Edgar Filing: CORTLAND BANCORP INC

Cortland Bancorp 10-Q

United States Securities and Exchange Commission

Washington, D. C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended: March 31, 2006


o		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		(I.R.S.Employer
Incorporation or organization		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 þ Noo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer o Accelerated filer þ Non-accelerated filer o

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

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		at May 5, 2006 4,384,144 Shares


	PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements

	Cortland Bancorp and Subsidiaries:

	Consolidated Balance Sheets — March 31, 2006 (unaudited) and December 31, 2005 (audited)	2

	Unaudited Consolidated Statements of Income — Three months ended March 31, 2006 and 2005	3

	Unaudited Consolidated Statement of Shareholders’ Equity — Three months ended March 31, 2006 and 2005	4

	Unaudited Consolidated Statements of Cash Flows — Three months ended March 31, 2006 and 2005	5

	Unaudited Notes to Consolidated Financial Statements March 31, 2006	6 — 15

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

	Consolidated Average Balance Sheets, Yields And Rates — Year to Date March 31, 2006, December 31, 2005 and March 31, 2005	16

	Selected Financial Data	17

	Financial Review	18 — 27

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28 — 29

Item 4.	Controls and Procedures	30

	PART II — OTHER INFORMATION

Item 1.	Legal Proceedings	31

Item 1A.	Risk Factors	31

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	31

Item 3.	Defaults Upon Senior Securities	31

Item 4.	Submission of Matters to a Vote of Security Holders	31

Item 5.	Other Information	31

Item 6.	Exhibits	31 — 34

Signatures		35

CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS

(Amounts in thousands, except share data)


	(Unaudited)			(Audited)
	MARCH 31,			DECEMBER 31,
	2006			2005
ASSETS
Cash and due from banks	$	9,718		$	14,587
Federal funds sold		1,600			4,650

Total cash and cash equivalents		11,318			19,237

Investment securities available for sale (Note 3)		110,205			113,247
Investment securities held to maturity (approximate market value of $125,105 at March 31, 2006 and, $121,395 at December 31, 2005 (Note 3)		126,346			121,405
Total loans (Note 4)		189,731			188,202
Less allowance for loan losses (Note 4)		(2,202	)		(2,168	)

Net loans		187,529			186,034

Premises and equipment		4,127			4,088
Other assets		17,133			15,690


Total assets	$	456,658		$	459,701


LIABILITIES
Noninterest-bearing deposits	$	59,465		$	61,782
Interest-bearing deposits		287,423			288,593

Total deposits		346,888			350,375

Federal Home Loan Bank advances and other borrowings		58,228			58,111
Other liabilities		2,977			2,890

Total liabilities		408,093			411,376


SHAREHOLDERS’ EQUITY
Common stock — $5.00 stated value — authorized 20,000,000 shares; issued 4,504,576 shares in both 2006 and 2005 (Note 1)		22,523			22,523
Additional paid-in capital (Note 1)		20,092			20,211
Retained earnings		10,523			10,310
Accumulated other comprehensive income (loss) (Note 1)		(1,296	)		(877	)
Treasury shares at cost, 133,004 at March 31, 2006 and 155,945 at December 31, 2005		(3,277	)		(3,842	)

Total shareholders’ equity		48,565			48,325


Total liabilities and shareholders’ equity	$	456,658		$	459,701

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

CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)

(Amounts in thousands, except per share data)


	THREE
	MONTHS ENDED
	MARCH 31,
	2006		2005
INTEREST INCOME
Interest and fees on loans	$	3,306	$	3,106
Interest and dividends on investment securities:
Taxable interest income		1,403		983
Nontaxable interest income		531		542
Dividends		45		34
Interest on mortgage-backed securities		996		982
Other interest income		38		14

Total interest income		6,319		5,661


INTEREST EXPENSE
Deposits		1,934		1,419
Borrowed funds		719		586

Total interest expense		2,653		2,005

Net interest income		3,666		3,656
Provision for loan losses		66		112


NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		3,600		3,544


OTHER INCOME
Fees for other customer services		502		539
Investment securities gains — net				302
Gain on sale of loans — net		14		9
Other non-interest income		106		140

