credit carryforward
Unrealized loss on available-for-sale securities
Other items
Total gross deferred tax assets
Valuation allowance
Total net deferred tax assets
Gross deferred tax liabilities:
Premises and equipment
Other items
Total net deferred tax liabilities
Net deferred tax asset
(Amounts in thousands)
December 31,
2016
2015
$
$
$
1,655
303
48
1,006
904
1,499
540
5,955
—
5,955
(566 )
(524 )
(1,090 )
4,865
$
1,766
314
48
939
704
76
763
4,610
(94 )
4,516
(586 )
(617 )
(1,203 )
3,313
The Company had a deferred tax asset of $904,000 for credits related to Alternative Minimum Taxes (AMT) as of December 31,
2016. In comparison, the Company had a deferred tax asset of $704,000 for credits related to AMT at December 31, 2015. The AMT
credits have an unlimited carry-forward period. No valuation allowance had been established for these deferred tax assets in view of
the Corporation’s ability to carry forward taxes paid and credits earned in previous years, to future years, coupled with the anticipated
future taxable income as evidenced by the Corporation’s earnings potential.
The following is a reconciliation of the valuation allowance for net deferred tax assets:
Valuation allowance at beginning of year
Utilization of capital loss carryover
Valuation allowance at end of year
December 31,
2016
2015
$
$
94,000
(94,000 )
—
$
$
94,000
—
94,000
The following is a reconciliation between tax expense using the statutory tax rate of 34% and the income tax provision:
Statutory tax expense
Tax effect of non-taxable interest income
Tax effect of earnings on bank-owned life insurance-net
Tax effect of deferred tax valuation reversal
Tax effect of low income housing credit
Tax effect of non-deductible expenses
Federal income tax expense
(Amounts in thousands)
Years Ended December 31,
2015
2014
2016
$
$
2,039 $
(628 )
(112 )
(94 )
(142 )
64
$
1,127
1,903 $
(600 )
(115 )
—
(54 )
85
$
1,219
1,622
(609 )
(114 )
—
(52 )
55
902
The related income tax expense on investment securities gains amounted to $142,000 for 2016, $22,000 for 2015 and $311,000 for
2014 and is included in the federal income tax expense.
The Company prescribes a recognition threshold and a measurement attribute for the financial statement recognition and measurement
of a tax position taken or expected to be taken in a tax return. Benefits from tax positions should be recognized in the financial
79
statements only when it is more-likely-than-not that the tax position will be sustained upon examination by the appropriate taxing
authority that would have full knowledge of all relevant information. A tax position that meets the more-likely-than-not recognition
threshold is measured at the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate
settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first
subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-
likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold
is no longer met. The provision also provides guidance on the accounting for and disclosure of unrecognized tax benefits, interest and
penalties. There were no significant unrecognized tax benefits at December 31, 2016 and the Company does not expect any significant
increase in unrecognized tax benefits in the next twelve months. No interest or penalties were incurred for income taxes which would
have been recorded as a component of income tax expense.
There is currently no liability for uncertain tax positions and no known unrecognized tax benefits. The Company’s federal and state
income tax returns for taxable years through 2012 have been closed for purposes of examination by the Internal Revenue Service and
the Ohio Department of Revenue.
NOTE 11 – FAIR VALUE
Measurements
The Company groups assets and liabilities recorded at fair value into three levels based on the markets in which the assets and
liabilities are traded and the reliability of the assumptions used to determine fair value. A financial instrument’s level within the fair
value hierarchy is based on the lowest level of input that is significant to the fair value measurement (with level 1 considered highest
and level 3 considered lowest). A brief description of each level follows:
Level 1: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
Level 2:
Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as
of the reported date. The nature of these assets and liabilities include items for which quoted prices are available
but which trade less frequently, and items that are fair valued using other financial instruments, the parameters of
which can be directly observed.
Level 3:
Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have
two-way markets and are measured using management’s best estimate of fair value, where inputs into the
determination of fair value require significant management judgment or estimation.
The following table presents the assets reported on the consolidated balance sheets at their fair value as of December 31, 2016 and
December 31, 2015 by level within the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the
lowest level of input that is significant to the fair value measurement.
Description
ASSETS
(Amounts in thousands)
Fair Value Measurements at December 31, 2016 Using
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Other
Observable
Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
December 31,
2016
$
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed securities
U.S. Government-sponsored collateralized mortgage obligations
U.S. Government-guaranteed small business administration pools
Trust preferred securities
Regulatory stock
Loans held for sale
Interest rate derivatives
7,988 $
66,770
79,767
9,349
11,939
825
2,581
4,554
297
— $
—
—
—
—
—
2,581
4,554
—
7,988 $
66,770
79,767
9,349
11,939
—
—
—
297
—
—
—
—
—
825
—
—
—
LIABILITIES
Interest rate derivatives
$
297 $
— $
297 $
—
80
Description
ASSETS
December 31,
2015
(Amounts in thousands)
Fair Value Measurements at December 31, 2015 Using
Significant
Other
Observable
Inputs
(Level 2)
Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
Significant
Unobservable
Inputs
(Level 3)
$
U.S. Government agencies and corporations
Obligations of states and political subdivisions
U.S. Government-sponsored mortgage-backed securities
U.S. Government-sponsored collateralized mortgage obligations
U.S. Government-guaranteed small business administration pools
Trust preferred securities
Regulatory stock
Trading securities
Loans held for sale
Interest rate derivatives
12,623 $
51,405
69,679
13,530
2,837
778
3,049
8,134
4,033
171
LIABILITIES
— $
—
—
—
—
—
3,049
—
4,033
—
12,623 $
51,405
69,679
13,530
2,837
—
—
8,134
—
171
Interest rate derivatives
$
171 $
— $
171 $
—
—
—
—
—
778
—
—
—
—
—
The following tables present the changes in the Level 3 fair value category for the years ended December 31, 2016, 2015 and 2014.
The Company classifies financial instruments in Level 3 of the fair-value hierarchy when there is reliance on at least one significant
unobservable input to the valuation model. In addition to these unobservable inputs, the valuation models for Level 3 financial
instruments typically also rely on a number of inputs that are readily observable either directly or indirectly.
Beginning balance
Net realized/unrealized gains/(losses) included in:
Noninterest income
Other comprehensive income
Discount accretion (premium amortization)
Sales
Purchases, issuance, and settlements
Ending balance
Losses included in net income for the period relating
to assets held at period end
(Amounts in thousands)
December 31,
2015
Trust preferred
securities
2014
Trust preferred
securities
2016
Trust preferred
securities
$
778 $
779 $
10,136
—
67
—
—
(20 )
825 $
—
21
—
—
(22 )
778 $
—
835
7
(10,044 )
(155 )
779
— $
— $
—
$
$
The Company conducts OTTI analyses on a quarterly basis. The initial indication of other-than-temporary impairment for both debt
and equity securities is a decline in the fair value below the amount recorded for an investment. A decline in value that is considered
to be other-than-temporary is recorded as a loss within non-interest income in the Consolidated Statements of Income. In determining
whether an impairment is other than temporary, the Company considers a number of factors, including, but not limited to, the length
of time and extent to which the market value has been less than cost, recent events specific to the issuer, including investment
downgrades by rating agencies and economic conditions of its industry, and a determination that the Company does not intend to sell
those investments and it is not more-likely-than-not that the Company will be required to sell the investments before recovery of its
amortized cost basis less any current period credit loss. Among the factors that are considered in determining the Company’s intent
and ability is a review of its capital adequacy, interest rate risk position and liquidity.
