Edgar Filing: CORTLAND BANCORP INC

Large accelerated filer

Accelerated filer

Non-accelerated filer

¨ (Do not check if a smaller reporting company)

Smaller reporting company

FORM 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D. C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended: March 31, 2012

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition from to

Commission file number: 0-13814

Cortland Bancorp

(Exact name of registrant as specified in its charter)


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

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

330- 637-8040

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 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 x No ¨

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 definition of “accelerated filer and large accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act. Yes ¨ No x

APPLICABLE ONLY TO CORPORATE ISSUERS:

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


TITLE OF CLASS		SHARES OUTSTANDING
Common Stock, No Par Value		4,525,526 Shares May 9, 2012


PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Cortland Bancorp and Subsidiaries:

Consolidated Balance Sheets – March 31, 2012 (unaudited) and December 31, 2011			2

Consolidated Statements of Income (unaudited) – Three months ended March 31, 2012 and 2011			3

Consolidated Statements of Comprehensive Income (unaudited) – Three months ended March 31, 2012 and 2011			4

Consolidated Statement of Changes in Shareholders’ Equity (unaudited) – Three months ended March 31, 2012 and 2011			5

Consolidated Statements of Cash Flows (unaudited) – Three months ended March 31, 2012 and 2011			6

Notes to Consolidated Financial Statements (unaudited) – March 31, 2012			7-31

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Consolidated Average Balance Sheets, Yields and Rates – Quarter-to-Date March 31, 2012, December 31, 2011 and March 31, 2011			32

Selected Financial Data			33

Financial Review			34-47

Item 3. Quantitative and Qualitative Disclosures About Market Risk			48-49

Item 4. Controls and Procedures			50

PART II - OTHER INFORMATION

Item 1. Legal Proceedings			51

Item 1A. Risk Factors			51

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds			51

Item 3. Defaults Upon Senior Securities			51

Item 4. Mine Safety Disclosures			51

Item 5. Other Information			51

Item 6. Exhibits			52-55

Signatures			56

Exhibit 31.1

Exhibit 31.2

Exhibit 32

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share data)


	(Unaudited)
	March 31,			December 31,
	2012			2011
ASSETS
Cash and due from banks	$	8,827		$	9,805
Interest-earning deposits and other earning assets		4,114			6,371

Total cash and cash equivalents		12,941			16,176

Investment securities available-for-sale (Note 3)		182,686			185,916
Loans held for sale		6,804			947
Total loans (Note 4)		277,357			289,096
Less allowance for loan losses (Note 4)		(3,139	)		(3,058	)

Net loans		274,218			286,038

Premises and equipment		6,446			6,474
Bank-owned life insurance		13,726			12,937
Other assets		11,625			11,342

Total assets	$	508,446		$	519,830

LIABILITIES
Noninterest-bearing deposits	$	73,712		$	70,726
Interest-bearing deposits		335,343			352,039

Total deposits		409,055			422,765

Federal Home Loan Bank advances—short term		7,500			6,500
Federal Home Loan Bank advances—long term		31,000			31,000
Other short-term borrowings		3,680			4,773
Subordinated debt (Note 7)		5,155			5,155
Other liabilities		4,423			3,918

Total liabilities		460,813			474,111

SHAREHOLDERS’ EQUITY
Common stock—$5.00 stated value—authorized 20,000,000 shares; issued 4,728,267 shares in 2011 and 2010; outstanding shares, 4,525,529 in 2012 and 4,525,530 in 2011		23,641			23,641
Additional paid-in capital		20,850			20,850
Retained earnings		8,644			7,485
Accumulated other comprehensive loss		(1,908	)		(2,663	)
Treasury stock, at cost, 202,738 shares in 2012 and 202,737 shares in 2011		(3,594	)		(3,594	)

Total shareholders’ equity		47,633			45,719

Total liabilities and shareholders’ equity	$	508,446		$	519,830

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

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(Amounts in thousands, except share data)


	THREE MONTHS
	ENDED MARCH 31,
	2012			2011
INTEREST INCOME
Interest and fees on loans	$	3,967		$	3,763
Interest and dividends on investment securities:
Taxable interest		951			1,113
Nontaxable interest		350			395
Dividends		32			32
Other interest income		5			17

Total interest income		5,305			5,320

INTEREST EXPENSE
Deposits		720			864
Other short-term borrowings		1			2
Federal Home Loan Bank advances—short term		19			51
Federal Home Loan Bank advances—long term		298			313
Subordinated debt		26			23

Total interest expense		1,064			1,253

Net interest income		4,241			4,067
PROVISION FOR LOAN LOSSES		270			174

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		3,971			3,893

NON-INTEREST INCOME
Fees for customer services		520			513
Investment securities gains—net		7			83
Impairment losses on investment securities:
Total other-than-temporary impairment losses		(35	)		(141	)
Portion of gains recognized in other comprehensive income (before tax)		(136	)		(61	)

Net impairment losses recognized in earnings		(171	)		(202	)
Mortgage banking gains		154			16
Other real estate losses—net		—			(28	)
Earnings on bank-owned life insurance		123			124
Other non-interest income		62			27

Total non-interest income		695			533
NON-INTEREST EXPENSES
Salaries and employee benefits		2,009			1,795
Net occupancy and equipment expense		430			455
State and local taxes		125			116
FDIC insurance expense		70			211
Professional fees		166			161
Loss on partnership		444			—
Other operating expenses		620			617

Total non-interest expenses		3,864			3,355

INCOME BEFORE FEDERAL INCOME TAX (BENEFIT)		802			1,071
Federal income tax (benefit) expense		(357	)		202

NET INCOME	$	1,159		$	869

EARNINGS PER SHARE, BOTH BASIC AND DILUTED (Note 6)	$	0.26		$	0.19
CASH DIVIDENDS DECLARED PER SHARE	$	—		$	—

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

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(Amounts in thousands)


	THREE MONTHS
	ENDED MARCH 31,
	2012			2011
Net income	$	1,159		$	869
Other comprehensive income:
Securities available for sale:
Unrealized holding gains on available-for-sale securities		981			1,641
Tax effect		(334	)		(558	)
Reclassification adjustment for other-than-temporary impairment losses on debt securities		171			202
Tax effect		(58	)		(69	)
Reclassification adjustment for net gains realized in net income		(7	)		(83	)
Tax effect		2			28

Total other comprehensive income		755			1,161

Total comprehensive income	$	1,914		$	2,030

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

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(Amounts in thousands)


							Accumulated
			Additional				Other						Total
	Common		Paid-in		Retained		Comprehensive			Treasury			Shareholders’
	Stock		Capital		Earnings		Loss			Stock			Equity
THREE MONTHS ENDED MARCH 31, 2011

Balance at December 31, 2010	$	23,641	$	20,850	$	3,413	$	(2,458	)	$	(3,594	)	$	41,852
Comprehensive income:
Net income		—		—		869		—			—			869
Other comprehensive income, net of tax:
Unrealized gains on available-for-sale securities, net of reclassification adjustment, net of tax of $577		—		—		—		1,121			—			1,121
Other comprehensive gain related to securities which other-than-temporary impairment has been recognized in earnings, net of tax of $21		—		—		—		40			—			40

Total comprehensive income		—		—		—		—			—			2,030

Balance at March 31, 2011	$	23,641	$	20,850	$	4,282	$	(1,297	)	$	(3,594	)	$	43,882

THREE MONTHS ENDED MARCH 31, 2012

Balance at December 31, 2011	$	23,641	$	20,850	$	7,485	$	(2,663	)	$	(3,594	)	$	45,719
Comprehensive income:
Net income		—		—		1,159		—			—			1,159
Other comprehensive income, net of tax:
Unrealized gains on available-for-sale securities, net of reclassification adjustment, net of tax of $343		—		—		—		665			—			665
Other comprehensive gain related to securities which other-than-temporary impairment has been recognized in earnings, net of tax of $46		—		—		—		90			—			90

Total comprehensive income		—		—		—		—			—			1,914

Balance at March 31, 2012	$	23,641	$	20,850	$	8,644	$	(1,908	)	$	(3,594	)	$	47,633

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

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(Amounts in thousands)


	FOR THE MONTHS
	ENDED MARCH 31,
	2012			2011
Net cash (deficit) flow from operating activities	$	(3,913	)	$	1,931
Cash (deficit) flow from investing activities
Purchases of available-for-sale securities		(5,857	)		(1,612	)
Proceeds from sales of securities		—			3,227
Proceeds from call, maturity and principal payments on securities		9,523			8,142
Net increase in loans made to customers		11,550			7,560
Proceeds from disposition of other real estate		78			260
Purchases of bank-owned life insurance		(694	)		—
Purchases of premises and equipment		(119	)		(86	)

Net cash flow from investing activities		14,481			17,491

Cash (deficit) flow from financing activities
Net decrease in deposit accounts		(13,710	)		(7,303	)
Repayments of Federal Home Loan Bank advances		(7,000	)		(17,000	)
Proceeds from Federal Home Loan Bank		8,000			10,000
Net (decrease) increase in other short-term borrowings		(1,093	)		1,664

Net cash deficit from financing activities		(13,803	)		(12,639	)

Net change in cash and cash equivalents		(3,235	)		6,783

Cash and cash equivalents
Beginning of year		16,176			15,804

End of year	$	12,941		$	22,587

Supplemental disclosures:
Cash paid during the period for:
Income taxes	$	200		$	—
Interest	$	1,089		$	1,303

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

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

1.) Basis of Presentation:

The accompanying unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States (U.S. GAAP) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2012 are not necessarily indicative of the results that may be expected for the year ending December 31, 2012. These interim unaudited consolidated financial statements should be read in conjunction with our annual audited financial statements as of December 31, 2011, included in our Form 10-K for the year ended December 31, 2011, filed with the United States Securities and Exchange Commission. The accompanying consolidated balance sheet at December 31, 2011, has been derived from the audited consolidated balance sheet but does not include all of the information and footnotes required by U.S. GAAP for complete financial statements.

2.) Reclassifications:

Certain items contained in the 2011 financial statements have been reclassified to conform to the presentation for 2012. Such reclassifications had no effect on the net results of operations.

3.) Investment Securities Available-for-Sale:

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. The Company currently has no securities classified as held-to-maturity or trading.

Available-for-sale securities are carried at fair value with unrealized gains and losses recorded as a separate component of shareholders’ equity, net of tax effects. Realized gains or losses on dispositions are based on net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. Interest income includes amortization of purchase premium or discount premiums. Discounts on securities are amortized on the level-yield method without anticipating payments, except for both U.S. Government and private-label mortgage-backed and related securities where twelve months of historical prepayments are taken into consideration.

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 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 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 while the non-credit related OTTI on securities not expected to be sold is recognized in other comprehensive loss.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following is a summary of investment securities:


			(Amounts in thousands)
			Gross		Gross
			Unrealized		Unrealized		Estimated Fair
	Amortized Cost		Gains		Losses		Value
March 31, 2012
Investment securities available-for-sale
U.S. Treasury securities	$	118	$	13	$	—	$	131
U.S. Government agencies and corporations		18,214		162		—		18,376
Obligations of states and political subdivisions		40,506		1,732		70		42,168
U.S. Government-sponsored mortgage-backed securities		65,741		2,909		21		68,629
U.S. Government-sponsored collateralized mortgage obligations		39,280		411		165		39,526
Private-label mortgage-backed securities		122		4		—		126
Private-label collateralized mortgage obligations		502		—		238		264
Trust preferred securities		17,415		106		7,591		9,930

Total debt securities		181,898		5,337		8,085		179,150
Regulatory stock		3,049		—		—		3,049
General Motors equity investments		630		—		143		487

Total available-for-sale	$	185,577	$	5,337	$	8,228	$	182,686

December 31, 2011
Investment securities available-for-sale
U.S. Treasury securities	$	119	$	14	$	—	$	133
U.S. Government agencies and corporations		20,280		262		—		20,542
Obligations of states and political subdivisions		37,419		1,602		2		39,019
U.S. Government-sponsored mortgage-backed securities		71,078		3,102		91		74,089
U.S. Government-sponsored collateralized mortgage obligations		39,131		318		255		39,194
Private-label mortgage-backed securities		127		3		—		130
Private-label collateralized mortgage obligations		518		—		267		251
Trust preferred securities		17,600		4		8,459		9,145

Total debt securities		186,272		5,305		9,074		182,503
Regulatory stock		3,049		—		—		3,049
General Motors equity investments		631		—		267		364

Total available-for-sale	$	189,952	$	5,305	$	9,341	$	185,916

At March 31, 2012 and December 31, 2011, regulatory stock consisted of $2.8 million in Federal Home Loan Bank (FHLB) stock and $226,000 in Federal Reserve Bank (FED) stock. Each investment is carried at cost, and the Company is required to hold such investments as a condition of membership in order to transact business with the FHLB and the FED.

While the FHLBs have been negatively impacted by the current economic conditions, the FHLB of Cincinnati has reported profits for 2011 and year-to-date 2012, remains in compliance with regulatory capital and liquidity requirements, continues to pay dividends on stock and makes redemptions at par value. With consideration given to these factors, management concluded that the stock was not impaired at March 31, 2012 or December 31, 2011.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The amortized cost and fair value of debt securities at March 31, 2012, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.