Total other income		622		990


OTHER EXPENSES
Salaries and employee benefits		1,678		1,656
Net occupancy and equipment expense		465		457
State and local taxes		139		138
Bank exam and audit expense		125		121
Office supplies		104		97
Marketing expense		38		49
Other operating expenses		420		432

Total other expenses		2,969		2,950


INCOME BEFORE FEDERAL INCOME TAXES		1,253		1,584

Federal income taxes		78		326


NET INCOME	$	1,175	$	1,258


BASIC EARNINGS PER COMMON SHARE (NOTE 6)	$	0.27	$	0.29

DILUTED EARNINGS PER COMMON SHARE (NOTE 6)	$	0.27	$	0.29

CASH DIVIDENDS DECLARED PER SHARE	$	0.22	$	0.21

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

CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS’ EQUITY (UNAUDITED)

(Amounts in thousands)


									ACCUMULATED						TOTAL
			ADDITIONAL						OTHER						SHARE-
	COMMON		PAID-IN			RETAINED			COMPREHENSIVE			TREASURY			HOLDERS’
	STOCK		CAPITAL			EARNINGS			INCOME			STOCK			EQUITY
THREE MONTHS ENDED MARCH 31, 2005:
BALANCE AT JANUARY 1, 2005	$	21,869	$	18,531		$	13,131		$	1,061		($	5,194	)	$	49,398
Comprehensive income:
Net income							1,258									1,258
Other comprehensive income, net of tax:
Unrealized gains or (losses) on available- for-sale securities, net of reclassification adjustment										(1,130	)					(1,130	)

Total comprehensive income																128


Common stock transactions:
Treasury shares reissued				(31	)								496			465
Treasury shares purchased													(1	)		(1	)
Cash dividends declared							(921	)								(921	)


BALANCE AT MARCH 31, 2005	$	21,869	$	18,500		$	13,468		($	69	)	($	4,699	)	$	49,069


THREE MONTHS ENDED MARCH 31, 2006:

BALANCE AT JANUARY 1, 2006	$	22,523	$	20,211		$	10,310		($	877	)	($	3,842	)	$	48,325
Comprehensive income:
Net income							1,175									1,175
Other comprehensive income, net of tax:
Unrealized gains or (losses) on available- for-sale securities, net of reclassification adjustment										(419	)					(419	)

Total comprehensive income																756



Common stock transactions:
Treasury shares reissued				(119	)								565			446
Cash dividends declared							(962	)								(962	)


BALANCE AT MARCH 31, 2006	$	22,523	$	20,092		$	10,523		($	1,296	)	($	3,277	)	$	48,565


	MARCH 31,
	2006			2005
DISCLOSURE OF RECLASSIFICATION FOR AVAILABLE FOR SALE SECURITY GAINS AND LOSSES:

Net unrealized holding gains or (losses) on available-for-sale securities arising during the period, net of tax	$	(419	)	$	(931	)
Less: Reclassification adjustment for net gains realized in net income, net of tax					199

Net unrealized gains (losses) on available- for-sale securities, net of tax	($	419	)	($	1,130	)

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

CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(Amounts in thousands)


	FOR THE
	THREE MONTHS ENDED
	MARCH 31,
	2006			2005
NET CASH FLOWS FROM OPERATING ACTIVITIES	$	191		$	1,887

CASH FLOWS FROM INVESTING ACTIVITIES
Purchases of securities held to maturity		(6,386	)		(6,327	)
Purchases of securities available for sale		(1,057	)		(5,824	)
Proceeds from sales of securities available for sale					1,478
Proceeds from call, maturity and principal payments on securities		4,768			17,808
Net increase in loans made to customers		(1,381	)		(3,849	)
Purchase of premises and equipment		(168	)		(170	)

Net cash flows from investing activities		(4,224	)		3,116


CASH FLOWS FROM FINANCING ACTIVITIES
Net decrease in deposit accounts		(3,487	)		(4,616	)
Net increase (decrease) in borrowings		117			(510	)
Dividends paid		(962	)		(921	)
Purchases of treasury stock					(1	)
Treasury shares reissued		446			465

Net cash flows from financing activities		(3,886	)		(5,583	)


NET CHANGE IN CASH AND CASH EQUIVALENTS		(7,919	)		(580	)

CASH AND CASH EQUIVALENTS
Beginning of period		19,237			12,897

End of period	$	11,318		$	12,317


SUPPLEMENTAL DISCLOSURES
Interest paid	$	2,639		$	2,088
Income taxes paid	$	0		$	0