The Company also considers the issuer’s financial condition, capital strength and near-term prospects. In addition, for debt securities
the Company considers the cause of the price decline (general level of interest rates and industry- and issuer-specific factors), current
ability to make future payments in a timely manner and the issuer’s ability to service debt, the assessment of a security’s ability to
recover any decline in market value, the ability of the issuer to meet contractual obligations and the Company’s intent and ability to
retain the security. All of the foregoing require considerable judgment.
81
Trust Preferred Securities
Trust preferred securities are accounted for under FASB ASC Topic 325 Investments Other. The Company evaluates current available
information in estimating the future cash flows of securities and determines whether there have been favorable or adverse changes in
estimated cash flows from the cash flows previously projected. The Company considers the structure and term of the pool and the
financial condition of the underlying issuers. Specifically, the evaluation incorporates factors such as interest rates and appropriate risk
premiums, the timing and amount of interest and principal payments and the allocation of payments to the various note classes.
Current estimates of cash flows are based on the most recent trustee reports, announcements of deferrals or defaults, expected future
default rates and other relevant market information.
As referenced in Note 2, Investment Securities, with the release of the Volcker Rule in December 2013, the Company could no longer
support the ability to hold certain trust preferred securities comprised of obligations issued by insurance companies. The inability to
hold the investments triggered a $2.0 million OTTI recognition reflecting the estimated fair value of the securities at December 31,
2013. For the remaining bank-issued trust preferred securities, the Company does not intend to sell the securities and it is more-likely-
than-not that the Company will not be required to sell the securities before recovery of its amortized cost basis. There is a risk that
subsequent evaluations could result in recognition of OTTI charges in the future. The securities had life-to-date impairment losses as
presented below.
The following table details the breakdown of trust preferred securities for the periods indicated:
Total number of trust preferred securities
Par value
Number not considered OTTI
Par value
Number considered OTTI
Par value
Life-to-date impairment recognized in earnings
Life-to-date impairment recognized in other comprehensive income
Total life-to-date impairment
(Dollar amounts in thousands)
December 31,
2016
2015
2
1,970 $
1
940 $
1
1,030 $
140 $
795
935 $
2
1,990
1
976
1
1,014
140
862
1,002
$
$
$
$
$
The following table details the one debt security with other-than-temporary impairment, its credit rating at December 31, 2016 and the
related loss recognized in earnings:
(Dollar amounts in thousands)
Amount of
OTTI
related to
credit loss at
January 1,
2016
Additions in QTD
March 31,
2016
Additions in QTD
June 30,
2016
Additions in QTD
September 30,
2016
Additions in QTD
December 31,
2016
Amount of
OTTI
related to
credit loss at
December 31,
2016
Moody’s/Fitch
Rating
Caa2/CC
$
Trapeza IX B-1
140 $
— $
— $
— $
— $
140
The following table details the one debt security with other-than-temporary impairment, its credit rating at December 31, 2015 and the
related losses recognized in earnings:
(Dollar amounts in thousands)
Amount of
OTTI
related to
credit loss at
January 1,
2015
Moody’s/Fitch
Rating
Additions in QTD
March 31,
2015
Additions in QTD
June 30,
2015
Additions in QTD
September 30,
2015
Additions in QTD
December 31,
2015
Amount of
OTTI
related to
credit loss at
December 31,
2015
Trapeza IX B-1
Ca/CC
$
140 $
— $
— $
— $
— $
140
82
The following table provides additional information related to the Company’s trust preferred securities as of December 31, 2016 used
to evaluate other-than-temporary impairments:
(Dollar amounts in thousands)
Deal
PreTSL XXIII
Trapeza IX
Total
Class
C-2
B-1
Amortized Cost Fair Value
760 $
$
860
1,620 $
310 $
515
825 $
$
(450 ) B2/CCC
(345 ) Caa2/CC
(795 )
Unrealized
Gain/(Loss)
Moody’s/
Fitch Rating
Number of
Issuers
Currently
Performing
90
32
Deferrals and
Defaults as a %
of Current
Collateral
Excess
Subordination as a
% of Current
Performing
Collateral
22.5 %
13.3
5.33 %
—
The following table provides additional information related to the Company’s trust preferred securities as of December 31, 2015 used
to evaluate other-than-temporary impairments:
(Dollar amounts in thousands)
Deal
PreTSL XXIII
Trapeza IX
Total
Class
C-2
B-1
Amortized Cost Fair Value
780 $
$
860
1,640 $
332 $
446
778 $
$
Unrealized
Gain/(Loss)
Moody’s/
Fitch Rating
(448 ) B2/CCC
(414 ) Ca/CC
(862 )
Number of
Issuers
Currently
Performing
90
31
Deferrals and
Defaults as a %
of Current
Collateral
Excess
Subordination as a
% of Current
Performing
Collateral
22.5 %
18.5
1.77 %
—
The market for these securities at December 31, 2016 and December 31, 2015 is not active and markets for similar securities are also
not active. The inactivity was evidenced first by a significant widening of the bid-ask spread in the brokered markets in which trust
preferred securities trade and then by a significant decrease in the volume of trades relative to historical levels. The new issue market
is also inactive as no new trust preferred securities have been issued since 2007. There are currently very few market participants who
are willing and/or able to transact for these securities. The pooled market value for these securities remains very depressed relative to
historical levels. Although there has been marked improvement in the credit spread premium in the corporate bond space, no such
improvement has been noted in the market for trust preferred securities.
Given conditions in the debt markets today and the absence of observable transactions in the secondary and the new issue markets, the
Company determined the following:
• The few observable transactions and market quotations that are available are not reliable for purposes of determining fair
value at December 31, 2016;
• An income valuation approach technique (present value technique) that maximizes the use of relevant observable inputs
and minimizes the use of unobservable inputs will be equally or more representative of fair value than the market
approach valuation technique used at measurement dates prior to 2008; and
• The trust preferred securities will be classified within Level 3 of the fair value hierarchy because the Company determined
that significant judgments are required to determine fair value at the measurement date.
The Company enlisted the aid of an independent third party to perform the trust preferred security valuations. The approach to
determining fair value involved the following process:
1. Estimate the credit quality of the collateral using average probability of default values for each issuer (adjusted for rating
levels).
2. Consider the potential for correlation among issuers within the same industry for default probabilities (e.g. banks with
other banks).
3. Forecast the cash flows for the underlying collateral and apply to each trust preferred security tranche to determine the
resulting distribution among the securities, including prepayment and cures.
4. Discount the expected cash flows to calculate the present value of the security.
83
The PreTSL XXIII cash flows are discounted at 15.11% through its maturity date of December 2036 and would have to experience an
additional $229 million of nonperforming collateral (of $852 million performing) in order to incur any impairment. The aggregate
cash flows for the C-2 tranche are estimated to be $44.2 million on a current principal of $26.2 million. The Trapeza IX cash flows are
discounted at 9.69% through its maturity of January 2038 and would experience additional impairment upon further occurrence of
nonperforming collateral of $31 million (of $213 million performing). The aggregate cash flows for the B-1 tranche are estimated to
be $42.8 million on a current principal of $23.7 million.