	(Amounts in thousands)
			Estimated Fair
	Amortized Cost		Value
Investment securities available-for-sale
Due in one year or less	$	1,831	$	1,843
Due after one year through five years		11,740		11,949
Due after five years through ten years		11,117		11,378
Due after ten years		51,565		45,435

Total investment securities available-for-sale		76,253		70,605
U.S. Government-sponsored mortgage-backed and related securities		105,021		108,155
Private-label mortgage-backed and related securities		624		390

Total investment securities	$	181,898	$	179,150

The table below sets forth the proceeds and gains or losses realized on securities sold or called for the three months ended:


	(Amounts in thousands)
	March 31,
	2012		2011
Proceeds on securities sold	$	—	$	3,227
Gross realized gains		—		81
Gross realized losses		—		—

Proceeds on securities called	$	2,246	$	330
Gross realized gains		7		2
Gross realized losses		—		—

Available-for-sale securities, carried at fair value, totaled $182.7 million at March 31, 2012 and $185.9 million at December 31, 2011. These securities represent 100.00% of all investment securities at both March 31, 2012 and December 31, 2011. In management’s opinion, these levels provide an adequate level of liquidity.

Investment securities with a carrying value of approximately $105.2 million at March 31, 2012 and $106.4 million at December 31, 2011 were pledged to secure deposits and for other purposes.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at March 31, 2012:

(Amounts in thousands)

Less than 12 Months

12 Months or More

Total

Unrealized

Fair Value

Losses

Fair Value

Losses

Fair Value

Losses

U.S. Government-sponsored mortgage-backed and related securities

7,333

—

7,333

U.S. Government-sponsored collateralized mortgage obligations

10,293

142

1,675

11,968

165

Private-label collateralized mortgage obligation

—

262

238

262

238

Obligations of states and political subdivisions

3,289

—

3,289

Trust preferred securities

2,678

594

6,647

6,997

9,325

7,591

General Motors equity investments

487

143

—

487

143

Total

24,080

970

8,584

7,258

32,664

8,228

The above table comprises 43 investment securities where the fair value is less than the related amortized cost.

The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at December 31, 2011:


	(Amounts in thousands)
	Less than 12 Months				12 Months or More				Total
			Unrealized				Unrealized				Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses
U.S. Government-sponsored mortgage-backed and related securities	$	13,593	$	91	$	—	$	—	$	13,593	$	91
U.S. Government-sponsored collateralized mortgage obligations		14,866		220		1,858		35		16,724		255
Private-label collateralized mortgage obligation		—		—		249		267		249		267
Obligations of states and political subdivisions		—		—		1,064		2		1,064		2
Trust preferred securities		—		—		8,628		8,459		8,628		8,459
General Motors equity investments		364		267		—		—		364		267

Total	$	28,823	$	578	$	11,799	$	8,763	$	40,622	$	9,341

The above table comprises 45 investment securities where the fair value is less than the related amortized cost.

The trust preferred securities with an unrealized loss represent pools of trust preferred debt primarily issued by bank holding companies and insurance companies. The unrealized loss on these securities at March 31, 2012 was $7.6 million compared to a $8.5 million loss at December 31, 2011.

The unrealized losses on the Company’s investment in obligations of states and political subdivisions, U.S. Government-sponsored mortgage-backed securities, U.S. Government-sponsored collateralized mortgage obligations, private-label mortgage-backed securities and private-label collateralized mortgage obligations (CMO) were caused by changes in market rates and related spreads, as well as reflecting current distressed conditions in the credit markets and the market’s on-going reassessment of appropriate liquidity and risk premiums. 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, 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 those investments to be other-than-temporarily impaired at March 31, 2012.

Among the Company’s numerous mortgage-backed securities is one privately-issued variable rate CMO. The security was valued on March 31, 2012 at $0.52 on a dollar and is scheduled to reprice in February of 2013. The Company had the security tested by a third party for subprime mortgage containment and none was found. As government intervention takes hold and the market in general somewhat settles, the CMO market has begun a slow recovery. At March 31, 2009, this security priced at $0.39 on a dollar and $0.62, $0.66 and $0.48 on a dollar at December 31, 2009, December 31, 2010 and December 31, 2011, respectively. The sizable fluctuations in the value since March 2009 provides evidence that the impairment is temporary. General market liquidity has been improving, even with the government phasing out of its many assistive programs. The security carries a credit rating of “CCC” indicating some probability of default. The security’s underlying delinquency rate is 6.15%. A current analysis of this security indicates at the current delinquency and default rates, no loss is projected on this security through its maturity. The structure of this security is such that it contains both senior and subordinate tranches. The Company owns the 1A2 tranche, subordinate only to the super senior 1A1 tranche. There were originally 4 tranches below the 1A2, but only two remain. Given this scenario, the structure of this security plays into its value as much as the underlying collateral itself. From a structural standpoint, the subordination and resulting support requirements are ultra- sensitive to prepayments. The higher the prepayment (CPR) rate, the lower the probability of impairment because prepayments are applied pari passu through the structure (not subordinate). For analysis purposes, the Company uses a third party credit profile that presents a price/yield credit stress table which contains 36 different scenarios. Each scenario is driven by CDR (default rate), loss severity, and CPR assumptions, with the results being any expected loss and the year any first loss may occur. In reviewing the occurrence of losses throughout each of the profiles, there is not a consistent range of results leading to any certainty of impairment. The Company will continue to monitor these stress results and upon noting a consistency in negative results, will seek to run present value cash flows to quantify an estimated loss. This CMO is in the available-for-sale portfolio and it is not more-likely-than-not that the Company will be required to sell the debt security before its anticipated recovery. As a result of all the facts presented, the Company does not consider this investment to be other-than-temporarily impaired.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Securities Deemed to be Other-Than-Temporarily Impaired

For debt securities in an unrealized loss position, ASC topic 320 requires an entity to assess 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), ASC topic 320 defines the presentation and amount of the OTTI recognized in the income statement.

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 income statement 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 9, the Company assessed the impairment of certain securities currently in an illiquid market. Through the impairment assessment process, the Company determined that the investments discussed in the following table were other-than-temporarily impaired at March 31, 2012 and 2011. The Company recorded impairment credit losses in earnings on available-for-sale securities of $171,000 and $202,000 for the quarters ended March 31, 2012 and 2011, respectively. The $136,000 and $61,000 non-credit portion of impairment recognized during the quarters ended March 31, 2012 and 2011, respectively, was recorded in other comprehensive income.


	(Amounts in thousands)
	March 31,
	2012		2011
Trust preferred securities	$	171	$	202

Total	$	171	$	202

For the quarter ended March 31, 2012, the Company recognized OTTI of $171,000 attributable to 2 trust preferred securities with a cost basis of $3.1 million. For the quarter ended March 31, 2011, the Company recognized OTTI of $202,000 attributable to 5 trust preferred securities with a cost basis of $8.5 million. The impairment charges were recognized after determining the likely future cash flows of these securities had been adversely impacted and attributable to credit deterioration.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following provides a cumulative roll forward of credit losses recognized in earnings for trust preferred securities held and not intended to be sold for the three months ended:


	(Amounts in thousands)
	March 31,
	2012		2011
Beginning balance	$	10,674	$	16,399
Additional credit losses on debt securities for which other-than-temporary impairment was previously recognized		171		202
Reduction for debt securities for which other-than-temporary impairment has been previously recognized and there is no related other comprehensive income		—		(5,927	)

Ending balance	$	10,845	$	10,674

In April 2011, as approved by the U.S. Bankruptcy court, unsecured bondholders of General Motors Corporation (“GM”) received partial distributions in accordance with the Amended Joint Chapter 11 Plan (the “Plan”). The Company owned $2.4 million par value of unsecured bonds determined to be other than temporarily impaired in 2008 and written down to $1.3 million in 2008 and $815,000 in 2009 to a value of $287,000. In accordance with the Plan, the Company received in exchange for the bonds 9,379 shares of GM common shares, 8,527 GM Class A Warrants exercisable at $10.00 per share, 8,527 GM Class B Warrants exercisable at $18.33 per share. The market value of the equity securities was $621,000, generating a recognizable gain of $334,000 over the fully written down value. The Company holds escrow stubs representing any remaining distributions from the bankruptcy trust. The fair value of the equity securities at March 31, 2012 was $487,000. In reviewing GM’s recent share price history, targets prices of analysts, GM’s achievement of the number one automaker in terms of sales and the Company’s ability to hold the securities for a period of time to allow for recovery, the securities are not considered other-than-temporarily impaired.

At March 31, 2012, there was $1.5 million of investment securities considered to be in non-accrual status. This balance is comprised of 14 of its 29 investments in trust preferred securities. The quarterly interest payments have been placed in “payment in kind” status, which results in a temporary delay in the payment of interest. 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. All other trust preferred securities remain in accrual status.

4.) Loans and Allowance for Loan Losses:

The Company, through its subsidiary bank, grants residential, consumer and commercial loans to customers located primarily in Northeast Ohio and Western Pennsylvania.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following represents the composition of the loan portfolio for the period ending:


	(Amounts in thousands)
	March 31, 2012				December 31, 2011
	Balance		%		Balance		%
Commercial real estate	$	172,437		62.2	$	160,319		55.5
Commercial		39,357		14.2		60,233		20.8
Residential real estate		43,147		15.5		45,780		15.8
Consumer		5,515		2.0		5,848		2.0
Home equity		16,901		6.1		16,916		5.9

Total loans	$	277,357			$	289,096

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, consumer loans and home equity 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:		Risk Trend:
Levels of and trends in charge-offs, classifications and non-accruals		Decreasing
Trends in volume and terms		Stable
Changes in lending policies and procedures		Stable
Experience, depth and ability of management		Stable
Economic trends		Stable
Concentrations of credit		Stable

The following factors are analyzed and applied to loans internally graded with higher credit risk in addition to the above factors for non-classified loans:


Factor Considered:		Risk Trend:
Levels and trends in classification		Stable
Declining trends in financial performance		Stable
Structure and lack of performance measures		Stable
Migration between risk categories		Stable

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following is an analysis of changes in the allowance for loan losses for the periods ended:


	(Amounts in thousands)
				Commercial						Home
March 31, 2012	Commercial			Real Estate			Consumer			Equity			Residential			Total
Balance at beginning of period	$	565		$	1,803		$	92		$	128		$	470		$	3,058
Loan charge-offs		(17	)		—			(46	)		(51	)		(100	)		(214	)
Recoveries		2			—			15			2			6			25

Net loan charge-offs		(15	)		—			(31	)		(49	)		(94	)		(189	)
Provision charged to operations		(16	)		(148	)		60			112			262			270

Balance at end of period	$	534		$	1,655		$	121		$	191		$	638		$	3,139


				Commercial						Home
March 31, 2011	Commercial			Real Estate			Consumer			Equity			Residential			Total
Balance at beginning of period	$	249		$	1,611		$	112		$	111		$	418		$	2,501
Loan charge-offs		—			—			(32	)		—			(25	)		(57	)
Recoveries		—			—			19			1			3			23

Net loan charge-offs		—			—			(13	)		1			(22	)		(34	)
Provision charged to operations		110			61			16			(1	)		(12	)		174

Balance at end of period	$	359		$	1,672		$	115		$	111		$	384		$	2,641

The total allowance of $3,139,000 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 segment, the changes in the allowance for loan losses and the recorded investment in loans for the periods ended March 31, 2012 and December 31, 2011.


	(Amounts in thousands)
			Commercial				Home
March 31, 2012	Commercial		Real Estate		Consumer		Equity		Residential		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	64	$	55	$	—	$	—	$	—	$	119
Collectively evaluated for impairment		470		1,600		121		191		638		3,020

Total ending allowance balance	$	534	$	1,655	$	121	$	191	$	638	$	3,139

Loan Portfolio:
Individually evaluated for impairment	$	64	$	1,911	$	—	$	—	$	—	$	1,975
Collectively evaluated for impairment		39,293		170,526		5,515		16,901		43,147		275,382

Total ending loans balance	$	39,357	$	172,437	$	5,515	$	16,901	$	43,147	$	277,357


			Commercial				Home
December 31, 2011	Commercial		Real Estate		Consumer		Equity		Residential		Total
Allowance for loan losses:
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	69	$	55	$	—	$	—	$	—	$	124
Collectively evaluated for impairment		496		1,748		92		128		470		2,934

Total ending allowance balance	$	565	$	1,803	$	92	$	128	$	470	$	3,058

Loan Portfolio:
Individually evaluated for impairment	$	69	$	2,618	$	—	$	—	$	—	$	2,687
Collectively evaluated for impairment		60,164		157,701		5,848		16,916		45,780		286,409

Total ending loans balance	$	60,233	$	160,319	$	5,848	$	16,916	$	45,780	$	289,096

The following tables represent credit exposures by internally assigned grades for March 31, 2012 and December 31, 2011. 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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 make 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 March 31, 2012 and December 31, 2011:


	(Amounts in thousands)
			Commercial
March 31, 2012	Commercial		Real Estate		Total
Pass	$	37,112	$	154,572	$	191,684
Special Mention		265		8,684		8,949
Substandard		1,980		9,181		11,161
Doubtful/Loss		—		—		—

Ending Balance	$	39,357	$	172,437	$	211,794


			Commercial
December 31, 2011	Commercial		Real Estate		Total
Pass	$	57,545	$	142,781	$	200,326
Special Mention		503		8,269		8,772
Substandard		2,185		9,269		11,454
Doubtful/Loss		—		—		—

Ending Balance	$	60,233	$	160,319	$	220,552

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.

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 deducted from interest income. Loans in foreclosure are considered nonperforming.