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

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

1.) Basis of Presentation:

The accompanying unaudited consolidated financial statements have been prepared in accordance with 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 generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. Operating results for the three months ended March 31, 2006 are not necessarily indicative of the results that may be expected for the year ending December 31, 2006. These interim unaudited consolidated financial statements should be read in conjunction with our annual audited financial statements as of December 31, 2005, included in our Form 10-K for the year ended December 31, 2005, filed with the United States Securities and Exchange Commission. The accompanying consolidated balance sheet at December 31, 2005, 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 2005 financial statements have been reclassified to conform to the presentation for 2006. Such reclassifications had no effect on the net results of operations.

3.) Investment Securities:

Securities classified as held to maturity are those that management has the positive intent and ability to hold to maturity. Securities held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts, with such amortization or accretion included in interest income.

Securities classified as available for sale are those that could be sold for liquidity, investment management, or similar reasons even though management has no present intentions to do so. Securities available for sale are carried at fair value using the specific identification method. Changes in the unrealized gains and losses on available for sale securities are recorded net of tax effect as a component of comprehensive income.

Trading securities are principally held with the intention of selling in the near term. Trading securities are carried at fair value with changes in fair value reported in the Consolidated Statements of Income.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

Realized gains or losses on dispositions are based on net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. The table below sets forth the proceeds, gains and losses realized on securities sold or called for the period ended:


	March 31,
	2006		2005

Proceeds on securities sold	$	—	$	1,478
Gross realized gains		—		287
Gross realized losses		—		—

Proceeds on securities called	$	—	$	5,000
Gross realized gains		—		15
Gross realized losses		—		—

Securities available for sale, carried at fair value, totaled $110,205 at March 31, 2006 and $113,247 at December 31, 2005 representing 46.6% and 48.3%, respectively, of all investment securities. These levels provide an adequate level of liquidity in management’s opinion.

Investment securities with a carrying value of approximately $63,059 at March 31, 2006 and $64,082 at December 31, 2005 were pledged to secure deposits and for other purposes.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

The amortized cost and estimated market value of debt securities at March 31, 2006, by contractual maturity, are shown below. Expected maturities may differ from contractual maturities because borrowers have the right to call or prepay certain obligations with or without call or prepayment penalties.


Investment securities	AMORTIZED		ESTIMATED
available for sale	COST		FAIR VALUE
Due in one year or less	$	1,888	$	1,891
Due after one year through five years		10,068		9,901
Due after five years through ten years		3,369		2,843
Due after ten years		34,826		34,921

		50,151		49,556
Mortgage-backed securities		58,579		57,211

	$	108,730	$	106,767


Investment securities	AMORTIZED		ESTIMATED
held to maturity	COST		FAIR VALUE
Due in one year or less	$	515	$	528
Due after one year through five years		3,218		3,117
Due after five years through ten years		35,967		35,420
Due after ten years		62,185		62,056

		101,885		101,121
Mortgage-backed securities		24,461		23,984

	$	126,346	$	125,105

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

The amortized cost and estimated fair value of investment securities available for sale and investment securities held to maturity as of March 31, 2006, are as follows:


			GROSS		GROSS		ESTIMATED
Investment securities	AMORTIZED		UNREALIZED		UNREALIZED		FAIR
available for sale	COST		GAINS		LOSSES		VALUE
U.S. Government agencies and corporations	$	13,984	$	15	$	265	$	13,734
Obligations of states and political subdivisions		10,860		374		11		11,223
Mortgage-backed and related securities		58,579		219		1,587		57,211
Corporate securities		25,307		13		721		24,599

Total debt securities		108,730		621		2,584		106,767
Other securities		3,438						3,438

Total available for sale	$	112,168	$	621	$	2,584	$	110,205


			GROSS		GROSS		ESTIMATED
Investment securities	AMORTIZED		UNREALIZED		UNREALIZED		FAIR
held to maturity	COST		GAINS		LOSSES		VALUE
U.S. Treasury Securities	$	147	$		$	2	$	145
U.S. Government agencies and corporations		68,913				1,730		67,183
Obligations of states and political subdivisions		32,825		1,001		33		33,793
Mortgage-backed and related securities		24,461				477		23,984