The following table presents the assets measured on a nonrecurring basis on the Consolidated Balance Sheets at their fair value as of
December 31, 2016 and December 31, 2015, by level within the fair value hierarchy. Impaired loans that are collateral dependent are
written down to fair value through the establishment of specific reserves. Techniques used to value the collateral that secure the
impaired loans include: quoted market prices for identical assets classified as Level 1 inputs; observable inputs, employed by certified
appraisers, for similar assets classified as Level 2 inputs. In cases where valuation techniques include inputs that are unobservable and
are based on estimates and assumptions developed by management based on the best information available under each circumstance,
the asset valuation is classified as Level 3 inputs. Other real estate owned is carried at the lower of cost or fair value less estimated
costs to sell.
Assets measured on a nonrecurring basis:
Impaired loans
Assets measured on a nonrecurring basis:
Impaired loans
Other real estate owned
Financial Instruments
(Amounts in thousands)
December 31, 2016
Level 1
Level 2
Level 3
Total
$
— $
— $
6,788 $
6,788
(Amounts in thousands)
December 31, 2015
Level 1
Level 2
Level 3
Total
$
$
— $
— $
8,800 $
8,800
— $
— $
61 $
61
The Company discloses fair value information about financial instruments, whether or not recognized in the Consolidated Balance
Sheets, for which it is practicable to estimate the value. In cases where quoted market prices are not available, fair values are based on
estimates using present value or other estimation techniques. Those techniques are significantly affected by the assumptions used,
including the discount rate and estimates of future cash flows.
Such techniques and assumptions, as they apply to individual categories of the financial instruments, are as follows:
Cash and cash equivalents – The carrying amounts for cash and cash equivalents are a reasonable estimate of those assets’ fair value.
Investment securities – Fair values of securities are based on quoted market prices, where available. If quoted market prices are not
available, fair values are based on quoted market prices of comparable securities. Prices on trust preferred securities were calculated
using a discounted cash-flow technique. Cash flows were estimated based on credit and prepayment assumptions. The present value of
the projected cash flows was calculated using a discount rate equal to the current yield used to accrete the beneficial interest.
Loans held for sale – Loans held for sale consist of residential mortgage loans originated for sale. Loans held for sale are recorded at
fair value based on what the secondary markets have offered on best efforts commitments.
Loans, net of allowance for loan losses – Market quotations are generally not available for loan portfolios. The fair value is estimated
by discounting future cash flows using current market inputs at which loans with similar terms and qualities would be made to
borrowers of similar credit quality.
Bank-owned life insurance – The fair value is based upon the cash surrender value of the underlying policies net of any split dollar
obligation and matches the book value.
Accrued interest receivable – The carrying amount is a reasonable estimate of these assets’ fair value.
84
Interest rate derivatives – The fair value is based on settlement values adjusted for credit risks associated with the counter parties and
the Company and observable market interest rate curves.
Demand, savings and money market deposits – Demand, savings, and money market deposit accounts are valued at the amount
payable on demand.
Time deposits – The fair value of certificates of deposit is based on the discounted value of contractual cash flows. The discount rates
are estimated using market rates currently offered for similar instruments with similar remaining maturities.
Short term borrowings – Short term borrowings generally have an original term to maturity of one year or less. Consequently, their
carrying value is a reasonable estimate of fair value.
FHLB advances - short term – Short term borrowings generally have an original term to maturity of one year or less. Advances of one
month or less are considered to be at fair value. The fair value of notes with one to twelve month terms is based on the discounted
value of contractual cash flows. The discount rates are estimated using market rates currently offered for similar instruments with
similar remaining maturities.
FHLB advances - long term – The fair value for fixed rate advances is estimated by discounting the future cash flows using rates at
which advances would be made to borrowers with similar credit ratings and for the same remaining maturities. The fair value for the
fixed rate advances that are convertible to quarterly LIBOR floating rate advances on or after certain specified dates at the option of
the FHLB and the FHLB fixed rate advances that are putable on or after certain specified dates at the option of the FHLB are priced
using the FHLB of Cincinnati’s model.
Subordinated debt – The floating issuances curves to maturity are averaged to obtain an index. The spread between BBB-rated bank
debt and 25-year swap rates is determined to calculate the spread on outstanding trust preferred securities. The discount margin is then
added to the index to arrive at a discount rate, which determines the present value of projected cash flows.
Accrued interest payable – The carrying amount is a reasonable estimate of these liabilities’ fair value. The fair value of unrecorded
commitments at December 31, 2016 and December 31, 2015 is not material.
In addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the disclosures,
such as property and equipment. Also, non-financial instruments 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.
85
The carrying amounts and estimated fair values of the Company’s financial instruments are as follows:
ASSETS:
Cash and cash equivalents
Investment securities available-for-sale
Loans held for sale
Loans, net of allowance for loan losses
Bank-owned life insurance
Accrued interest receivable
Interest rate derivatives
LIABILITIES:
Demand, savings and money market deposits
Time deposits
Short-term borrowings
Federal Home Loan Bank advances - short term
Federal Home Loan Bank advances - long term
Subordinated debt
Accrued interest payable
Interest rate derivatives
ASSETS:
Cash and cash equivalents
Investment securities available-for-sale
Trading securities
Loans held for sale
Loans, net of allowance for loan losses
Bank-owned life insurance
Accrued interest receivable
Interest rate derivatives
LIABILITIES:
Demand, savings and money market deposits
Time deposits
Short-term borrowings
Federal Home Loan Bank advances - short term
Federal Home Loan Bank advances - long term
Subordinated debt
Accrued interest payable
Interest rate derivatives
(Amounts in thousands)
December 31, 2016
Carrying
Amount
Level 1
Level 2
Level 3
Fair Value
$
15,351 $
179,219
4,554
414,900
17,376
2,041
297
15,351 $
2,581
4,554
—
17,376
2,041
—
— $
175,813
—
—
—
—
297
— $
825
—
418,532
—
—
—
15,351
179,219
4,554
418,532
17,376
2,041
297
$ 408,983 $ 408,983 $
—
2,702
17,000
—
—
288
—
130,867
2,702
23,000
17,500
5,155
288
297
— $
—
—
—
—
—
—
297
— $ 408,983
133,108
2,702
22,998
17,580
4,363
288
297
133,108
—
5,998
17,580
4,363
—
—
(Amounts in thousands)
December 31, 2015
Carrying
Amount
Level 1
Level 2
Level 3
Fair Value
$
18,496 $
153,901
8,134
4,033
389,060
17,328
1,640
171
18,496 $
3,049
—
4,033
—
17,328
1,640
—
— $
150,074
8,134
—
—
—
—
171
— $
778
—
—
393,355
—
—
—
18,496
153,901
8,134
4,033
393,355
17,328
1,640
171
$ 364,577 $ 364,577 $
—
2,499
12,000
—
—
255
—
131,827
2,499
17,000
25,000
5,155
255
171
— $
—
—
—
—
—
—
171
— $ 364,577
134,251
2,499
16,995
25,667
4,321
255
171
134,251
—
4,995
25,667
4,321
—
—
86
The following table presents quantitative information about the Level 3 significant unobservable inputs for assets and liabilities
measured at fair value on a recurring and nonrecurring basis at December 31, 2016.