Troubled Debt Restructuring

Nonperforming loans also include certain loans that have been modified in trouble 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

There were $1.5 million in TDRs at March 31, 2012, $1.2 million at December 31, 2011 and $1.3 million at March 31, 2011. The total interest recognized on these loans was $17,000, $69,000 and $20,000 at March 31, 2012, December 31, 2011 and March 31, 2011, respectively. Had the loans not been restructured, interest would have increased pretax income by $4,000, $16,000 and $7,000 at March 31, 2012, December 31, 2011 and March 31, 2011, respectively.

The following presents by class, information related to loans modified in a TDR during the periods ended (1):


	(Amounts in thousands)
	March 31, 2012						December 31, 2011
			Recorded		Increase in the				Recorded		Increase in the
Troubled Debt Restructurings	Number of		Investment		Allowance		Number of		Investment		Allowance
(amounts in thousands)	Contracts		(as of period end)		(as of period end)		Contracts		(as of period end)		(as of period end)
Commercial Real Estate		1	$	269	$	—		1	$	1,155	$	23

Total		1	$	269	$	—		1	$	1,155	$	23

(1)	The period end balances are inclusive of all partial paydowns and charge-offs since the modification date. Loans modified in a TDR that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

There were no loans modified in a TDR from April 1, 2011 through March 31, 2012 that subsequently defaulted (i.e., 60 days or more past due following a modification) during the three months ended March 31, 2012. There were no loans modified in a TDR from April 1, 2010 through March 31, 2011 that subsequently defaulted (i.e., 60 days or more past due following a modification) during the three months ended March 31, 2011.

The following is a summary of consumer credit exposure as of March 31, 2012 and December 31, 2011.


	(Amounts in thousands)
			Consumer -		Consumer-
	Residential		home equity		other
March 31, 2012
Performing	$	42,533	$	16,819	$	4,465
Nonperforming		614		82		1,050

Total	$	43,147	$	16,901	$	5,515

December 31, 2011
Performing	$	44,938	$	16,805	$	4,775
Nonperforming		842		111		1,073

Total	$	45,780	$	16,916	$	5,848

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following is an aging analysis of the recorded investment of past due loans as of March 31, 2012 and December 31, 2011.


	(Amounts in thousands)
													Recorded
													Investment >
	31-59 Days		60-89 Days		90 Days Or		Total Past						90 Days and
	Past Due		Past Due		Greater		Due		Current		Total Loans		Accruing
March 31, 2012
Commercial real estate	$	292	$	—	$	771	$	1,063	$	171,374	$	172,437	$	—
Commercial		—		—		64		64		39,293		39,357		—
Residential		77		3		389		469		42,678		43,147		—
Consumer:
Consumer—home equity		193		—		70		263		16,638		16,901		—
Consumer—other		—		—		1,037		1,037		4,478		5,515		—

Total	$	562	$	3	$	2,331	$	2,896	$	274,461	$	277,357	$	—

December 31, 2011
Commercial real estate	$	50	$	—	$	515	$	565	$	159,754	$	160,319	$	—
Commercial		1		—		69		70		60,163		60,233		—
Residential		296		112		667		1,075		44,705		45,780		—
Consumer:
Consumer—home equity		—		3		90		93		16,823		16,916		—
Consumer—other		54		33		1,039		1,126		4,722		5,848		—

Total	$	401	$	148	$	2,380	$	2,929	$	286,167	$	289,096	$	—

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.

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

Any loan evaluated for impairment is 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 March 31, 2012 and December 31, 2011. Also presented are the average recorded investments in the impaired balances and interest income recognized after impairment, at March 31, 2012 and March 31, 2011.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


	(Amounts in thousands)
	Recorded Investment		Unpaid Principal Balance		Related Allowance
March 31, 2012
With no related allowance recorded:
Commercial real estate	$	519	$	519	$	—
Commercial		—		—		—
With an allowance recorded:
Commercial real estate	$	1,392	$	1,392	$	55
Commercial		64		64		64

Total:
Commercial real estate	$	1,911	$	1,911	$	55
Commercial		64		64		64

December 31, 2011
With no related allowance recorded:
Commercial real estate	$	1,218	$	1,218	$	—
Commercial		—		—		—
With an allowance recorded:
Commercial real estate	$	1,400	$	1,400	$	55
Commercial		69		69		69

Total:
Commercial real estate	$	2,618	$	2,618	$	55
Commercial		69		69		69

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


	(Amounts in thousands)
	Average Recorded Investment		Interest Income Recognized
March 31, 2012
With no related allowance recorded:
Commercial real estate	$	978	$	1
Commercial		—		—
With an allowance recorded:
Commercial real estate	$	1,382	$	17
Commercial		66		—

Total:
Commercial real estate	$	2,360	$	18
Commercial		66		—

March 31, 2011
With no related allowance recorded:
Commercial real estate	$	1,251	$	2
Commercial		—		—
With an allowance recorded:
Commercial real estate	$	1,295	$	18
Commercial		107		1

Total:
Commercial real estate	$	2,546	$	20
Commercial		107		1

The following is a summary of classes of loans on non-accrual status as of March 31, 2012 and December 31, 2011:


	(Amounts in thousands)
	March 31, 2012		December 31, 2011
Commercial real estate	$	771	$	1,470
Commercial		64		70
Residential		614		842
Consumer:
Consumer—home equity		82		111
Consumer—other		1,050		1,073

Total	$	2,581	$	3,566

As of March 31, 2012 and December 31, 2011, there were $9.2 and $8.9 million, respectively, in loans that were neither classified as non-accrual nor considered impaired, but which can be considered potential problem loans.

5.) Legal Proceedings:

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

6.) Earnings Per Share and Capital Transactions:

The following table sets forth the computation of basic earnings per common share and diluted earnings per common share. Basic earnings per share is computed by dividing net income by the weighted average number of shares outstanding during the applicable period.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)


	March 31,
	2012		2011
Net income (amounts in thousands)	$	1,159	$	869
Weighted average common shares outstanding		4,525,530		4,525,542
Basic earnings per share	$	0.26	$	0.19
Diluted earnings per share	$	0.26	$	0.19

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 Bancorp 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 March 31, 2012 and December 31, 2011 were 1.92% and 2.00%, 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 a premium declining ratably to par in September 2012.

In accordance with FASB ASC, Topic 942, Financial Services – Depository and Lending 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.

8.) Commitments:

Commitments to fund certain mortgage loans (interest rate locks) to be sold into the secondary market, forward contracts for the future purchase of mortgage-backed securities and forward contracts for the future delivery of these mortgage loans are considered derivatives. It is the Company’s practice to enter into the forward contracts for the future purchase of mortgage-backed securities when interest rate lock commitments are entered into in order to economically hedge the effect of changes in interest rates resulting from its commitments to fund the loans. These mortgage banking derivatives are not formally designated in hedge relationships. At March 31, 2012, the Company had $32.4 million of interest rate lock commitments and $20.5 million of forward contracts for the future purchase of mortgage-backed securities. The fair value of these mortgage banking derivatives was reflected by a derivative asset of $56,000. At year-end 2011, the Company had approximately $12.3 million of interest rate lock commitments and no forward commitments for the future delivery of residential mortgage loans. The fair value of these mortgage banking derivatives was reflected by a derivative asset of $66,000. The Company reports these derivative assets and liabilities in other assets and other liabilities, associated income and expense is reported in mortgage banking gains.

Although residential mortgage loans originated and sold are without recourse as to performance, third parties to which the loans are sold can require repurchase of loans in the event noncompliance with the representations and warranties included in the sales agreements exists. These repurchases are typically those for which the borrower is in a nonperforming status, diminishing the prospects for future collection on the loan. The Company historically has not been required to repurchase any loans, however, provision is made for the contingent probability of this occurrence. At March 31, 2012 and December 31, 2011, $45,000 and $19,000, respectively, is included in other liabilities in the consolidated balance sheets for this contingency.

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 or 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following is a summary of such contractual commitments:


	(Amounts in thousands)
	March 31, 2012		December 31, 2011
Commitments to extend credit:
Fixed rate	$	8,618	$	7,725
Variable rate		40,810		52,026
Standby letters of credit		331		714

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 Bank 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 available amount of overdraft protection on depositors’ accounts totaled $10.1 million at both March 31, 2012 and December 31, 2011. The total average daily balance of overdrafts used at March 31, 2012 was $106,000 and $120,000 at December 31, 2011, or less than 2% of the total aggregate overdraft protection available to depositors. The balance at March 31, 2012 of all deposit overdrafts included in total loans was $77,000 and $115,000 at December 31, 2011.

The Company also does not participate in special purpose entities that might give rise to off-balance sheet liabilities.

9.) Fair Value of Assets and Liabilities:

Measurements

Accounting guidance under ASC Topic 820, Fair Value Measurements and Disclosures, affirms that the objective of fair value when the market for an asset is not active is the price that would be received to sell the asset in an orderly transaction, and clarifies and includes additional factors for determining whether there has been a significant decrease in market activity for an asset when the market for that asset is not active. ASC Topic 820 requires an entity to base its conclusion about whether a transaction was not orderly on the weight of the evidence.

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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table presents the assets reported on the consolidated balance sheets at their fair value as of March 31, 2012 and December 31, 2011 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.


			(Amounts in thousands)
			Fair Value Measurements at 3/31/12 Using
Description	March 31, 2012		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Treasury securities	$	131	$	—	$	131	$	—
U.S. Government agencies and corporations		18,376		—		18,376		—
Obligations of states and political subdivisions		42,168		—		42,168		—
U.S. Government-sponsored mortgage-backed and CMO securities		108,155		—		108,155		—
Private-label mortgage-backed and related securities		390		—		390		—
Trust preferred securities		9,930		—		—		9,930
General Motors equity investments		487		487		—		—
Loans held for sale		6,804		—		6,804		—
Derivatives—commitments to make loans		56		—		56		—

Total	$	186,497	$	487	$	176,080	$	9,930


			Fair Value Measurements at 12/31/11 Using
Description	December 31, 2011		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
U.S. Treasury securities	$	133	$	—	$	133	$	—
U.S. Government agencies and corporations		20,542		—		20,542		—
Obligations of states and political subdivisions		39,019		—		39,019		—
U.S. Government-sponsored mortgage-backed and CMO securities		113,283		—		113,283		—
Private-label mortgage-backed and related securities		381		—		381		—
Trust preferred securities		9,145		—		—		9,145
General Motors equity investments		364		364		—		—
Loans held for sale		947		—		947		—
Derivatives—commitments to make loans		66		—		66		—

Total	$	183,880	$	364	$	174,371	$	9,145

The following tables present the changes in the Level 3 fair value category for the three months ended March 31, 2012. 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Amounts in thousands)


	Trust
	preferred
	securities
Beginning balance, January 1, 2012	$	9,145
Net realized/unrealized gains/(losses) included in:
Noninterest income		(171	)
Other comprehensive income		970
Transfers in and/or out of Level 3		—
Purchases, issuances and settlements		(14	)

Ending balance, March 31, 2012	$	9,930

Losses included in net income for the period relating to assets held at March 31, 2012	$	(171	)

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.

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.

The Company holds 31 trust preferred securities totaling $34.6 million (par value) that are backed by pooled trust preferred debt issued by banks, thrifts, insurance companies and real estate investment trusts. These securities were all rated investment grade at inception. Beginning during the second half of 2008 and through the first quarter of 2012, factors outside the Company’s control impacted the fair value of these securities and will likely continue to do so for the foreseeable future. These factors include, but are not limited to, the following: guidance on fair value accounting, issuer credit deterioration, issuer deferral and default rates, potential failure or government seizure of underlying financial institutions or insurance companies, ratings agency actions, or regulatory actions. As a result of changes in these and various other factors during 2009 through the first quarter of 2012, Moody’s Investors Service, Fitch Ratings and Standards and Poors downgraded multiple trust preferred securities, including securities held by the Company. All 31 of the trust preferred securities held by the Company are now considered to be below investment grade. The deteriorating economic, credit and financial conditions experienced in 2008 and through the first quarter of 2012 have resulted in illiquid and inactive financial markets and severely depressed prices for these securities. Two securities totaling $5.9 million were determined worthless for book and tax purposes. The Company analyzed the cash flow characteristics of the remaining 29 securities. For 11 of these securities, the Company does not consider the investment in these assets to be OTTI at March 31, 2012. The Company does not intend to sell the securities and it is more-likely-than-not that the Company will be required to sell the securities before recovery of its amortized cost basis. There was no adverse change in the cash flows. Although the Company does not consider the investment in these assets to be OTTI at March 31, 2012, there is a risk that subsequent evaluations could result in recognition of OTTI charges in the future. The remaining 18 securities had life-to-date impairment losses of $13.7 million, of which $10.8 million was recorded as expense, and $2.9 million was recorded in other comprehensive loss. The securities subjected to FASB ASC Topic 320 accounted for the entire $7.5 million of gross unrealized losses in the trust preferred securities category at March 31, 2012.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table details the 18 debt securities with other-than-temporary impairment, their credit ratings at March 31, 2012 and the related losses recognized in earnings:

(Amounts in thousands)