Total held to maturity	$	126,346	$	1,001	$	2,242	$	125,105

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

The following provides a summary of the amortized cost and estimated fair value of investment securities available for sale and investment securities held to maturity as of December 31, 2005:


			GROSS		GROSS		ESTIMATED
Investment securities	AMORTIZED		UNREALIZED		UNREALIZED		FAIR
available for sale	COST		GAINS		LOSSES		VALUE
U.S. Government agencies and corporations	$	14,010	$	34	$	196	$	13,848
Obligations of states and political subdivisions		11,372		506		6		11,872
Mortgage-backed and related securities		61,494		314		1,174		60,634
Corporate securities		24,307		50		857		23,500

Total debt securities		111,183		904		2,233		109,854
Other securities		3,393						3,393

Total available for sale	$	114,576	$	904	$	2,233	$	113,247


			GROSS		GROSS		ESTIMATED
Investment securities	AMORTIZED		UNREALIZED		UNREALIZED		FAIR
held to maturity	COST		GAINS		LOSSES		VALUE
U.S. Treasury Securities	$	148	$	2	$		$	150
U.S. Government agencies and corporations		66,057		5		943		65,119
Obligations of states and political subdivisions		32,842		1,307		23		34,126
Mortgage-backed and related securities		22,358		14		372		22,000

Total held to maturity	$	121,405	$	1,328	$	1,338	$	121,395

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

4.) Concentration of Credit Risk and Off Balance Sheet Risk:

The Company currently does not enter into derivative financial instruments including futures, forwards, interest rate risk swaps, option contracts, or other financial instruments with similar characteristics. The Company also does not participate in any partnerships or other special purpose entities that might give rise to off-balance sheet liabilities.

The Company, through its subsidiary bank, is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit, and financial guarantees. Such instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized on the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.

In the event of nonperformance by the other party, the Company’s exposure to credit loss on these financial instruments is represented by the contract or notional amount of the instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for instruments recorded on the balance sheet. The amount and nature of collateral obtained, if any, is based on management’s credit evaluation.


	CONTRACT OR
	NOTIONAL AMOUNT
	March 31,		December 31,
	2006		2005
Financial instruments whose contract amount represents credit risk:
Commitments to extend credit:
Fixed rate	$	6,628	$	2,101
Variable		36,104		39,180
Standby letters of credit		740		1,195

Standby letters of credit are conditional commitments issued by the Company’s subsidiary bank to guarantee the performance of a customer to a third party. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Generally these financial arrangements have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of these commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

The Company’s subsidiary bank also offers limited overdraft protection as a non-contractual courtesy which is available to individually/jointly owned accounts in good standing for personal or household use. The Company reserves the right to discontinue this service without prior notice. The available amount of overdraft protection on depositors’ accounts not included in the table above at March 31, 2006 totaled $6,068 and $6,191 at December 31, 2005. The total average daily balance of overdrafts used in 2006 was $110 and $126 in 2005, or approximately 2% of the total aggregate overdraft protection available to depositors at both March 31, 2006 and December 31, 2005.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

The Company, through its subsidiary bank, grants residential, consumer and commercial loans, and also offers a variety of saving plans to customers located primarily in Northeast Ohio and Western Pennsylvania. The following represents the composition of the loan portfolio:


	March 31,			December 31,
	2006			2005
1-4 family residential mortgages		32.5	%		31.8	%
Commercial mortgages		47.8	%		48.3	%
Consumer loans		3.7	%		3.6	%
Commercial loans		10.4	%		10.5	%
Home equity loans		5.6	%		5.8	%

There are $315 in mortgage loans held for sale included in 1-4 family residential mortgages as of March 31, 2006, and none at December 31, 2005. These loans are carried, in the aggregate, at the lower of cost or estimated market value based on secondary market prices.

The following table sets forth the aggregate balance of underperforming loans for each of the following categories at March 31, 2006 and December 31, 2005:


	March 31,		December 31,
	2006		2005
Loans accounted for on a Non-accrual basis	$	3,325	$	3,746

Loans contractually past due 90 days or more as to interest or principal payments (not included in non-accrual loans above)	NONE		NONE

Loans considered troubled debt restructurings (not included in non-accrual loans or loans contractually past due above)	NONE		NONE

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

The following shows the amounts of contractual interest income and interest income actually reflected in income on loans accounted for on a non-accrual basis and loans considered troubled debt restructuring for the three months ended March 31, 2006 and 2005.