(Amounts in thousands)
Fair value at
December 31,
2016
Valuation
Technique
Trust preferred securities
$
825 Discounted Cash
Flow
Significant
Unobservable Input
Projected
Prepayments
Description of Inputs
1) Trust preferred securities issued by banks subject to Dodd-
Frank's phase-out of trust preferred securities from Tier 1 Capital.
All fixed rate within one year; variable rate at increasing intervals
depending on spread.
2) Trust preferred securities issued by healthy, well capitalized
banks that have fixed rate coupons greater than 8%.
3) 1% annually for all other fixed rate issues and all variable rate
issues.
4) Zero for collateral issued by REITs and 2% for insurance
companies.
Projected
Defaults
1) All deferring issuers that do not meet the criteria for curing, as
described below, are projected to default immediately.
2) Banks with high, near team default risk are identified using a
CAMELS model, and projected to default immediately. Healthy
banks are projected to default at a rate of 2% annually for 2 years,
and 0.36% annually thereafter.
3) Insurance and REIT defaults are projected according to the
historical default rates exhibited by companies with the same credit
ratings. Historical default rates are doubled in each of the first two
years of the projection to account for current economic conditions.
Unrated issuers are assumed to have CCC- ratings.
Projected Cures
1) Deferring issuers that have definitive agreements to either be
acquired or recapitalized.
Projected
Recoveries
1) Zero for insurance companies, REITs and insolvent banks, and
10% for projected bank deferrals lagged 2 years.
Discount Rates
1) Ranging from ~9.69% to ~15.11%, depending on each bond's
seniority and remaining subordination after projected losses.
Impaired loans
6,788
Appraisal of
Collateral (1)
Appraisal
Adjustments (2)
Range (0)% to (50)%
Weighted average (29)%
Liquidation
Expenses (2)
Range (0)% to (48)%
Weighted average (5)%
(1)
(2)
Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not
identifiable.
Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted
average of liquidation expenses are presented as a percent of the appraisal. The adjustment of appraised value is measured as the effect on fair value as a
percentage of unpaid principal.
87
The following table presents quantitative information about the Level 3 significant unobservable inputs for assets and liabilities
measured at fair value on a recurring and nonrecurring basis at December 31, 2015.
(Amounts in thousands)
Fair value at
December 31,
2015
Valuation
Technique
Trust preferred securities
$
778 Discounted Cash
Flow
Significant
Unobservable Input
Projected
Prepayments
Description of Inputs
1) Trust preferred securities issued by banks subject to Dodd-
Frank's phase-out of trust preferred securities from Tier 1 Capital.
All fixed rate within one year; variable rate at increasing intervals
depending on spread.
2) Trust preferred securities issued by healthy, well capitalized
banks that have fixed rate coupons greater than 8%.
3) 1% annually for all other fixed rate issues and all variable rate
issues.
4) Zero for collateral issued by REITs and 2% for insurance
companies.
Projected
Defaults
1) All deferring issuers that do not meet the criteria for curing, as
described below, are projected to default immediately.
2) Banks with high, near team default risk are identified using a
CAMELS model, and projected to default immediately. Healthy
banks are projected to default at a rate of 2% annually for 2 years,
and 0.36% annually thereafter.
3) Insurance and REIT defaults are projected according to the
historical default rates exhibited by companies with the same
credit ratings. Historical default rates are doubled in each of the
first two years of the projection to account for current economic
conditions. Unrated issuers are assumed to have CCC- ratings.
Projected Cures
1) Deferring issuers that have definitive agreements to either be
acquired or recapitalized.
Projected
Recoveries
1) Zero for insurance companies, REITs and insolvent banks, and
10% for projected bank deferrals lagged 2 years.
Discount Rates
1) Ranging from ~10.26% to ~14.12%, depending on each bond's
seniority and remaining subordination after projected losses.
Impaired loans
8,800
Appraisal of
Collateral (1)
Appraisal
Adjustments (2)
Range (0)% to (53)%
Weighted average (29)%
Liquidation
Expenses (2)
Range (0)% to (43)%
Weighted average (5)%
Other real estate owned
61
Appraisal of
Collateral (1), (3)
Appraisal
Adjustments (2)
0%
(1)
(2)
(3)
Fair value is generally determined through independent appraisals of the underlying collateral, which generally include various Level 3 inputs which are not
identifiable.
Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated liquidation expenses. The range and weighted
average of liquidation expenses are presented as a percent of the appraisal. The adjustment of appraised value is measured as the effect on fair value as a
percentage of unpaid principal.
Includes qualitative adjustments by management and estimated liquidation expenses.
88
NOTE 12 - ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME
The following table presents the changes in accumulated other comprehensive loss or income by component net of tax for the years
ended December 31, 2016 and 2015.
Balance as of December 31, 2014
Other comprehensive loss before reclassification
Amount reclassified from accumulated other comprehensive loss
Total other comprehensive loss
Balance as of December 31, 2015
Other comprehensive (loss) income before reclassification
Amount reclassified from accumulated other comprehensive loss
Total other comprehensive (loss) income
Balance as of December 31, 2016
(a) All amounts are net of tax. Amounts in parentheses indicate debits.
(Amounts in thousands)
Unrealized gains (losses)
on available-for-sale
securities (a)
Change in pension and
postretirement
obligations (a)
$
$
$
359 $
(457 )
(49 )
(506 )
(147 ) $
(2,454 )
(308 )
(2,762 )
(2,909 ) $
17
(108 )
—
(108 )
(91 )
39
—
39
(52 )
The following table presents significant amounts reclassified out of each component of accumulated other comprehensive loss or
income for the years ended December 31, 2016 and 2015.
(Amounts in thousands)
December 31, 2016
Amount reclassified from
accumulated other
comprehensive loss (a)
Affected line item in the
statement where net
income is presented
Investment securities
available-for-sale
gains, net
466
(158 ) Federal income tax expense
308 Net of tax
(Amounts in thousands)
December 31, 2015
Amount reclassified from
accumulated other
comprehensive loss (a)
Affected line item in the
statement where net
income is presented
Investment securities
available-for-sale
gains, net
75
(26 ) Federal income tax expense
49 Net of tax
$
$
$
$
Details about other comprehensive income or loss:
Unrealized gains on available-for-sale securities
Details about other comprehensive income or loss:
Unrealized gains on available-for-sale securities
(a) Amounts in parentheses indicate debits to net income.
NOTE 13 - REGULATORY MATTERS
The Company and the Bank are subject to regulatory capital requirements administered by federal banking agencies. Capital adequacy
guidelines and prompt corrective action regulations involve quantitative measures of assets, liabilities, and certain off-balance-sheet
items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments
by regulators about components, risk weightings, and other factors, and the regulators can lower classifications in certain cases.
Failure to meet various capital requirements can initiate regulatory action that could have a direct material effect on the financial
statements.
89
The prompt corrective action regulations provide five categories, including well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized, although these terms are not used to represent overall financial
condition. If a bank is only adequately capitalized, regulatory approval is required to, among other things, accept, renew or roll-over
brokered deposits. If a bank is undercapitalized, capital distributions and growth and expansion are limited, and plans for capital
restoration are required.
In July 2013, the Board of Governors of the Federal Reserve Board and the FDIC approved the final rules implementing the Basel
Committee on Banking Supervision's capital guidelines for U.S. banks and their holding companies (commonly known as Basel III).