Amount of OTTI

Additions in

related to credit

Moody’s/Fitch

related to credit loss

QTD March 31,

loss at March 31,

Rating

at January 1, 2012

2012

MM Community Funding II Class B

Ba1/CC

—

PreTSL I Mezzanine

Ca/C

430

—

430

PreTSL II Mezzanine

Ca/C

1,416

1,497

PreTSL V Mezzanine

Ba3/D

—

PreTSL VIII B-3

C/C

1,635

—

1,635

PreTSL IX Class B-2

Ca/C

274

—

274

PreTSL XV Class B-2

C/C

277

—

277

PreTSL XV Class B-3

C/C

279

—

279

PreTSL XVI D

NR/C

518

—

518

PreTSL XVI D

NR/C

991

—

991

PreTSL XVII Class C

C/C

978

—

978

PreTSL XVII Class D

NR/C

930

—

930

PreTSL XVIII Class D

NR/C

513

—

513

PreTSL XXIII Class C-FP

C/C

211

—

211

PreTSL XXV Class D

NR/C

1,001

—

1,001

PreTSL XXVI Class D

NR/C

465

—

465

Trapeza CDO II Class C-1

Ca/C

598

—

598

Trapeza IX B-1

Ca/CC

140

Total

10,674

171

10,845

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table details the 20 debt securities with other-than-temporary impairment, their credit ratings at March 31, 2011 and the related losses recognized in earnings:


		(Amounts in thousands)
								Amount of OTTI
		Amount of OTTI		Additions in		Deductions in		related to credit
	Moody’s/Fitch	related to credit loss		QTD March 31,		QTD March 31,		loss at March 31,
	Rating	at January 1, 2011		2011		2011*		2011
Alesco Preferred Funding VIII Class E Notes 1	C/C	$	1,500	$	—	$	1,500	$	—
MM Community Funding II Class B	Ba1/CC		11		—		—		11
PreTSL I Mezzanine	Ca/C		430		—		—		430
PreTSL II Mezzanine	Ca/C		1,274		142		—		1,416
PreTSL V Mezzanine	Ba3/D		97		—		—		97
PreTSL VIII B-3	C/C		1,635		—		—		1,635
PreTSL IX Class B-2	Ca/C		274		—		—		274
PreTSL XV Class B-2	C/C		267		10		—		277
PreTSL XV Class B-3	C/C		269		10		—		279
PreTSL XVI D	NR/C		518		—		—		518
PreTSL XVI D	NR/C		991		—		—		991
PreTSL XVII Class C	Ca/C		978		—		—		978
PreTSL XVII Class D	NR/C		930		—		—		930
PreTSL XVIII Class D	NR/C		513		—		—		513
PreTSL XXIII Class C-FP	C/C		211		—		—		211
PreTSL XXV Class D	NR/C		1,001		—		—		1,001
PreTSL XXVI Class D	NR/C		465		—		—		465
Trapeza CDO II Class C-1	Ca/C		598		—		—		598
Tropic CDO V Class B-1L	C/C		4,427		—		4,427		—
Trapeza IX B-1	Ca/CC		10		40		—		50

Total		$	16,399	$	202	$	5,927	$	10,674

*	Reduction for debt securities for which other-than-temporary-impairment has been previously recognized and there is no related other comprehensive income.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table provides additional information related to the Company’s trust preferred securities as of March 31, 2012 used to evaluate other-than-temporary impairments.

(Amounts in thousands)

Deal

Class

Book Value

Fair Value

Unrealized
Gain/(Loss)

Moody’s/
Fitch Rating

Number of
Issuers
Currently
Performing

Deferrals and
Defaults as a %
of Current
Collateral

Excess
Subordination as a
% of Current
Performing
Collateral

PreTSL I

Mezzanine

498

604

106

Ca/C

39.50

—

PreTSL II

Mezzanine

605

434

(171

)

Ca/C

46.44

—

PreTSL IV

Mezzanine

183

144

(39

)

Ca/CCC

27.07

19.64

PreTSL V

Mezzanine

(11

)

Ba3/D

—

100.00

—

PreTSL VIII

B-3

365

158

(207

)

C/C

45.91

—

PreTSL IX

B-2

720

308

(412

)

Ca/C

31.02

—

PreTSL XV

B-2

224

(152

)

C/C

35.97

—

PreTSL XV

B-3

224

(151

)

C/C

35.97

—

PreTSL XVI

—

NR/C

47.08

—

PreTSL XVI

—

NR/C

47.08

—

PreTSL XVII

—

C/C

36.46

—

PreTSL XVII

—

NR/C

36.46

—

PreTSL XVIII

—

NR/C

30.63

—

PreTSL XXIII

C-2

1,011

150

(861

)

C/C

26.90

—

PreTSL XXIII

C-FP

1,551

567

(984

)

C/C

26.90

—

PreTSL XXV

—

NR/C

36.74

—

PreTSL XXVI

—

NR/C

27.97

—

I-PreTSL I

B-1

985

641

(344

)

NR/CCC

17.24

3.19

I-PreTSL I

B-2

1,000

641

(359

)

NR/CCC

17.24

3.19

I-PreTSL I

B-3

1,000

641

(359

)

NR/CCC

17.24

3.19

I-PreTSL II

B-3

2,991

2,451

(540

)

NR/B

5.14

13.90

I-PreTSL III

B-2

1,000

641

(359

)

B2/CCC

12.35

8.11

I-PreTSL III

1,000

413

(587

)

NR/CCC

12.35

—

I-PreTSL IV

B-1

1,000

552

(448

)

Ba2/CCC

13.23

6.04

I-PreTSL IV

B-2

1,000

552

(448

)

Ba2/CCC

13.23

6.04

I-PreTSL IV

480

156

(324

)

Caa1/CC

13.23

0.77

MM Community Funding III

281

228

(53

)

Ba1/CC

41.11

2.76

Trapeza II

C-1

414

337

(77

)

Ca/C

38.43

—

Trapeza IX

B-1

860

155

(705

)

Ca/CC

19.22

—

Total

17,415

9,930

(7,485

)

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The following table provides additional information related to the Company’s trust preferred securities as of December 31, 2011 used to evaluate other-than-temporary impairments.


	(Amounts in thousands)
Deal	Class	Book Value		Fair Value		Unrealized Gain/(Loss)			Moody’s/ Fitch Rating	Number of Issuers Currently Performing		Deferrals and Defaults as a % of Current Collateral			Excess Subordination as a % of Current Performing Collateral
PreTSL I	Mezzanine	$	513	$	517	$	4		Ca/C		17		38.07	%		—	%
PreTSL II	Mezzanine		688		480		(208	)	Ca/C		16		48.26			—
PreTSL IV	Mezzanine		183		175		(8	)	Ca/CCC		4		27.07			19.56
PreTSL V	Mezzanine		22		11		(11	)	Ba3/D		—		100.00			—
PreTSL VIII	B-3		365		91		(274	)	C/C		21		45.91			—
PreTSL IX	B-2		719		249		(470	)	Ca/C		33		31.02			—
PreTSL XV	B-2		224		55		(169	)	C/C		51		31.31			—
PreTSL XV	B-3		224		55		(169	)	C/C		51		31.31			—
PreTSL XVI	D		—		—		—		NR/C		34		42.55			—
PreTSL XVI	D		—		—		—		NR/C		34		42.55			—
PreTSL XVII	C		—		—		—		Ca/C		36		32.11			—
PreTSL XVII	D		—		—		—		NR/C		36		32.11			—
PreTSL XVIII	D		—		—		—		NR/C		52		26.46			—
PreTSL XXIII	C-2		1,011		99		(912	)	C/C		95		26.81			—
PreTSL XXIII	C-FP		1,550		472		(1,078	)	C/C		95		26.81			—
PreTSL XXV	D		—		—		—		NR/C		48		33.52			—
PreTSL XXVI	D		—		—		—		NR/C		48		28.26			—
I-PreTSL I	B-1		985		603		(382	)	NR/CCC		15		16.80			2.63
I-PreTSL I	B-2		1,000		603		(397	)	NR/CCC		15		16.80			2.63
I-PreTSL I	B-3		1,000		603		(397	)	NR/CCC		15		16.80			2.63
I-PreTSL II	B-3		2,991		2,383		(608	)	NR/B		26		5.09			13.16
I-PreTSL III	B-2		1,000		621		(379	)	B2/CCC		22		12.35			7.56
I-PreTSL III	C		1,000		383		(617	)	NR/CCC		22		12.35			—
I-PreTSL IV	B-1		1,000		485		(515	)	Ba2/CCC		27		8.44			10.46
I-PreTSL IV	B-2		1,000		484		(516	)	Ba2/CCC		27		8.44			10.46
I-PreTSL IV	C		480		136		(344	)	Caa1/CC		27		8.44			5.48
MM Community Funding III	B		280		216		(64	)	Ba1/CC		5		41.11			2.76
Trapeza II	C-1		414		278		(136	)	Ca/C		23		33.43			—
Trapeza IX	B-1		951		146		(805	)	Ca/CC		40		12.99			—

Total		$	17,600	$	9,145	$	(8,455	)

The market for these securities at March 31, 2012 and December 31, 2011 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 March 31, 2012;

•

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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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:

Estimate the credit quality of the collateral using average probability of default values for each issuer (adjusted for rating levels).

Consider the potential for correlation among issuers within the same industry for default probabilities (e.g. banks with other banks).

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.

Discount the expected cash flows to calculate the present value of the security.

The effective discount rates on an overall basis generally range from 13.83% to 59.02% 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 security and the prepayment assumptions.

With the passage of the Dodd-Frank Act, trust preferred securities issued by institutions with assets greater than $15.0 billion will no longer be included in Tier 1 capital after 2013. As a result, prepayment assumptions were adjusted to include early redemptions by all institutions meeting this criteria. As the vast majority of institutions in the trust preferred securities collateral base fall below this threshold, the revised assumption did not materially impact the valuation results.

The following table presents the assets measured on a nonrecurring basis on the consolidated balance sheets at their fair value as of March 31, 2012 and December 31, 2011 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.

(Amounts in thousands)
March 31, 2012

Level 1

Level 2

Level 3

Total

Assets measured on a nonrecurring basis:

Impaired loans

—

1,856

Other real estate owned

—

359


	December 31, 2011
	Level 1		Level 2		Level 3		Total
Assets measured on a nonrecurring basis:
Impaired loans	$	—	$	—	$	2,563	$	2,563
Other real estate owned		—		—		437		437

Impaired loans: A loan is considered to be impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due (both interest and principal) according to the contractual terms of the loan agreement. Impaired loans are measured, as a practical expedient, at the loan’s observable market price or the fair market value of the collateral if the loan is collateral dependent. At March 31, 2012, the recorded investment in impaired loans was $1,975,000 with a related reserve of $119,000 resulting in a net balance of $1,856,000. At December 31, 2011, the recorded investment in impaired loans was $2,687,000 with a related reserve of $124,000 resulting in a net balance of $2,563,000.

Other real estate owned (OREO): Real estate acquired through foreclosure or deed-in-lieu of foreclosure is included in other assets. 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 market value is reflected as a valuation allowance through a charge to income. Costs of significant property improvements are capitalized, whereas costs, relating to holding and maintaining the property, are charged to expense. At March 31, 2012, the recorded investment in OREO was $482,000 with a valuation allowance of $123,000 resulting in a net balance of $359,000. At December 31 2011, the recorded investment in OREO was $560,000 with a valuation allowance of $123,000 resulting in a net balance of $437,000.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

Financial Instruments

The FASB ASC Topic 825, Financial Instruments, requires disclosure of 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 the price secondary markets are currently offering for loans with similar characteristics.

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. Loans held for sale are carried, in aggregate, at the lower of cost or fair value.

Accrued interest receivable – The carrying amount is a reasonable estimate of these assets’ fair value.

Mortgage banking derivatives – The Company enters into derivative financial instruments in the form of interest rate locks with potential mortgage loan borrowers, and likewise enters into contracts for the future delivery of residential mortgage loans into the secondary markets. These derivative instruments are recognized as either assets or liabilities at fair value on a recurring basis in the consolidated balance sheets as indicated in the ensuing table. Fair value adjustments relating to these mortgage banking derivatives are recorded in current year earnings as a component of mortgage banking gains.

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.

FHLB advances – 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.

Other short-term borrowings – Other 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.

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 March 31, 2012 and December 31, 2011 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.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

The carrying amounts and estimated fair values of the Company’s financial instruments are as follows:

(Amounts in thousands)

March 31, 2012

Carrying
Amount

Level 1

Level 2

Level 3

Estimated
Fair Value

ASSETS:

Cash and cash equivalents

12,941

—

12,941

Investment securities available-for-sale

182,686

487

172,269

9,930

182,686

Loans held for sale

6,804

—

6,804

—

6,804

Loans, net of allowance for loan losses

274,218

—

280,118

Accrued interest receivable

2,015

—

2,015

Mortgage banking derivatives

—

LIABILITIES:

Demand, savings and money market deposits

251,357

—

251,357

Time deposits

157,698

—

161,837

—

161,837

FHLB advances

38,500

—

41,927

Other short-term borrowings

3,680

—

3,680

Subordinated debt

5,155

—

3,845

Accrued interest payable

416

—

416


	(Amounts in thousands) December 31, 2011
	Carrying Amount		Estimated Fair Value
ASSETS:
Cash and cash equivalents	$	16,176	$	16,176
Investment securities available-for-sale		185,916		185,916
Loans held for sale		947		947
Loans, net of allowance for loan losses		286,038		291,681
Accrued interest receivable		1,919		1,919
Mortgage banking derivatives		66		66
LIABILITIES:
Demand, savings and money market deposits	$	265,171	$	265,171
Time deposits		157,594		160,978
FHLB advances		37,500		41,113
Other short-term borrowings		4,773		4,773
Subordinated debt		5,155		3,508
Accrued interest payable		441		441

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

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 March 31, 2012.