	March 31,		March 31,
	2006		2005

Gross interest income that would have been recorded if the loans had been current in accordance with their original terms	$	120	$	73

Interest income actually included in income on the loan		2		4

A loan is placed on a non-accrual basis whenever sufficient information is received to question the collectibility of the loan or any time legal proceedings are initiated involving a loan. When a loan is placed on non-accrual status, any interest that has been accrued and not collected on the loan is charged against earnings. Cash payments received while a loan is classified as non-accrual are recorded as a reduction to principal or reported as interest income according to management’s judgment as to collectibility of principal.

A loan is returned to accrual status when either, all of the principal and interest amounts contractually due are brought current and future payments are, in management’s opinion, collectible, or when it otherwise becomes well secured and in the process of collection. When a loan is charged-off, any interest accrued but not collected on the loan is charged against earnings.

Impaired loans are generally included in non-accrual loans. Management does not individually evaluate certain smaller balance loans for impairment as such loans are evaluated on an aggregate basis. These loans include 1 — 4 family, consumer and home equity loans. Impaired loans were evaluated using the fair value of collateral as the measurement method. At March 31, 2006 the recorded investment in impaired loans was $1,532 while the related portion of the allowance for loan losses was $710. At December 31, 2005, there were $1,857 in loans considered impaired while the allocated portion of the allowance for loan losses for such loans was $714.

Loans in the amount of $8,763 as of March 31, 2006, and $5,304 as of December 31, 2005, were not included in any of the above categories and were not currently considered impaired, but which can be considered to be potential problem loans.

Any loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that have not been disclosed above do not (i) represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, or (ii) represent material credits about which management is aware of any information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

The following is an analysis of the allowance for loan losses for the periods ended March 31, 2006 and March 31, 2005:


	THREE MONTHS
	2006			2005
Balance at beginning of period	$	2,168		$	2,629
Loan charge-offs:
1-4 family residential mortgages		5			6
Commercial mortgages		20			—
Consumer loans and Other loans		38			35
Commercial loans		—			5
Home equity loans		—			—

		63			46
Recoveries on previous loan losses:
1 - 4 family residential mortgages		—			—
Commercial mortgages		—			—
Consumer loans and Other loans		27			38
Commercial loans		4			1
Home equity loans		—			—

		31			39


Net charge-offs		(32	)		(7	)

Provision charged to operations		66			112

Balance at end of period	$	2,202		$	2,734

Ratio of annualized net charge-offs to average loans outstanding		0.07	%		0.01	%

For each of the periods presented above, the provision for loan losses charged to operations is based on management’s judgment after taking into consideration all known factors connected with the collectibility of the existing portfolio. Management evaluates the portfolio in light of economic conditions, changes in the nature and volume of the portfolio, industry standards and other relevant factors. Specific factors considered by management in determining the amounts charged to operations include previous loan loss experience; the status of past due interest and principal payments; the quality of financial information supplied by customers; the cash flow coverage and trends evidenced by financial information supplied by customers; the nature and estimated value of any collateral supporting specific loan credits; risk classifications determined by the Company’s loan review systems or as the result of the regulatory examination process; and general economic conditions in the lending area of the Company’s bank subsidiary. Key risk factors and assumptions are dynamically updated to reflect actual experience and changing circumstances.

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

(Dollars in thousands)

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

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

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

5.) Legal Proceedings:

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

6.) Earnings Per Share and Capital Transactions:

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


	THREE MONTHS ENDED
	March 31,
	2006		2005

Net Income	$	1,175	$	1,258
Weighted average common shares outstanding *		4,371,069		4,313,275

Basic earnings per share *	$	0.27	$	0.29
Diluted earnings per share *	$	0.27	$	0.29
Dividends declared per share*	$	0.22	$	0.21

* Average shares outstanding and resultant per share amounts have been restated to give retroactive effect to the 3% stock dividend of
January 1, 2006.