Under the final rules, which began for the Company and the Bank on January 1, 2015 and are subject to a phase-in period through
January 1, 2019, minimum requirements will increase for both the quantity and quality of capital held by the Company and the Bank.
The rules include a new common equity Tier 1 capital to risk-weighted assets ratio (CET1 ratio) of 4.5% and a capital conservation
buffer of 2.5% of risk-weighted assets, which when fully phased-in, effectively results in a minimum CET1 ratio of 7.0%. Basel III
raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% (which, with the capital conservation buffer,
effectively results in a minimum Tier 1 capital ratio of 8.5% when fully phased-in), effectively results in a minimum total capital to
risk-weighted assets ratio of 10.5% (with the capital conservation buffer fully phased-in), and requires a minimum leverage ratio of
4.0%. Basel III also makes changes to risk weights for certain assets and off-balance-sheet exposures. Management expects that the
capital ratios for the Company and the Bank under Basel III will continue to exceed the well capitalized minimum capital
requirements, as they currently exceed the fully phased in 2019 requirements.
In addition to the capital requirements for bank holding companies generally, financial holding companies are also required to meet
“well-capitalized” requirements of the Federal Reserve Board. A bank holding company or financial holding company that is covered
by the Federal Reserve’s Small Bank Holding Company Policy is not required to comply with the consolidated capital requirements,
although its bank subsidiaries still must comply with the applicable capital requirements. As a bank holding company with assets of
less than $1 billion and meeting certain other requirements, the Company is covered by the Small Bank Holding Company Policy.
At December 31, 2016 and December 31, 2015, actual capital levels and minimum required levels for the Company, if it were not
covered by the Small Bank Holding Company Policy, were:
December 31, 2016
CET1 capital (to risk-weighted assets)
Tier 1 capital (to risk-weighted assets)
Total capital (to risk-weighted assets)
Tier 1 capital (to average assets)
December 31, 2015
CET1 capital (to risk-weighted assets)
Tier 1 capital (to risk-weighted assets)
Total capital (to risk-weighted assets)
Tier 1 capital (to average assets)
$
$
(Amounts in thousands)
Actual
Amount
Ratio
Minimum required for capital
adequacy purposes
Amount
Ratio
60,631
65,631
70,583
65,631
12.97 % $
14.04 %
15.10 %
10.46 %
21,033
28,044
37,392
25,086
4.5 %
6.0 %
8.0 %
4.0 %
(Amounts in thousands)
Actual
Amount
Ratio
Minimum required for capital
adequacy purposes
Amount
Ratio
56,922
61,922
67,199
61,922
12.78 % $
13.90 %
15.09 %
10.62 %
20,043
26,723
35,631
23,314
4.5 %
6.0 %
8.0 %
4.0 %
Approximately $5.0 million of trust preferred securities outstanding at December 31, 2016 and December 31, 2015, respectively,
qualified as Tier 1 capital. Refer to Note 7, “Subordinated Debt.”
The Bank met all capital requirements to be categorized as "well capitalized" at December 31, 2016 and December 31, 2015.
90
NOTE 14 - RELATED PARTY TRANSACTIONS
Certain directors, executive officers and companies with whom they are affiliated were loan customers during 2016. The following is
an analysis of such loans:
Total related-party loans at December 31, 2015
New related-party loans
Repayments or other
Total related-party loans at December 31, 2016
(Amounts in thousands)
$
$
4,370
2,599
(2,686 )
4,283
Deposits from executive officers, directors, and their affiliates at December 31, 2016 and 2015 were $2.9 million and $2.5 million,
respectively.
The banking relationships were made in the ordinary course of business with the Bank.
NOTE 15 - CONDENSED FINANCIAL INFORMATION – PARENT COMPANY
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, adjusted for any unrealized gains or
losses on available-for-sale securities.
BALANCE SHEETS
(Amounts in thousands)
ASSETS
Cash
Investment in bank subsidiary
Subordinated note from subsidiary bank
Other assets
Total assets
LIABILITIES
Other liabilities
Subordinated debt (Note 7)
Total liabilities
SHAREHOLDERS’ EQUITY
Common stock
Additional paid-in capital
Retained earnings
Accumulated other comprehensive loss
Treasury stock
Total shareholders’ equity
Total liabilities & shareholders’ equity
December 31,
2016
2015
$
$
$
$
320 $
53,759
6,000
3,700
63,779 $
954 $
5,155
6,109
23,641
20,878
21,485
(2,961 )
(5,373 )
57,670
63,779 $
122
52,848
6,000
3,833
62,803
964
5,155
6,119
23,641
20,833
17,851
(238 )
(5,403 )
56,684
62,803
91
STATEMENTS OF COMPREHENSIVE INCOME
(Amounts in thousands)
Years ended December 31,
2015
2014
2016
Dividends from bank subsidiary
Interest and dividend income
Other income
Interest on subordinated debt
Other expenses
Income before income tax and equity in undistributed earnings of
subsidiaries
Income tax benefit
Equity in undistributed earnings of subsidiaries
Net income
Comprehensive income
$
$
$
1,400 $
121
60
(112 )
(497 )
972
265
3,634
4,871 $
2,148 $
3,310 $
97
63
(91 )
(513 )
2,866
133
1,379
4,378 $
3,764 $
1,013
93
62
(88 )
(311 )
769
95
3,005
3,869
7,133
STATEMENTS OF CASH FLOWS
(Amounts in thousands)
Cash flow from operating activities
Net income
Adjustments to reconcile net income to net cash flow from operating
activities:
Equity in undistributed net income of subsidiaries
Deferred tax benefit
Equity compensation
Change in other assets and liabilities
Net cash flow from operating activities
Cash deficit from financing activities
Dividends paid
Treasury shares purchased
Net cash deficit from financing activities
Net change in cash
Cash
Beginning of year
End of year
NOTE 16 - DIVIDEND RESTRICTIONS
2016
Years ended December 31,
2015
2014
$
4,871 $
4,378 $
3,869
(3,634 )
(15 )
75
138
1,435
(1,237 )
—
(1,237 )
198
(1,379 )
(6 )
—
(35 )
2,958
(1,082 )
(1,850 )
(2,932 )
26
$
122
320 $
96
122 $
(3,005 )
—
—
(156 )
708
(816 )
—
(816 )
(108 )
204
96
The Bank is subject to a dividend restriction that generally limits the amount of dividends that can be paid by an Ohio state-chartered
bank. Under the Ohio Banking Code, cash dividends may not exceed net profits as defined for that year combined with retained net
profits for the two preceding years less any required transfers to surplus. Under this formula, the amount available for payment of
dividends in 2017 is $5.0 million plus 2017 profits retained up to the date of the dividend declaration.
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.
92
NOTE 18 – STOCK REPURCHASE PROGRAM
On March 24, 2015, the Company’s Board of Directors adopted a Stock Repurchase Program which allowed the Company to
repurchase up to 200,000 shares or approximately 4.4% of its 4,527,849 outstanding common shares in the open market or in privately
negotiated transactions in accordance with applicable regulations of the Securities and Exchange Commission. Based on the value of
the Company’s stock on March 24, 2015, the commitment to repurchase the stock during the program was approximately $3.1 million.