	(Amounts in thousands) Fair value at March 31, 2012		Valuation Technique	Significant Unobservable Input	Description of Inputs
Trust preferred securities	$	9,930	Discounted Cash Flow	Projected Prepayments	1) Trust preferred securities issued by banks subject to Dodd- Frank's phase-out of trust preferred securities from Tier 1 Capital. 2) Trust preferred securities issued by healthy, well capitalized banks that have fixed rate coupons greater than 8% or floating rate spreads greater than 300 bps. 3) 5% every 5 years for all banks beginning in 2018. 4) Zero for collateral issued by REITs or 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.

				Discount Rates	1) Ranging from ~6.5% to ~23.6%, depending on each bond's seniority and remaining subordination after projected losses.

Impaired loans		716	Appraisal of Collateral	Appraisal Adjustments	0% to (27)%

				Liquidation Expenses	(3)% to (27)%

		1,140	Discounted Cash Flow	Discount Rate	5.75% (only one loan)

Other real estate owned		359	Appraisal of Collateral	N/A	N/A

CONSOLIDATED AVERAGE BALANCE SHEETS, YIELDS AND RATES (UNAUDITED)


					(Fully taxable equivalent basis in thousands of dollars)
	QUARTER TO DATE AS OF
	MARCH 31, 2012							DECEMBER 31, 2011							MARCH 31, 2011
	Average				Average			Average				Average			Average				Average
	Balance		Interest		Rate			Balance		Interest		Rate			Balance		Interest		Rate
ASSETS
Interest earning deposits and other assets	$	5,097	$	5		0.37	%	$	6,451	$	6		0.48	%	$	12,614	$	17		0.52	%
Investment securities (1) (2)		187,235		1,505		3.22	%		192,792		1,524		3.17	%		187,949		1,734		3.70	%
Loans (1) (2) (3)		286,715		3,979		5.56	%		266,232		3,827		5.73	%		257,266		3,775		5.91	%

Total interest-earning assets		479,047	$	5,489		4.56	%		465,475	$	5,357		4.60	%		457,829	$	5,526		4.85	%

Cash and due from banks		7,484							7,577							6,649
Bank premises and equipment		6,483							6,538							6,704
Other assets		17,590							16,602							19,808

Total non-interest-earning assets		31,557							30,717							33,161

Total assets	$	510,604						$	496,192						$	490,990

LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing demand deposits	$	82,365	$	34		0.16	%	$	76,821	$	40		0.20	%	$	74,471	$	48		0.26	%
Savings		100,057		25		0.10	%		97,141		28		0.12	%		91,303		39		0.17	%
Time		157,560		661		1.68	%		159,765		706		1.75	%		160,600		777		1.96	%

Total interest-bearing deposits		339,982		720		0.85	%		333,727		774		0.92	%		326,374		864		1.07	%
Other borrowings		43,625		318		2.93	%		39,064		320		3.26	%		51,342		366		2.89	%
Subordinated debt		5,155		26		1.97	%		5,155		24		1.86	%		5,155		23		1.78	%

Total interest-bearing liabilities		388,762	$	1,064		1.10	%		377,946	$	1,118		1.17	%		382,871	$	1,253		1.33	%

Demand deposits		70,987							69,564							61,721
Other liabilities		4,088							3,831							3,675
Shareholders’ equity		46,767							44,851							42,723

Total liabilities and Shareholders’ equity	$	510,604						$	496,192						$	490,990

Net interest income			$	4,425						$	4,239						$	4,273

Net interest rate spread (4)						3.46	%						3.43	%						3.52	%

Net interest margin (5)						3.67	%						3.64	%						3.74	%

Ratio of interest-earning assets to interest-bearing liabilities						1.23							1.23							1.20

(1)	Includes both taxable and tax exempt securities and loans.

(2)

The amounts are presented on a fully taxable equivalent basis using the statutory tax rate of 34%. The tax equivalent income adjustment for loans and investments is $12,000 and $172,000 for March 31, 2012, $12,000 and $168,000 for December 31, 2011 and $12,000 and $194,000 for March 31, 2011, respectively.

(3)	Includes applicable loan origination and commitment fees, net of deferred origination cost amortization.

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

(5)	Interest margin is calculated by dividing net interest income by total interest-earning assets.

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

SELECTED FINANCIAL DATA FOR THE QUARTER ENDED

(In thousands of dollars, except for ratios and per share amounts)


	March 31,			December 31,			September 30,			June 30,			March 31,
Unaudited	2012			2011			2011			2011			2011
SUMMARY OF OPERATIONS
Total interest income	$	5,305		$	5,177		$	5,275		$	5,338		$	5,320
Total interest expense		(1,064	)		(1,118	)		(1,158	)		(1,203	)		(1,253	)

NET INTEREST INCOME (NII)		4,241			4,059			4,117			4,135			4,067
Provision for loan losses		(270	)		(324	)		(324	)		(374	)		(174	)

NII after loss provision		3,971			3,735			3,793			3,761			3,893
Security gains ( losses) including impairment losses		(164	)		9			92			698			(119	)
Mortgage banking gains		154			42			25			20			16
Total other income (excluding security and loan gains)		705			764			753			622			636
Total other noninterest expense		(3,864	)		(3,508	)		(3,291	)		(3,321	)		(3,355	)

Income before tax		802			1,042			1,372			1,780			1,071

Net income	$	1,159		$	828		$	1,054		$	1,321		$	869

PER COMMON SHARE DATA (1)
Net income, both basic and diluted	$	0.26		$	0.18		$	0.24		$	0.29		$	0.19
Book value		10.53			10.10			9.78			9.88			9.62

BALANCE SHEET DATA
Assets	$	508,446		$	519,830		$	497,757		$	484,623		$	489,568
Investments		182,686			185,916			188,712			176,689			179,916
Loans		277,357			289,096			263,514			258,815			257,585
Loans held for sale		6,804			947			216			89			146
Deposits		409,055			422,765			402,121			390,982			384,206
Borrowings		42,180			42,273			42,449			39,749			52,565
Subordinated Debt		5,155			5,155			5,155			5,155			5,155
Shareholders equity		47,633			45,719			44,268			44,715			43,882

AVERAGE BALANCES
Assets	$	510,604		$	496,192		$	495,765		$	492,263		$	490,990
Investments		187,235			192,792			188,967			177,703			187,949
Loans		281,594			265,427			259,172			259,194			257,174
Loans held for sale		5,121			805			172			221			92
Deposits		410,969			403,291			399,445			391,208			388,095
Borrowings		43,625			39,064			38,401			46,322			51,342
Subordinated Debt		5,155			5,155			5,155			5,155			5,155
Shareholders equity		46,767			44,851			45,698			45,060			42,723

ASSET QUALITY RATIOS
Loan charge-offs	$	(214	)	$	(341	)	$	(144	)	$	(290	)	$	(57	)
Recoveries on loans		25			17			25			128			23

Net charge-offs	$	(189	)	$	(324	)	$	(119	)	$	(162	)	$	(34	)

Net charge-offs as a percentage of average total loans		0.27	%		0.49	%		0.18	%		0.25	%		0.05	%

Loans 30 days or more beyond their contractual due date as a percent of total loans		1.13	%		1.40	%		2.18	%		1.39	%		1.47	%
Nonperforming loans	$	3,721		$	4,714		$	4,501		$	3,804		$	3,782
Nonperforming securities		1,523			1,542			1,626			3,179			3,861
Other real estate owned		359			437			479			562			560

Total nonperforming assets	$	5,603		$	6,693		$	6,606		$	7,545		$	8,203

Nonperforming assets as a percentage of:
Total assets		1.10	%		1.29	%		1.33	%		1.56	%		1.68	%
Equity plus allowance for loan losses		11.02			13.70			13.93			15.83			17.60
Tier I capital		10.64			12.94			13.08			15.37			17.26

FINANCIAL RATIOS
Return on average equity		9.91	%		7.38	%		9.23	%		11.73	%		8.14	%
Return on average assets		0.91			0.67			0.85			1.07			0.71
Efficiency ratio		75.76			72.11			67.23			69.52			71.10
Effective tax rate		(44.51	)		20.54			23.18			25.79			18.86
Net interest margin		3.67			3.64			3.72			3.78			3.74

(1)	Basic and diluted earnings per share are based on weighted average shares outstanding. Book value per common share is based on shares outstanding at each period.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Financial Review

The following is management’s discussion and analysis of the financial condition and results of operations of Cortland Bancorp (the “Company”). The discussion should be read in conjunction with the Consolidated Financial Statements and related notes 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 material filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) may contain 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; 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; and unforeseen risks associated with other global economic, political and financial factors.

While actual results may differ significantly from the results discussed in the forward-looking statements, the Company undertakes no obligation to update publicly any forward-looking statement for any reason, even if new information becomes available.

Analysis of Assets and Liabilities for the First Three Months

Earning assets are comprised of investment securities, loans and deposits at financial institutions, including the Federal Reserve Bank. Earning assets were $471.0 million at March 31, 2012, an increase of 4.1% from the March 31, 2011 balance of $452.6 million, and a decrease of 2.4% from the December 31, 2011 balance of $482.3 million. The increase at December 31 was the result of $19.5 million of 60-day loans redeemed prior to March 31, 2012. Absent these loans, the March 2011 to December 2011 increase was 2.2%, while the December 2011 to March 2012 increase was 1.8%. Total cash and cash equivalents decreased by $3.2 million from year-end and decreased by $9.6 million from the balance at March 31, 2011.

At March 31, 2012, the investment securities portfolio was $182.7 million compared to $179.9 million at March 31, 2011, an increase of $2.8 million, or 1.5%. Investment securities decreased $3.2 million compared to December 31, 2011, a decrease of 1.7%. Investment securities represented 38.8% of earning assets at March 31, 2012, compared to 39.8% at March 31, 2011 and 38.5% at December 31, 2011. As the Company manages its balance sheet for loan growth, asset mix, liquidity and for current interest rates and interest rate forecasts, the investment portfolio is a primary source of liquidity. Management has also used funds to decrease borrowings as they mature. The investment portfolio represented 44.7% of each deposit dollar, down from 46.8% a year ago and up from 44.0% of year-end levels.

The investment securities available-for-sale portfolio had net unrealized losses of $2.9 million at March 31, 2012, an increase of $900,000 compared to net unrealized losses of $2.0 million at March 31, 2011, and a decrease of $1.1 million compared to net unrealized losses of $4.0 million at December 31, 2011. Contributing to the volatility in net unrealized losses over the past twelve months are changes in interest rates and an inactive market for certain securities as discussed in Note 9 to the financial statements.

The Company’s investment portfolio contains trust preferred securities, which have resulted in valuation charges against income of $13.7 million in 2009, $2.7 million in 2010, 202,000 in 2011 and $171,000 in the first quarter of 2012. The Company continues to value these securities consistent with valuation techniques prescribed under accounting standards. The market for these securities and similar securities, which had been relatively active since 2003, became illiquid during the financial crisis of 2008 and is still currently not active. Since 2008, the Company has modeled and analyzed the cash flow characteristics and has concluded that a major portion of these devalued securities were not recoverable. The charge for this “other than temporary” impairment for the first quarter of 2012 was $171,000 versus $202,000 in the first quarter of 2011.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Total loans at March 31, 2012 were $277.4 million as compared to $257.6 million a year ago, an 8% increase. Total assets of $508.4 million at March 31, 2012 reflect a modest increase of 4% from year ago asset totals of $489.6 million as management orchestrates balance sheet strategies designed to reinvest cash flows from its investment portfolio and increase loan balances with no material change in composite asset totals. This balance sheet strategy is designed to improve net interest income margins and overall profitability while maintaining assets which support the Company’s current capital position.

Loans net of the allowance for losses increased by $19.3 million during the twelve month period from March 31, 2011 to March 31, 2012, and decreased by $11.8 million from December 31, 2011. Gross loans as a percentage of earning assets stood at 58.9% as of March 31, 2012, 56.9% at March 31, 2011 and 59.9% as of December 31, 2011. The loan to deposit ratio was 67.8% at March 31, 2012, 67.1% at March 31, 2011 and 68.4% at December 31, 2011. The increase in loans year-to-year has primarily resulted from efforts designed to increase market share. The decrease in loans from year-end was due in part to 60-day term commercial loans for a total of $19.5 million that closed in December 2011 and was fully secured by segregated deposit accounts with the Bank. The loans matured in the first quarter of 2012. At March 31, 2012, the loan loss allowance of $3.1 million represented approximately 1.13% of outstanding loans, and at March 31, 2011 the loan loss allowance of $2.6 million represented approximately 1.03% of outstanding loans. The loan loss allowance at December 31, 2011 of $3.1 million represented approximately 1.06% of outstanding loans, or 1.15% excluding the 60-day term loans.

During the first three months, loan charge-offs were $214,000 in 2012 compared to $57,000 in 2011, while the recovery of previously charged-off loans amounted to $25,000 in 2012 and $23,000 in 2011. The net charge-offs represent 0.27% and 0.05% of average loans for the respective periods. Charge-offs of specific problem loans, as well as for smaller balance homogeneous loans, are recorded periodically during the year. The number of loan accounts and the amount of charge-off associated with account balances vary from period to period as loans are deemed uncollectible by management.