The repurchase program terminated on December 31, 2015. As of December 31, 2015, the Company had repurchased 123,066 shares
under the program to date. 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. On January 26, 2016, the Company’s Board of Directors approved a new program which allowed the Company to
repurchase up to 100,000 shares, or approximately 2.3% of the 4,404,783 shares outstanding at January 26, 2016, of the Company’s
outstanding common stock. This program terminated on December 31, 2016 . The Company did not purchase any shares under this
program. On January 24, 2017, the Company’s Board of Directors approved a new program which allows the Company to repurchase
up to 100,000 shares, or approximately 2.3% of the 4,420,055 shares outstanding at January 24, 2017, of the Company’s outstanding
common stock. This program will terminate on December 31, 2017 or upon purchase of 100,000 shares if earlier or at any time
without prior notice.
NOTE 19 – EQUITY COMPENSATION
During 2015, the Company, created the 2015 Omnibus Equity Plan and The Director Equity Plan.
The Omnibus Equity Plan permits the award of up to 340,000 shares to the Company’s employees to promote the long-term financial
success of the Company, increasing shareholder value by providing employees the opportunity to acquire an ownership interest in the
Company and enabling the Company and its related entities to attract and retain the services of those upon whom the successful
conduct of business depends. There were 13,683 restricted board approved shares granted under the plan in April 2016. The Company
is expensing the grant date fair value of all share-based compensation over the requisite vesting periods on a prorated straight-line
basis. In 2016, compensation expense of $48,000 was recorded in the Consolidated Statements of Income. As of December 31, 2016,
there was $161,000 of total unrecognized compensation expense related to the non-vested shares granted under the Plan. Shares
awarded under this plan vest in equal thirds on the first three anniversaries of the award date if the employee remains employed with
Cortland Bancorp. The remaining cost is expected to be recognized over 2.25 years, which is the remainder of the three-year tiered
vesting period. There were no shares granted under the plan in 2015.
Granted shares are awarded upon meeting achievement of performance objectives derived from one or more of the performance
criteria. The main metrics used include net earnings, earnings per share, return on average assets and equity, share price and other
earnings ratios.
The Director Equity Plan permits the award of up to 113,000 shares to nonemployee directors to promote the long-term financial
success of the Company, increasing shareholder value by enabling the Company and its related entities to attract and retain the
services of those directors upon whom the successful conduct of business depends. There were 1,789 board approved shares granted
under the plan in April 2016 with immediate vesting. In 2016, compensation expense of $27,000 was recorded in the Consolidated
Statements of Income.
The following is the activity under the two plans during the period ended December 31, 2016:
Nonvested at January 1, 2016
Granted
Vested
Forfeited
Nonvested at December 31, 2016
Restricted Stock Units
Units
Price at Grant Date
$
—
15,472
1,789
—
13,683
$
—
15.25
15.25
—
15.25
93
NOTE 20 – EXTINGUISHMENT OF DEBT
In January of 2016, the Company paid off two FHLB convertible fixed rate advances totaling $4.5 million with an average rate of 4.01%
due in 2017. The Company incurred prepayment penalties of $242,000, or $160,000 after tax. The Earnings per Share effect of ($.04)
was offset by gains generated on investment securities sales during the same month. The Company used a combination of alternative
wholesale borrowings at a rate of 1.44% and current liquidity to fund the early payoff, for an estimated annual interest expense
savings of $130,000.
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures - None
Item 9A. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. With the supervision and participation by management, including the Company’s
principal executive officer and principal financial officer, the effectiveness of disclosure controls and procedures (as defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”)) has been evaluated as of the end of the
period covered by this report. Based upon that evaluation, the Company’s principal executive officer and principal financial officer
have concluded that these controls and procedures were effective.
Management’s Annual Report on Internal Control Over Financial Reporting. The report on management’s assessment of internal
control over financial reporting is included in Item 8.
Changes in Internal Control Over Financial Reporting. Our Chief Executive Officer and Chief Financial Officer have concluded that
there have been no changes during the fourth quarter of 2016 in the Company’s internal control over financial reporting (as defined in
Rules 13a-13 and 15d-15 of the Exchange Act) that have materially affected, or are reasonable likely to materially affect, internal
control over financial reporting.
Item 9B. Other Information – Not applicable.
PART III
Item l0. Directors, Executive Officers and Corporate Governance
Information relating to this item will be set forth in the Company’s definitive proxy statement to be filed on or about March 29, 2017
in connection with the Annual Meeting of Shareholders to be held May 23, 2017 (the “Proxy Statement”). The information contained
in the Proxy Statement under the following captions is incorporated herein by reference: “Board Nominees,” “Continuing Directors,”
“The Board of Directors and Committees of the Board,” and “Section 16(a) Beneficial Ownership Reporting Compliance.”
Information relating to executive officers of the Company is set forth in Part I of this Form 10-K.
Item ll. Executive Compensation
Information relating to this item is incorporated herein by reference to the information in the Proxy Statement that is set forth under
the following captions of “Executive Compensation” and “Director Compensation in 2016.”
Item l2. Security Ownership of Certain Beneficial Owners and Management and Related Shareholders Matters
Information relating to this item is incorporated herein by reference to the information in the Proxy Statement that is set forth under
the caption “Share Ownership of Directors and Executive Officers.”
Information relating to equity compensation is incorporated herein by reference to the information in the Proxy Statement that is set
forth under the caption “Outstanding Equity Awards.”
Item l3. Certain Relationships and Related Transactions, and Director Independence
Information relating to this item is incorporated herein by reference to the information in the Proxy Statement that is set forth under
the captions of “Transactions with Related Persons” and “The Board of Directors and Committees of the Board.”
94
Item l4. Principal Accountant Fees and Services
Information relating to this item is incorporated herein by reference to the information in the Proxy Statement that is set forth under
the caption “Ratification of Independent Auditors.”
PART IV
Item l5. Exhibits, Financial Statement Schedules
(a)
l. Financial Statements
Included in Part II of this report:
Item 8. Financial Statements
Consolidated Financial Statements included in this Annual Report:
Management’s Annual Report on Internal Control Over Financial Reporting ........................................................................
Report of Independent Registered Public Accounting Firm ....................................................................................................
Consolidated Balance Sheets as of December 31, 2016 and 2015 ..........................................................................................
Consolidated Statements of Income for the Years Ended December 31, 2016, 2015 and 2014 ..............................................
Consolidated Statements of Comprehensive Income for the Years Ended December 31, 2016, 2015 and 2014 ....................
Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2016, 2015 and 2014 ........................
Consolidated Statements of Cash Flows for the Years Ended December 31, 2016, 2015 and 2014 .......................................
Notes to Consolidated Financial Statements ...........................................................................................................................
48
49
50
51
52
53
54
55
(a)
2. Financial Statement Schedules
Financial statements schedules are omitted because the required information is either not applicable, not required or is not
shown in the respective financial statements or in the notes thereto.
(a)
3. Exhibits Required by Item 601 of Regulation S-K
The exhibits filed or incorporated by reference as a part of this report are listed in the Index to Exhibits.
95
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
SIGNATURES
Date: March 23, 2017
CORTLAND BANCORP
By: /s/ James M. Gasior
James M. Gasior
President, Chief Executive Officer, Director
(Principal Executive Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on
behalf of the registrant and in the capacities and on the dates indicated.