Loans accounted for on a non-accrual basis decreased from $3.6 million at December 31, 2011 to $2.6 million at the recent quarter ended March 31, 2012 and was stable from $2.5 million at March 31, 2011. Non-accrual loans at March 31, 2012 represented 0.9% of the loan portfolio compared to 1.2% at December 31, 2011 and 1.0% at March 31, 2011.

Bank-owned life insurance had a cash surrender value of $13.7 million at March 31, 2012, $12.9 million at December 31, 2011 and $12.6 million at March 31, 2011. The Company purchased $694,000 in bank-owned life insurance in 2012 as part of its funding of executive post retirement benefits. Other assets increased slightly to $11.6 million at March 31, 2012 from $11.3 million at December 31, 2011 and decreased from $12.7 million at March 31, 2011. Included in other assets is a prepaid assessment paid to the FDIC in December of 2009. This prepayment is the estimate, based on projected assessment rates and assessment base, made by the FDIC of premiums due until December 31, 2012. On a quarterly basis, this prepayment is reduced through a charge to expense until the prepayment is depleted. The balance is $1.4 million at March 31, 2012, $1.5 million at December 31, 2011 and $1.9 million at March 31, 2011. Other real estate decreased to $359,000 at March 31, 2012 compared to $437,000 at December 31, 2011 and $560,000 at March 31, 2011.

Noninterest-bearing deposits measured $73.7 million at March 31, 2012 up from $70.7 million at December 31, 2011 and $61.8 million at March 31, 2011. Interest-bearing deposits decreased $16.7 million to $335.3 million at March 31, 2012 from $352.0 million at December 31, 2011 and increased $12.9 million from $322.4 million at March 31, 2011. The decrease in non-interest bearing deposits from year end is due in part to segregated deposit accounts with the Bank which fully collateralized $19.5 million in 60-day term commercial loans that closed in December 2011. The loans matured and the deposits withdrew the first quarter of 2012.

Federal Home Loan Bank advances and other short term borrowings were stable at $42.2 million at March 31, 2012 and $42.3 million at December 31, 2011 compared to a decrease from $52.6 million at March 31, 2011. The decrease is due to management’s decision to pay down individual long-term borrowings at their respective maturities rather than refinancing. Future maturities are also expected to be paid off. Management continues to use short-term borrowings to bridge its cash flow needs.

Other liabilities remain fairly consistent measuring $4.4 million at March 31, 2012 compared to $3.9 at December 31, 2011 and $3.8 million at March 31, 2011.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The Company’s total shareholders’ equity increased from $45.7 million on December 31, 2011 to $47.6 million at March 31, 2012, an increase of $1.9 million. The Company continues to remain well capitalized under all regulatory measures. The Company’s total risk-based capital is $16.7 million in excess of the 10% well capitalized threshold.

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.

In April 2009, the FFIEC issued additional instructions for reporting 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. Adopting these instructions 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.

As a result of investment downgrades by the rating agencies, all of the 31 trust preferred securities and a private-label CMO were rated as “highly speculative grade” debt securities. As a consequence, the Bank is required to maintain higher levels of regulatory risk-based capital for these securities due to the greater perceived risk of default by the underlying bank and insurance company issuers. Specifically, regulatory guidance requires the Bank to apply a higher “risk weighting formula” for these securities to calculate its regulatory capital ratios. The result of that calculation increases the Bank’s risk-weighted assets for these securities to $72.6 million, well above the $17.9 million in amortized cost of these securities as of March 31, 2012, thereby significantly diluting the risk-based capital ratios by approximately 2.3% and 2.2% as of March 31, 2012 and December 31, 2011, respectively.

Regardless of the trust preferred securities risk weighting, the Company met all capital adequacy requirements to which it was subject as of March 31, 2012 and December 31, 2011, as supported by the data in the following table. As of those dates, the Company was “well capitalized” under regulatory prompt corrective action provisions.


	Actual Regulatory Capital Ratios as of:						Regulatory Capital Ratio requirements to be:
	March 31, 2012			December 31, 2011			Well Capitalized			Adequately Capitalized
Total risk-based capital to risk-weighted assets		14.28	%		14.18	%		10.00	%		8.00	%
Tier I capital to risk-weighted assets		13.45	%		13.37	%		6.00	%		4.00	%
Tier I capital to average assets		10.31	%		10.47	%		5.00	%		4.00	%

Risk based capital standards require a minimum ratio of 8.00% of qualifying total capital to risk-adjusted total assets with at least 4.00% constituting Tier 1 capital. Capital qualifying as Tier 2 capital is limited to 100.00% of Tier 1 capital. All banks and bank holding companies are also required to maintain a minimum leverage capital ratio (Tier 1 capital to total average assets) in the range of 3.00% to 4.00%, subject to regulatory guidelines. Capital ratios remain above regulatory minimums for “well capitalized” financial institutions.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) requires banking regulatory agencies to revise risk-based capital standards to ensure that they adequately account for the following additional risks: interest rate, concentration of credit, and non-traditional activities. Accordingly, regulators will subjectively consider an institution’s exposure to declines in the economic value of its capital due to changes in interest rates in evaluating capital adequacy. The following table illustrates the Company’s components of risk weighted capital ratios and the excess over amounts considered well-capitalized at March 31, 2012 and December 31, 2011. Management considers these excesses to be adequate with regard to the risks inherent in the balance sheet.


	(Amounts in thousands)
	March 31,		December 31,
	2012		2011
Tier 1 Capital	$	52,671	$	51,739
Tier 2 Capital		3,223		3,142

QUALIFYING CAPITAL	$	55,894	$	54,881

Risk-Adjusted Total Assets (*)	$	391,465	$	387,091

Tier 1 Risk- Based Capital Excess	$	29,183	$	28,514
Total Risk- Based Capital Excess		16,748		16,172
Total Leverage Capital Excess		27,120		27,028

(*)	Includes off-balance sheet exposures

Average total assets for leverage capital purposes is calculated as average assets less disallowed deferred tax assets and the net unrealized market value adjustment of quarter ended March 31, 2012 investment securities available for sale, which averaged $511.0 million for the three months ended March 31, 2012 and $494.2 million for the year ended December 31, 2011.

Regulations require that investments designated as available-for-sale are marked-to-market with corresponding entries to the deferred tax account and shareholders’ equity. Regulatory agencies, however, exclude these adjustments in computing risk-based capital, as their inclusion would tend to increase the volatility of this important measure of capital adequacy.

Executive Summary – Income and Expenses

Net income for the three months ended March 31, 2012 was $1.16 million, or $0.26 per share, compared to $0.87 million or $0.19 per share, a year ago. Core earnings for the three months which exclude non-recurring items such as impairment loss and the impact of a historical tax credit investment were $1.1 million at March 31, 2012 compared to $1.0 million for the same period in 2011.

Net interest income increased by $174,000 in 2012 versus 2011 despite a 7 basis point decline in net interest margin as the Company continues to optimally manage its balance sheet in this historically low interest rate environment. Net interest income, which provides the core earnings base for the Company, increased 4.3% to $4.241 million in the first quarter of 2012 versus $4.067 million in 2011. The Company has benefited from increasing balances in the loan portfolio yielding 5.56% during the quarter in lieu of allocating funds into the investment portfolio earning 3.22%. Also, as liabilities continue to mature and reprice at lower rates, the net interest income has, and is expected to continue to improve. Even with deposit rates creeping lower to reflect market trends, the Company has been able to both retain and grow deposits and has recorded a 6.5% increase in balances over the past year.

The Company, to date, has not experienced notable deterioration in credit quality despite less than favorable economic conditions over the past several years. Net loan charge-offs were 0.27% of average loans in 2012 and 0.05% for 2011. The allowance for loan loss (ALLL) to total loans ratio was 1.13% at March 31, 2012 versus 1.02% a year ago. The Company’s allowance for loan losses covers 122.0% of nonaccrual loans at March 31, 2012. Nonaccrual loans were $2.6 million at March 31, 2012 or 0.93% of loans, down from $3.6 million at December 31, 2011. Included in these totals is a single loan of $1.0 million fully secured by collateral for which no loss is expected.

Non-interest income for the quarter, excluding securities transactions, increased by $207,000 from a year ago. This is mainly due to mortgage banking gains in 2012 of $154,000 versus gains in 2011 of $16,000. Included in non-interest expenses is the impairment of $444,000 related to an investment in a partnership for the purpose of acquiring historical tax credits totaling $634,000. Non-interest expenses exclusive of this investment increased $65,000 or 1.9% from the same quarter a year ago.

The mortgage banking gains are in line with results expected from the wholesale mortgage unit which was formed late last year specifically as a result of strategic initiatives aimed at improving overall profitability. The Company incurred over $200,000 in non-interest expenses in 2011 associated with the start-up of the mortgage banking unit. As its operations ramp up in 2012, CSB Mortgage Company will enhance the Company’s non-interest income, and has already made a positive contribution in the first quarter. CSB Mortgage Company partners with mortgage brokers in contiguous states to originate mortgage loans. The loans are sold to investors in the secondary market generating a profit margin.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The Company invested in a partnership for the purpose of acquiring tax credits which increased net income by $190,000 for the quarter. From the presentation perspective, other non-interest expense includes a $444,000 partnership loss, while income tax benefits and credits for this transaction were $634,000.

For the current quarter, the provision for loan losses was $270,000, more than a 50% increase from the prior year provision of $174,000, and far exceeding the net charge-offs for the quarter of $189,000. Provision expense was increased 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.

Certain Non-GAAP Measures

Certain financial information has been determined by methods other than Generally Accepted Accounting Principles (GAAP). Specifically, certain financial measures are based on core earnings rather than net income. Core earnings exclude income, expense, gains and losses that either are not reflective of ongoing operations or that are not expected to reoccur with any regularity or reoccur with a high degree of uncertainty and volatility. Such information may be useful to both investors and management, and can aid them in understanding the Company’s current 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 shown as part of management’s discussion and analysis of financial results of operations.

Core earnings (earnings before other-than-temporary-impairment charge and certain other non-recurring items) increased for the three months ended March 31, 2012 as compared to the comparable 2011 period. Core earnings for the first quarter of 2012 was $1.1 million, or $0.24 per share, compared to $1.0 million, or $0.22 per share in the first quarter of 2011.

The following is a reconciliation between core earnings and earnings under GAAP.


	(Amounts in thousands, except per share amounts)
	THREE MONTHS ENDED March 31,
	2012			2011
GAAP earnings	$	1,159		$	869
Impairment losses on investment securities (net of tax)		113			133
Net impact of historic tax credit investment		(190	)		—

Core earnings	$	1,082		$	1,002

Core earnings per share	$	0.24		$	0.22

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Analysis of Net Interest Income –Three months ended March 31, 2012 and 2011


	(Amounts in thousands)
	March 31, 2012							March 31, 2011
	Average Balance		Interest		Average Rate			Average Balance		Interest		Average Rate
INTEREST-EARNING ASSETS
Interest-earning deposits and other earning assets	$	5,097	$	5		0.37	%	$	12,614	$	17		0.52	%
Investment securities(1)(2)		187,235		1,505		3.22	%		187,949		1,734		3.70	%
Loans(1)(2)(3)		286,715		3,979		5.56	%		257,266		3,775		5.91	%

Total interest-earning assets	$	479,047	$	5,489		4.56	%	$	457,829	$	5,526		4.85	%

INTEREST-BEARING LIABILITIES
Interest-bearing demand and money market deposits	$	82,365	$	34		0.16	%	$	74,471	$	48		0.26	%
Savings		100,057		25		0.10	%		91,303		39		0.17	%
Time		157,560		661		1.68	%		160,600		777		1.96	%

Total interest-bearing deposits		339,982		720		0.85	%		326,374		864		1.07	%
Other borrowings		43,625		318		2.93	%		51,342		366		2.89	%
Subordinated debt		5,155		26		1.97	%		5,155		23		1.78	%

Total interest-bearing liabilities	$	388,762	$	1,064		1.10	%	$	382,871	$	1,253		1.33	%

Net interest income			$	4,425						$	4,273

Net interest rate spread(4)						3.46	%						3.52	%

Net interest margin(5)						3.67	%						3.74	%

(1)	Includes both taxable and tax exempt securities and loans.

(2)

The amounts are presented on a fully taxable equivalent basis using the statutory tax rate of 34%, and have been adjusted to reflect the effect of disallowed interest expense related to carrying tax-exempt assets. The tax equivalent income adjustment for loans and investments is $12,000 and $172,000 for 2012 and $12,000 and $194,000 for 2011, respectively.

(3)	Includes applicable loan origination and commitment fees, net of deferred origination cost amortization.

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

(5)	Net interest margin is calculated by dividing the net interest income by total interest-earning assets.

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 $4.4 million at March 31, 2012 and $4.3 million at March 31, 2011. During the recent reporting period the net interest margin registered 3.67% at March 31, 2012 and 3.74% at March 31, 2011.

The decrease in interest income, on a fully taxable equivalent basis, of $37,000 is the product of a 29 basis point decrease in interest rates earned and a 4.6% year-over-year increase in average earning assets. The decrease in interest expense of $189,000 was a product of a 23 basis point decrease in rates paid and a 1.5% increase in interest-bearing liabilities. The net result was a 3.6% increase in net interest income on a fully taxable equivalent basis, and a 7 basis point decrease in the Company’s net interest margin on an asset base of similar size, but different mix.