/s/ Timothy K. Woofter
Timothy K. Woofter
/s/ James M. Gasior
James M. Gasior
/s/ Timothy Carney
Timothy Carney
/s/ David C. Cole
David C. Cole
/s/ J. Martin Erbaugh
J. Martin Erbaugh
/s/ James E. Hoffman, III
James E. Hoffman, III
/s/ Neil J. Kaback
Neil J. Kaback
/s/ Joseph E. Koch
Joseph E. Koch
/s/ Joseph P. Langhenry
Joseph P. Langhenry
/s/ Thomas P. Perciak
Thomas P. Perciak
/s/ Richard B. Thompson
Richard B. Thompson
/s/ Anthony R. Vross
Anthony R. Vross
/s/ David J. Lucido
David J. Lucido
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
March 23, 2017
Date
Director and Chairman of the Board
President, Chief Executive Officer and
Director (Principal Executive Officer)
Director
Director
Director
Director
Director
Director
Director
Director
Director
Director
Chief Financial Officer
(Principal Financial and Accounting Officer)
96
The following exhibits are filed or incorporated by reference as part of this report:
INDEX TO EXHIBITS
Exhibit
No.
3.1
3.2
4.1
4.2
*10.1
Exhibit Description
Form**
Exhibit
Filing
Date
Filed
Herewith
Incorporated by Reference
Restated Amended Articles of Cortland Bancorp reflecting
amendment dated June 25, 1999. Note: filed for purposes of SEC
reporting compliance only. This restated document has not been
filed with the State of Ohio.
Code of Regulations, as amended.
The rights of holders of equity securities are defined in portions of the
Articles of Incorporation and Code of Regulations as referenced in
Exhibits 3.1 and 3.2
Agreement to furnish instruments and agreements defining rights of
holders of long-term debt
Group Term Carve Out Plan dated February 23, 2001, by The Cortland
Savings and Banking Company with each executive officer other than
Rodger W. Platt and with selected other officers, as amended by the
August 2002 letter amendment
10-K(1)
3.1 03/16/06
10-K
3.2
03/24/15
10-K(1)
4.1
03/16/06
10-K(1)
10.1
03/16/06
*10.1.1
Amendment of Group Term Carve Out Plan, dated October 28,
2014
8-K
10.1.1 11/03/14
10.2
[Reserved]
10.3
[Reserved]
*10.4
Amended Director Retirement Agreement between Cortland
Bancorp and David C. Cole, dated as of December 18, 2007
10-K
10.4 03/17/08
10.5
[Reserved]
10.6
[Reserved]
*10.7
*10.8
Amended Director Retirement Agreement between Cortland
Bancorp and James E. Hoffman III, dated as of December 18, 2007
10-K
10.7 03/17/08
Amended Director Retirement Agreement between Cortland
Bancorp and Neil J. Kaback, dated as of December 18, 2007
10-K
10.8 03/17/08
10.9
[Reserved]
*10.10
*10.11
*10.12
Amended Director Retirement Agreement between Cortland
Bancorp and Richard B. Thompson, dated as of December 18, 2007
10-K
10.10 03/17/08
Amended Director Retirement Agreement between Cortland
Bancorp and Timothy K. Woofter, dated as of December 18, 2007
Form of Split Dollar Agreement entered into by Cortland Bancorp
and each of Directors David C. Cole, James E. Hoffman III, and
Timothy K. Woofter as of February 23, 2001, as of March 1, 2004,
with Director Neil J. Kaback, and as of October 1, 2001, with
Director Richard B. Thompson;
as amended on December 26, 2006, for Directors Cole, Hoffman,
Thompson, and Woofter;
10-K
10.11 03/17/08
10-K(1)
10.12
03/16/06
10-K
10.12 03/15/07
*10.13
Director’s Retirement Agreement between Cortland Bancorp and
Director Joseph E. Koch, dated as of April 19, 2011
8-K
10.13 04/22/11
97
Exhibit
No.
*10.14
*10.15
*10.16
*10.17
*10.18
*10.19
Exhibit Description
Form**
Exhibit
Filing
Date
Filed
Herewith
Incorporated by Reference
Split Dollar Agreement and Endorsement between Cortland
Bancorp and Director Joseph E. Koch, dated as of April 19, 2011
Form of Indemnification Agreement entered into by Cortland
Bancorp with each of its directors
Endorsement Split Dollar Agreement between The Cortland
Savings and Banking Company and David J. Lucido, dated as of
March 27, 2012
Seventh Amended Salary Continuation Agreement between The
Cortland Savings and Banking Company and Timothy Carney,
dated as of November 24, 2015
Third Amended Salary Continuation Agreement between The
Cortland Savings and Banking Company and Lawrence A.
Fantauzzi, dated as of December 3, 2008
Seventh Amended Salary Continuation Agreement between The
Cortland Savings and Banking Company and James M. Gasior,
dated as of November 24, 2015
8-K
10.14 04/22/11
10-K(1)
10.15 03/16/06
10-K
10.16 03/29/12
8-K
10.17 12/01/15
8-K
10.18 12/12/08
8-K
10.19 12/01/15
10.20
[Reserved]
10.21
[Reserved]
10.22
[Reserved]
*10.23
*10.24
*10.25
*10.26
Amended Salary Continuation Agreement between The Cortland
Savings and Banking Company and David J. Lucido dated as of
November 24, 2015
Fourth Amended Split Dollar Agreement and Endorsement between
The Cortland Savings and Banking Company and Timothy Carney,
dated as of April 19, 2011
Amended Salary Continuation Agreement between The Cortland
Savings and Banking Company and Stanley P. Feret dated as of
November 24, 2015
Fourth Amended Split Dollar Agreement and Endorsement between
The Cortland Savings and Banking Company and James M. Gasior,
dated as of April 19, 2011
8-K
10.23
12/01/15
8-K
10.24 04/22/11
8-K
10.25 12/01/15
8-K
10.26 04/22/11
10.27
[Reserved]
10.28
[Reserved]
10.29
[Reserved]
*10.30
Endorsement Split Dollar Agreement between The Cortland Savings
and Banking Company and Stanley P. Feret, dated as of July 23, 2013
10-Q
10.30 08/13/13
*10.31.1
Severance Agreement between Cortland Bancorp and Tim Carney,
dated as of September 28, 2012, as amended November 24, 2015
8-K
10.31.1 12/01/15
*10.31.2
Severance Agreement between Cortland Bancorp and James Gasior,
dated as of September 28, 2012, as amended November 24, 2015
8-K
10.31.2 12/01/15
*10.31.3
Severance Agreement between Cortland Bancorp and David J.
Lucido, dated as of September 28, 2012, as amended November 24,
2015
8-K
10.31.3 12/01/15
10.32
[Reserved]
98
Exhibit
No.
10.33
[Reserved]
Exhibit Description
Form**
Exhibit
Filing
Date
Filed
Herewith
Incorporated by Reference
*10.34
Severance Agreement between Cortland Bancorp and Stanley P.