On a fully taxable equivalent basis, income on investment securities decreased by $229,000, or 13.2%. The average invested balances in securities decreased by $714,000, or 0.4%, from the levels of a year ago. The decrease in the average balance of investment securities was accompanied by a 48 basis point decrease in the tax equivalent yield of the portfolio. The Company expects to continue redeployment of liquidity into loans. Any reinvestment into the securities portfolio will serve to decrease the yield due to the current low rate environment.

On a fully taxable equivalent basis, income on loans increased by $204,000, or 5.4%, for the first three months of 2012 compared to the same period in 2011. A $29.5 million increase in the average balance of the loan portfolio, or 11.4%, was accompanied by a 35 basis point decrease in the portfolio’s tax equivalent yield. Likewise, new loan volume is at historic low interest rates, while strong competition for good credits also drives rates downward.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Other interest income decreased by $12,000, or 70.6%, from the same period a year ago. The average balance of interest earning deposits decreased by $7.5 million, or 59.6%. The yield decreased by 15 basis points during the first three months of 2012 compared to 2011. Management intends to remain fully invested, minimizing on-balance sheet liquidity.

Average interest-bearing demand deposits and money market accounts increased by $7.9 million, or 10.6%, while average savings balances increased by $8.8 million, or 9.6%. Total interest paid on interest-bearing demand deposits and money market account was $34,000, a $14,000 decrease from last year. The average rate paid on these products decreased by 10 basis points. Average total interest paid on savings accounts was $25,000, a $14,000 decrease from last year. The average rate paid on savings accounts decreased by 7 basis points. The average balance of time deposit products decreased by $3.0 million, or 1.9%, as the average rate paid decreased by 28 basis points, from 1.96% to 1.68%. Interest expense decreased on time deposits by $116,000 from the prior year. As time deposits mature, the balances are reinvested at the lower current rates. After an extended period of declining average rates paid on deposits, the Company is experiencing a flattening on a linked quarter basis.

Average borrowings and subordinated debt decreased by $7.7 million while the average rate paid on borrowings increased by 4 basis points. FHLB borrowings, net of new short term advances taken in 2012, of $5.0 milllion were paid off at their due dates over the twelve month period from March 2011 to March 2012. Management plans to pay down individual borrowings at their respective due dates in the future using current liquidity.

Impairment Analysis of Investment Securities

The Company owns 31 trust preferred securities totaling $34.6 million (par value) issued by banks, thrifts, insurance companies and real estate investment trusts. Two securities totaling $5.9 million were determined worthless for book and tax purposes. The market for the remaining 29 securities at March 31, 2012 is not active and markets for similar securities are also not 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 March 31, 2012. 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:

Estimate the credit quality of the collateral using average probability of default values for each issuer (adjusted for rating levels).

Consider the potential for correlation among issuers within the same industry for default probabilities (e.g. banks with other banks).

Forecast the cash flows for the underlying collateral and apply to each trust preferred security tranche to determine the resulting distribution among the securities.

Discount the expected cash flows to calculate the present value of the security.

The effective fair value discount rates on an overall basis generally range from 3.83% to 59.02% 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.

Based upon the results of the analysis, the Company currently believes that a weighted average price of approximately $0.35 per $1.00 of par value is representative of the fair value of the 29 trust preferred securities, with individual securities therein ranging from zero to $0.82.

The Company considered all information available as of March 31, 2012 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. The FDIC has recently indicated that there are many financial institutions still considered troubled banks even after the numerous failures in 2010 and 2011. The Company recognized credit related impairment of $171,000 in the first quarter of 2012 versus $202,000 in the first quarter of 2011. If the conditions of the underlying banks in the trust preferred securities worsen, there may be additional impairment to recognize in 2012 or later.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

Analysis of Other Income, Other Expense and Federal Income Tax for the First Three Months

During the first quarter of both 2011 and 2012, the amount charged to operations as a provision for loan loss was increased to account for the increase in 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 for a number of specific problem loans through the first three months of 2012, but has not experienced significant deterioration in any loan type including the residential real estate portfolios or the commercial loan portfolio, and accordingly has not added any special provision for these loan types. The provision for loan loss was $270,000 and $174,000 at March 31, 2012 and March 31, 2011, respectively.

Total non-interest income, excluding investment gains and impairment losses, increased by $207,000. After impairment losses and gains on investment securities, non-interest income increased by $162,000 from the same period a year ago. The increase is due mainly to mortgage banking gains of $154,000 compared to $16,000 in 2011.

Fees for other customer services increased by $7,000. Loss on the sale of other real estate owned (OREO) was $28,000 at March 31, 2011 and none at March 31, 2012, resulting in an increase to income of $28,000. Other sources of non-recurring non-interest income increased by $34,000 from the same period a year ago. This latter income category is subject to fluctuation due to the non-recurring nature of the items.

Gains on securities called and net gains on the sale of available for sale investment securities decreased by $76,000 from year ago levels. Gains were offset by impairment losses attributable to trust preferred securities primarily issued by bank holding companies. Losses of $171,000 were recognized in 2012 as compared to $202,000 in 2011.

Total non-interest expenses in the first three months were $3.9 million in 2012 compared to $3.4 million in 2011, an increase of $0.5 million, or 15.2%. Full time equivalent employment averaged 158 during the first three months of 2012 and 147 in 2011. Salaries and benefits increased by $214,000, or 11.9%, from the similar period a year ago. This increase is due mainly to costs associated with the wholesale mortgage unit which was formed late in 2011.

Charges for insurance premiums paid to the FDIC decreased by $141,000. Deposits are insured by the Federal Deposit Insurance Corporation (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 change in the basis used to calculate the assessment resulted in part to the decrease in expense in 2012. The assessment base changed to an asset-based calculation effective for the second quarter of 2011. Concurrently with the effects of the change in assessment base, the Company was also subject to higher insurance premiums in 2011 due to its informal agreement with regulatory agencies. As a result of its fulfillment of the terms of the agreement, FDIC insurance expense declined by 50% in 2012. The Company anticipates its FDIC insurance expense will continue to adversely impact operating expenses for the year ended December 31, 2012.

In late March 2012, the Company invested in a partnership for the purpose of acquiring tax credits which increased other non-interest expense by $444,000 as a result of partnership losses and impairment recognition. At the same time it generated a $483,000 tax credit in addition to the $151,000 tax benefit on the partnership loss. The net effect is a $190,000 increase to net income.

All other expense categories decreased by 0.6%, or $8,000 in the aggregate. These expense categories are subject to fluctuation due to non-recurring items.

The effective tax rate for the first three months was (44.5)% in 2012 and 19.9% in 2011, resulting in income tax (benefit) expense of $(357,000) and $202,000, respectively. As discussed above, a $634,000 tax benefit was generated from a historic tax credit structure.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The provision for income taxes differs from the amount of income tax determined applying the applicable U.S. statutory federal income tax rate (34%) to pre-tax income as a result of the following differences:


	(Amounts in thousands)
	March 31, 2012						March 31, 2011
	Balance			%			Balance			%
Provision at statutory rate	$	273			34.0	%	$	364			34.0	%
Add (Deduct):
Tax effect of earnings on bank-owned life insurance-net		(32	)		(4.0	%)		(33	)		(3.1	%)
Tax effect of historic tax credit		(483	)		(60.0	%)		—			—
Tax effect of other non-taxable income		(127	)		(15.9	%)		(143	)		(13.3	%)
Tax effect of non-deductible expense		12			1.4	%		14			1.3	%

Federal income taxes	$	(357	)		(44.5	%)	$	202			18.9	%

The majority of non-taxable income consists of interest on obligations of states and political subdivisions.

Net income registered $1,159,000 for the three months ended March 31, 2012 and $869,000 for the similar period of 2011, representing per share amounts of $0.26 in 2012 and $0.19 in 2011.

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 we have 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, proper management of capital markets funding sources and addressing unexpected liquidity requirements.

Principal sources of liquidity for the Company include assets considered relatively liquid, such as interest-bearing deposits in other banks, federal funds sold, cash and due from banks, as well as cash flows from maturities and repayments of loans, investment securities and mortgage-backed securities.

Concerns over deposit fluctuations with respect to the overall banking industry were addressed by the FDIC in September and October 2008. The FDIC temporarily increased the individual account deposit insurance from $100,000 per account to $250,000 per account through December 31, 2009, which has subsequently been made permanent. The FDIC also implemented the Transaction Account Guarantee Program (TAGP), which provides for full FDIC coverage for transaction accounts, regardless of dollar amounts. The Company elected to opt-in to this program, thus, customers received full coverage for transaction accounts under the program. The TAGP expired December 31, 2010. It was replaced by a final rule to implement the section of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) that provides temporary unlimited coverage for non-interest bearing transaction accounts at all FDIC-insured depository institutions. The separate coverage for non-interest bearing transaction accounts became effective on December 31, 2010 and terminates on December 31, 2012. This provision is similar to the TAGP, except it does not include low-interest Negotiable Order of Withdrawal (NOW) accounts. The Dodd-Frank provision also differs significantly from the TAGP in that it applies to all FDIC-insured depository institutions with qualifying deposits. Concerns regarding the overall banking industry or the Company could have an adverse effect on future deposit levels.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

In order to address the concern of FDIC insurance of larger depositors, the Bank became a member of the Certificate of Deposit Account Registry Service (CDARS®) program in 2009 and the Insured Cash Sweep (ICS) program in 2011. 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. At March 31, 2012, the Bank did not have any deposits in either program. For regulatory purposes, CDARS® and ICS are considered a brokered deposit even though reciprocal deposits are generally from customers in the local market.

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 yet another source of liquidity. At March 31, 2012, the Bank had approximately $12.6 million available of collateral-based borrowing capacity at FHLB of Cincinnati, supplementing the $0.7 million of availability with the Federal Reserve Discount window. Additionally, the FHLB has committed a $24.1 million cash management line, of which none has been dispersed, subject to posting additional collateral. The Bank has access to approximately 10% of total assets in brokered certificates of deposit that could be used as an additional source of liquidity. At March 31, 2012, there was no outstanding balance in brokered certificates of deposit. 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 March 31, 2012. Unpledged securities of $63.8 million are also available for borrowing under repurchase agreements or as additional collateral for FHLB lines of credit.

CSB obtains its funding through the Bank. The Bank utilizes short term borrowings under its FHLB cash management line to fund the needs of CSB. Upon establishing an inventory of loans held for sale, such loans may be used as additional collateral for FHLB borrowings.

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 its bank subsidiary. 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 Company has cash of $433,000 at March 31, 2012 available to meet cash needs. It also holds 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, pay dividends to common shareholders and to fund operating expenses.

In May 2012, the Bank plans to close its North Bloomfield branch in an effort to consolidate it with the Bristol branch approximately five miles away. Any loss of deposits or customers is not expected to have a material effect on liquidity or consolidated deposit totals.

Cash and cash equivalents decreased from $22.6 million in March 2011 to $12.9 million in March 2012.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

The following table details the cash flows from operating activities for the three months ended:


	(Amounts in thousands) March 31,
	2012			2011
Net income	$	1,159		$	869
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation, amortization and accretion		691			566
Provision for loan loss		270			174
Investment securities gains		(7	)		(83	)
Impairment losses		171			202
Loss on partnership		444			—
Other real estate losses		—			28
Originations of mortgage banking loans held for sale		(28,007	)		(582	)
Proceeds from the sale of mortgage banking loans		22,304			714
Net mortgage banking income		(154	)		(16	)
Changes in:
Deferred tax		(422	)		(142	)
Prepaid FDIC assessment		67			203
Bank-owned life insurance		(95	)		(124	)
Other assets and liabilities		(334	)		122

Net cash flows from operating activities	$	(3,913	)	$	1,931

Key variations stem from: 1) Amortization on investments measured $544,000 at March 31,2012 compared to $426,000 at March 31, 2011, reflecting more securities purchased at a premium in this low rate environment. 2) Provision for loan losses increased by $96,000 from 2011 to 2012. The increase is due to increased loan volume and changing economic conditions. 3) Gains were recognized on the sale, call or maturity of investments of $83,000 in 2011 compared to $7,000 in the same period of 2012. 4) Impairment losses of $202,000 were recognized in 2011 compared to $171,000 in 2012. 5) In March 2012, the Company recognized an impairment of $444,000 related to an investment in a partnership for the purpose of acquiring historical tax credits. 6) Loans held for sale increased by $5.9 million due to increased activity of the mortgage banking company. 7) Change in the deferred tax asset was $422,000 at March 31, 2012 and $142,000 at March 31, 2011. The increase is due in part to a $151,000 increase in deferred tax related to the historical tax credit. 8) Prepaid FDIC assessment was reduced by $203,000 in 2011 and $67,000 in 2012 due to decreased assessment. Refer to the Consolidated Statements of Cash Flows for a summary of the sources and uses of cash for 2012 and 2011.

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 accounting principles generally accepted in the United States of America. 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 our 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.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

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: specific valuation allowances based on probable losses on specific loans; valuation allowances based on historical loan loss experience for similar loans with similar characteristics and trends; and 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 based on current information and events, 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 the Notes to the Consolidated Financial Statements (NOTE 4) and further more in Management’s Discussion and Analysis.

Investment Securities and Impairment

The classification and accounting for investment securities is discussed in detail in Note 3 of 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 our 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 our 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).

The Company reviews investment debt securities on an ongoing basis for the presence of other-than-temporary impairment (OTTI) with formal reviews performed quarterly. OTTI losses on individual investment securities were recognized during 2012 and 2011 in accordance with FASB ASC topic 320, Investments – Debt and Equity Securities. The purpose of this ASC is to provide greater clarity to investors about the credit and noncredit component of an OTTI event and to communicate more effectively when an OTTI event has occurred. This ASC amends the OTTI guidance in GAAP for debt securities, improves the presentation and disclosure of OTTI on investment securities and changes the calculation of the OTTI recognized in earnings in the financial statements. This ASC does not amend existing recognition and measurement guidance related to OTTI of equity securities.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

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 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), 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 other-than-temporary impairment 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.

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. 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 the Company’s 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. The Company conducts periodic assessments of deferred tax assets to determine if it is more-likely-than-not that they will be realized. In making these assessments, the Company considers 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.

Authoritative Accounting Guidance

In May 2011, the FASB issued ASU 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The amendments in this Update result in common fair value measurement and disclosure requirements in U.S. GAAP and IFRSs. Consequently, the amendments change the wording used to describe many of the requirements in U.S. GAAP for measuring fair value and for disclosing information about fair value measurements. The amendments in this Update are to be applied prospectively. For public entities, the amendments are effective during interim and annual periods beginning after December 15, 2011. For nonpublic entities, the amendments are effective for annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Company has provided the necessary disclosure in Note 9.

In June 2011, the FASB issued ASU 2011-05, Presentation of Comprehensive Income. The amendments in this Update improve the comparability, clarity, consistency, and transparency of financial reporting and increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. GAAP and IFRS, the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity was eliminated. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income. All entities that report items of comprehensive income, in any period presented, will be affected by the changes in this Update. For public entities, the amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011. For nonpublic entities, the amendments are effective for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The amendments in this Update should be applied retrospectively, and early adoption is permitted. The Company has provided the necessary disclosure in the Statement of Comprehensive Income.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL

CONDITION AND RESULTS OF OPERATIONS

In December 2011, the FASB issued ASU 2011-12, Comprehensive Income (Topic 220): Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05. In order to defer only those changes in Update 2011-05 that relate to the presentation of reclassification adjustments, the paragraphs in this Update supersede certain pending paragraphs in Update 2011-05. Entities should continue to report reclassifications out of accumulated other comprehensive income consistent with the presentation requirements in effect before Update 2011-05. All other requirements in Update 2011-05 are not affected by this Update, including the requirement to report comprehensive income either in a single continuous financial statement or in two separate but consecutive financial statements. Public entities should apply these requirements for fiscal years, and interim periods within those years, beginning after December 15, 2011. Nonpublic entities should begin applying these requirements for fiscal years ending after December 15, 2012, and interim and annual periods thereafter. The Company has provided the necessary disclosure in Statement of Comprehensive Income.

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 Securities and Exchange Commission (SEC) pursuant to Section 13(a) or 15(d) of the Exchange Act of 1934 Amended (the Exchange Act). The Company’s website is www.cortland-banks.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 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Interest rate risk is measured as the impact of interest rate changes on the Company’s net interest income. Components of interest rate risk comprise 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, swaps, caps, floors or other similar instruments.

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 March 31, 2012 and December 31, 2011. 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 (lower) than the rates in effect at March 31, 2012. Under both the rising rate scenario and the falling rate scenario, the yield curve is assumed to exhibit a parallel shift.

During the previous twelve months, the Federal Reserve kept its target rate for overnight federal funds constant. At March 31, 2012, the difference between the yield on the ten-year Treasury and the three-month Treasury had decreased to a positive 216 from the positive 187 basis points that existed at December 31, 2011, indicating that the yield curve had become more steeply upward sloping. At March 31, 2012, 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 $16,468 for the twelve month period ending March 31, 2013.


	(Amounts in thousands)
	Net Interest Income				$ Change						% Change
	March 31, 2013		December 31, 2012		March 31, 2013			December 31, 2012			March 31, 2013			December 31, 2012
Change in Interest Rates:
Graduated increase of +300 basis points	$	17,967	$	17,380	$	1,499		$	1,659			9.1	%		10.6	%
Short-term rates unchanged (base case)		16,468		15,721		—			—			—			—
Graduated decrease of -300 basis points		14,363		13,316		(2,105	)		(2,405	)		(12.8	)%		(15.3	)%

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.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of Disclosure Controls and Procedures. With the supervision and participation of management, including the Company’s principal executive officer and chief financial officer, the effectiveness of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) has been evaluated as of the end of the period covered by this report. Based upon that evaluation, the Company’s principal executive officer and chief financial officer has concluded that such disclosure controls and procedures are, to the best of their knowledge, effective as of the end of the period covered by this report to ensure that material information relating to the Company and its consolidated subsidiaries is made known to them, particularly during the period for which our periodic reports, including this report, are being prepared.

Changes in Internal Control Over Financial Reporting. Our Chief Executive Officer and Chief Financial Officer have concluded that there have been no significant changes during the period covered by this report 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 reasonably likely to materially affect, internal control over financial reporting.

CORTLAND BANCORP AND SUBSIDIARIES

PART II—OTHER INFORMATION

Item 1.

Legal Proceedings

See Note (5) of the financial statements.

Item 1A

Risk Factors

There have been no material changes from the risk factors previously disclosed in response to Item 1A of Part 1 of Form 10-K filed March 29, 2012.

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

Not applicable

Company’s Common Stock.

There were no repurchases of shares of the Company’s common stock during the three months ended March 31, 2012.

Item 3.

Defaults upon Senior Securities

Not applicable

Item 4.

Mine Safety Disclosures

Not applicable

Item 5.

Other Information

Not applicable

CORTLAND BANCORP AND SUBSIDIARIES

INDEX TO EXHIBITS

The following exhibits are filed or incorporated by reference as part of this report:

Incorporated by Reference

Exhibit

No.

Exhibit Description

Form

Exhibit

Filing
Date

Filed
Herewith

3.1

Restated Amended Articles of Cortland Bancorp reflecting amendment dated May 18, 1999. Note: filed for purposes of SEC reporting compliance only. This restated document has not been filed with the State of Ohio.

10-K

(1)

3.1

03/16/06

3.2

Code of Regulations, as amended:

For the Bancorp

10-K

(1)

3.2

03/16/06

For Cortland Savings and Banking

10-K

3.2

03/15/07

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

10-K

(1)

03/16/06

*10.1

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)

10.1

03/16/06

*10.2

Group Term Carve Out Plan Amended Split Dollar Policy Endorsement entered into by The Cortland Savings and Banking Company on December 15, 2003 with Stephen A. Telego, Sr.

10-K

(1)

10.2

03/16/06

*10.3

Amended Director Retirement Agreement between Cortland Bancorp and Jerry A. Carleton, dated as of December 18, 2007

10-K

10.3

03/17/08

*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

Amended Director Retirement Agreement between Cortland Bancorp and George E. Gessner, dated as of December 18, 2007

10-K

10.5

03/17/08

*10.6

Amended Director Retirement Agreement between Cortland Bancorp and William A. Hagood, dated as of October 12, 2003

10-K

(1)

10.6

03/16/06

*10.7

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

*10.8

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

Director Retirement Agreement between Cortland Bancorp and K. Ray Mahan, dated as of March 1, 2001

10-K

(1)

10.9

03/16/06

*10.10

Amended Director Retirement Agreement between Cortland Bancorp and Richard B. Thompson, dated as of December 18, 2007

10-K

10.10

03/17/08

*10.11

Amended Director Retirement Agreement between Cortland Bancorp and Timothy K. Woofter, dated as of December 18, 2007

10-K

10.11

03/17/08

*10.12

Form of Split Dollar Agreement entered into by Cortland Bancorp and each of Directors David C. Cole, George E. Gessner, William A. Hagood, James E. Hoffman III, K. Ray Mahan, 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;

10-K

(1)

10.12

03/16/06

as amended on December 26, 2006, for Directors Cole, Gessner, Hoffman, Mahan, Thompson, and Woofter;

10-K

10.12

03/15/07

Amended Split Dollar Agreement and Endorsement entered into by Cortland Bancorp as of December 18, 2007, with Director Jerry A. Carleton

10-K

10.12

03/17/08

CORTLAND BANCORP AND SUBSIDIARIES

INDEX TO EXHIBITS (continued)

Incorporated by Reference

Exhibit

No.

Exhibit Description

Form

Exhibit

Filing
Date

Filed
Herewith

*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

*10.14

Split Dollar Agreement and Endorsement between Cortland Bancorp and Director Joseph E. Koch, dated as of April 19, 2011

8-K

10.14

04/22/11

*10.15

Form of Indemnification Agreement entered into by Cortland Bancorp with each of its directors

10-K

(1)

10.15

03/16/06

*10.16

Endorsement Split Dollar Agreement between The Cortland Savings and Banking Company and David J. Lucido, dated as of March 27, 2012

10-K

10.16

03/29/12

*10.17

Fifth Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Timothy Carney, dated as of March 27, 2012

10-K

10.17

03/29/12

*10.18

Third Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Lawrence A. Fantauzzi, dated as of December 3, 2008

8-K

10.18

12/12/08

*10.19

Fifth Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and James M. Gasior, dated as of March 27, 2012

10-K

10.19

03/29/12

*10.20

Second Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Marlene Lenio, dated as of December 3, 2008

8-K

10.20

12/12/08

*10.20.1

Amendment of the December 3, 2008 Second Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Marlene J. Lenio

10-Q

10.20.1

05/17/10

*10.21

Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Craig Phythyon, dated as of December 3, 2008

8-K

10.21

12/12/08

*10.21.1

Amendment of the December 3, 2008 Second Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Craig M. Phythyon

10-Q

10.21.1

05/17/10

*10.22

Third Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Stephen A. Telego, Sr., dated as of December 3, 2008

8-K

10.22

12/12/08

*10.22.1

Amendment of the December 3, 2008 Third Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Stephen A. Telego, Sr.

10-Q

10.22.1

05/17/10

*10.23

Salary Continuation Agreement between The Cortland Savings and Banking Company and David J. Lucido dated as of June 1, 2010

8-K

10.23

06/02/10

*10.24

Fourth Amended Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Timothy Carney, dated as of April 19, 2011

8-K

10.24

04/22/11

*10.25

Salary Continuation Agreement between The Cortland Savings and Banking Company and Stanley P. Feret dated as of June 1, 2010

8-K

10.25

06/02/10

*10.26

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

10.26

04/22/11

CORTLAND BANCORP AND SUBSIDIARIES

INDEX TO EXHIBITS (continued)

Incorporated by Reference

Exhibit

No.

Exhibit Description

Form

Exhibit

Filing
Date

Filed
Herewith

*10.27

Second Amended Split Dollar Agreement between The Cortland Savings and Banking Company and Marlene Lenio, dated as of December 3, 2008

8-K

10.27

12/12/08

*10.27.1

Termination of Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Marlene Lenio

10-Q

10.27.1

05/17/10

*10.28.1

Termination of the Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Craig Phythyon

10-Q

10.28.1

05/17/10

*10.29

Third Amended Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Stephen A. Telego, Sr., dated as of December 3, 2008

8-K

10.29

12/12/08

*10.29.1

Termination of the Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Stephen A. Telego, Sr.

10-Q

10.29.1

05/17/10

10.30

Reserved

*10.31

Severance Agreement entered into by Cortland Bancorp with each of Messrs. Timothy Carney, James M. Gasior and David J. Lucido

8-K

10.31

12/12/08

*10.32

Severance Agreement entered into by Cortland Bancorp and The Cortland Savings and Banking Company in December 3, 2008, with each of Marlene J. Lenio, Craig M. Phythyon and Barbara R. Sandrock

8-K

10.32

12/12/08

*10.32.1

Termination of Severance Agreement entered into by each of Mses. Marlene J. Lenio and Barbara R. Sandrock and Messrs. Craig M. Phythyon and Stephen A. Telego, Sr.

10-Q

10.32.1

05/17/10

*10.33

Agreement and General Release with Lawrence A. Fantauzzi

8-K

10.1

10/22/09

*10.34

Severance Agreement between Cortland Bancorp and Stanley P. Feret

8-K

10.34

06/02/10

Statement of re-computation of per share earnings

See Note 6
of Financial
Statements

Letter re unaudited interim financial statements

N/A

Letter re change in accounting principles

N/A

Reports furnished to security holders

N/A

Published report regarding matters submitted to vote of security holders

N/A

Consents of experts and counsel – Consent of Independent Registered Public Accounting firms

N/A

Power of attorney

N/A

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)

Section 1350 Certification of Chief Executive Officer and Chief Financial Officer required under section 906 of the Sarbanes-Oxley Act of 2002

101

The following materials from Cortland Bancorp’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, 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) Notes to Consolidated Financial Statements. **

(1)	Film number 06691632

CORTLAND BANCORP AND SUBSIDIARIES

*	Management contract or compensatory plan or arrangement

Pursuant to Rule 406T of Regulation S-T, these interactive data files are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933 or Section 18 of the Securities Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

Copies of any exhibits will be furnished to shareholders upon written request. Requests should be directed to Tim Carney, Secretary, Cortland Bancorp, 194 West Main Street, Cortland, Ohio 44410.

CORTLAND BANCORP AND SUBSIDIARIES

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

CORTLAND BANCORP

(Registrant)



/s/ James M. Gasior				Date: May14, 2012
James M. Gasior
President and
Chief Executive Officer
(Principal Executive Officer)

/s/ David J. Lucido				Date: May 14, 2012
David J. Lucido
Senior Vice President and
Chief Financial Officer
(Principal Financial Officer)