Feret, dated as of September 28, 2012, as amended November 24,
2015
*10.35
Annual Incentive Plan for Executive Officers
*10.36
2015 Omnibus Equity Plan
8-K
10.34 12/01/15
8-K
10.35 08/03/15
10-Q
10.36 08/11/15
10.36.1
Form of incentive stock option award under the 2015 Omnibus
Equity Plan
10-Q
10.36.1 08/11/15
10.36.2
Form of nonqualified stock option award under the 2015 Omnibus
Equity Plan
10-Q
10.36.2 08/11/15
10.36.3
Form of restricted stock award under the 2015 Omnibus Equity
Plan
*10.37
2015 Director Equity Plan
10-Q
10.36.3 08/11/15
10-Q
10.37 08/11/15
10.37.1
Form of nonqualified stock option award under the 2015 Director
Equity Plan
10-Q 10.37.1 08/11/15
10.37.2
Form of incentive stock option award under the 2015 Director
Equity Plan
10-Q 10.37.2 08/11/15
11
Statement of re-computation of per share earnings
14
21
23
Code of Ethics
Subsidiaries of the Registrant
Consents of experts and counsel – Consent of independent
registered public accounting firm
31.1
Certification of the Chief Executive Officer under Rule 13a-14(a)
31.2
Certification of Chief Financial Officer under Rule 13a-14(a)
32
101
Section 1350 Certification of Chief Executive Officer and Chief
Financial Officer required under section 906 of the Sarbanes-Oxley
Act of 2002
The following materials from Cortland Bancorp’s Annual Report on
Form 10-K for the year ended December 31, 2016, formatted in
Extensible Business Reporting Language (XBRL): (a) Consolidated
Balance Sheets; (b) Consolidated Statements of Income; (c)
Consolidated Statements of Comprehensive Income; (d)
Consolidated Statements of Changes in Shareholders’ Equity; (e)
Consolidated Statements of Cash Flows; and (f) the Notes to
Consolidated Financial Statements tagged as blocks of text and in
detail (included with this filing)
(1) Film number 06691632
* Management contract or compensatory plan or arrangement
**
SEC File No. 000-13814
See Note 1
of Financial
Statements
10-K
14
3/17/08
Copies of any exhibits will be furnished to shareholders upon written request. Requests should be directed to Lance A. Morrison,
Secretary, Cortland Bancorp, 194 West Main Street, Cortland, Ohio 44410.
99
CORTLAND BANCORP AND
THE CORTLAND SAVINGS AND BANKING COMPANY
BOARD OF DIRECTORS
TIMOTHY K. WOOFTER
Chairman of the Board
President and Chief Executive Officer, Stan-Wade Metal Products
Tank Manufacturer and Oil Equipment Distributor
TIMOTHY CARNEY
Executive Vice President and Chief Operating Officer
Cortland Bancorp and The Cortland Savings and Banking Company
DAVID C. COLE
Partner and President, Cole Valley Motor Company
Automobile Dealership
J. MARTIN ERBAUGH
President, JM Erbaugh Co.
Investment Firm
JAMES M. GASIOR
President and Chief Executive Officer
Cortland Bancorp and The Cortland Savings and Banking Company
JAMES E. HOFFMAN, III
Attorney, Hoffman and Walker
Law Firm
NEIL J. KABACK
Vice President, Cohen & Company, Ltd.
Accounting Firm
JOSEPH E. KOCH
President, Joe Koch Construction
Homebuilding, Developing and Remodeling Company
JOSEPH P. LANGHENRY
Managing Principal, Langhenry Venture Partners
Investment Firm
THOMAS P. PERCIAK
Mayor, Strongsville, OH
Government
RICHARD B. THOMPSON
Executive, Therm-O-Link, Inc.
Electrical Wire and Cable Manufacturer
ANTHONY R. VROSS
Executive, Simon Roofing
Commercial Roofing and Industrial Roof Maintenance
DIRECTOR EMERITUS
K. RAY MAHAN
100
CORTLAND BANCORP
EXECUTIVE OFFICERS
JAMES M. GASIOR
President and Chief Executive Officer
TIMOTHY CARNEY
Executive Vice President and Chief Operating Officer
DAVID J. LUCIDO
Senior Vice President and Chief Financial Officer
STANLEY P. FERET
Senior Vice President and Chief Lending Officer
THE CORTLAND SAVINGS AND BANKING COMPANY
OFFICERS
JAMES M. GASIOR
President and Chief Executive Officer
TIMOTHY CARNEY
Executive Vice President and Chief Operating Officer
DAVID J. LUCIDO
Senior Vice President and Chief Financial Officer
STANLEY P. FERET
Senior Vice President and Chief Lending Officer
KAREN BOSLEY
Assistant Vice President
Business Banking Officer
DEBORAH L. EAZOR
Vice President
Operations Manager
DANIELLE CANTRELL
Vice President
Retail, Business Banking and Investment Sales Manager
MELANIE CHRISTIE
Assistant Vice President
BSA/Compliance Officer/Director of Security
JONI EVERSON
Vice President
Retail Mortgage Banking Officer
KEITH STINSON
Vice President
Retail Mortgage Banking Officer
JOAN M. FRANGIAMORE
Vice President
Controller
KEVIN CULP
Vice President
Commercial Banking Officer
JOHN HEWITT
Vice President
Credit Manager
HEATHER J. BOWSER
Assistant Vice President
Collection Officer
BRENT MARAKAS
Assistant Vice President
Commercial Banking Portfolio Manager
101
LANCE A. MORRISON
Vice President
General Counsel/Corporate Secretary/Director of Human Resources
J. MICHAEL BRAINARD
Vice President
Commercial Banking Officer
KEITH MROZEK
Vice President
Special Assets & Loan Review
ROCCO PAGE
Vice President
Retail Mortgage Banking Officer
MICHAEL KANE
Assistant Vice President
Market Development Officer
MICHELLE REILLY
Vice President, Assistant Treasurer
Mortgage Banking/ Funds Management
BARBARA R. SANDROCK
Vice President
Information Systems Manager
KAREN SHARP
Vice President
Retail Mortgage Banking Officer
ROBERT MEEK
Assistant Vice President
Treasury Management/Sales Representative
CARRIE STACKHOUSE
Vice President
Commercial Banking Officer
KAREN JINDRA
Vice President
Retail Mortgage Banking Officer
BRYAN IGNAZIO
Assistant Vice President
Business Banking Officer
KAREN MILLER
Assistant Secretary
Retail Operations Manager/Retail Training
MICHAEL LIPKE
Vice President
Special Assets & Loan Review
JANET K. HOUSER
Assistant Vice President
Electronic Banking Specialist
MELISSA MAKI
Assistant Vice President
Director of Marketing and Communications
MARK CHUEY
Vice President
Retail Mortgage Banking Officer
NATHANIEL J. MARSHALL
Market Vice President
Private Bank Officer/Greater Cleveland
NICOLE WHITSEL
Assistant Vice President
Risk Manager/Compliance
MARK E. TAYLOR
Vice President
Commercial Banking Officer
AMY MANOLIO
Vice President
Private Bank Officer/Mahoning Valley
JACQUELINE TREHARNE
Assistant Vice President
Mortgage Operations Manager
SHIRLEY A. WADE
Assistant Vice President
Executive Secretary
JAMES E. WELLINGTON
Vice President
Retail Mortgage Banking Officer
DARLENE MACK
Assistant Vice President
Human Resources Manager
STANLEY MAGIELSKI
Vice President
Commercial Banking Officer
DAVID BELL
Vice President
Senior Commercial Banking Officer/Greater Cleveland Team Lead
102