CORTLAND BANCORP AND SUBSIDIARIES
CONSOLIDATED AVERAGE BALANCE SHEETS,
YIELDS AND RATES (UNAUDITED)

(Fully taxable equivalent basis in thousands of dollars)


	YEAR TO DATE AS OF
	March 31, 2006							DECEMBER 31, 2005							March 31, 2005
	Average				Average			Average				Average			Average				Average
	Balance (1)		Interest		Rate			Balance (1)		Interest		Rate			Balance (1)		Interest		Rate

ASSETS
Federal funds sold and other money market funds	$	3,500	$	38		4.4	%	$	3,619	$	119		3.3	%	$	2,321	$	14		2.5	%
Investment securities (1) (2)		238,304		3,221		5.4	%		221,844		11,547		5.2	%		220,117		2,798		5.1	%
Loans (2) (3)		188,272		3,332		7.2	%		192,873		13,040		6.8	%		192,907		3,132		6.5	%

Total interest-earning assets		430,076	$	6,591		6.2	%		418,336	$	24,706		5.9	%		415,345	$	5,944		5.7	%

Cash and due from banks		9,236							9,417							8,983
Bank premises and equipment		4,116							4,316							4,435
Other assets		11,931							12,418							12,723

Total non-interest-earning assets		25,283							26,151							26,141


Total Assets	$	455,359						$	444,487						$	441,486


LIABILITIES AND SHAREHOLDERS’ EQUITY
Interest-bearing demand deposits	$	46,359	$	162		1.4	%	$	49,355	$	389		0.8	%	$	46,744	$	66		0.6	%
Savings		85,260		215		1.0	%		89,107		647		0.7	%		90,526		126		0.6	%
Time		157,423		1,557		4.0	%		144,793		5,123		3.5	%		146,661		1,227		3.4	%

Total interest-bearing deposits		289,042		1,934		2.7	%		283,255		6,159		2.2	%		283,931		1,419		2.0	%
Federal funds purchased		81		1		4.8	%		428		15		3.5	%		608		4		2.5	%
Other borrowings		57,546		718		5.1	%		49,504		2,491		5.0	%		46,838		582		5.0	%

Total interest-bearing liabilities		346,669	$	2,653		3.1	%		333,187	$	8,665		2.6	%		331,377	$	2,005		2.5	%

Demand deposits		56,845							58,320							56,647
Other liabilities		3,075							3,315							3,557
Shareholders’ equity		48,770							49,665							49,905

Total liabilities and Shareholders’ equity	$	455,359						$	444,487						$	441,486

Net interest income			$	3,938						$	16,041						$	3,939

Net interest rate spread (4)						3.1	%						3.3	%						3.2	%

Net interest margin (5)						3.7	%						3.8	%						3.8	%

Ratio of interest-earning assets to interest-bearing liabilities						1.24							1.26							1.25


(1)		Includes both taxable and tax exempt securities

(2)		Tax exempt interest is shown on a tax equivalent basis for proper comparison using a statutory federal income tax rate of 34%.

(3)		Includes loan origination and commitment fees.

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

(5)		Interest margin is calculated by dividing the difference between total interest earned and total interest expensed by total interest-earning assets.

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

CORTLAND BANCORP AND SUBSIDIARIES
ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS

SELECTED FINANCIAL DATA FOR QUARTER ENDED
(In thousands of dollars, except for ratios and per share amounts)


	March 31,			December 31,			September 30,			June 30,			March 31,
	2006			2005			2005			2005			2005

SUMMARY OF OPERATIONS
Total interest income	$	6,319		$	6,212		$	5,884		$	5,829		$	5,661
Total interest expense		2,653			2,439			2,197			2,024			2,005

NET INTEREST INCOME (NII)		3,666			3,773			3,687			3,805			3,656
Provision for loan losses		66			135			160			138			112

NII after loss provision		3,600			3,638			3,527			3,667			3,544
Security gains (losses)		—			—			4			2			302
Gain on sale of loans		14			30			28			22			9
Total other income		622			665			732			677			679
Total other expense		2,969			2,990			3,288			2,972			2,950

Income before tax		1,253			1,340			971			1,396			1,584
Net income	$	1,175		$	1,093		$	851		$	1,132		$	1,258

Core earnings (1)	$	1,021		$	1,075		$	990		$	1,116		$	1,053

Net income (Rolling 4 Quarters) (2)	$	4,251		$	4,334		$	4,546		$	5,010		$	4,960
Core earnings (Rolling 4 Quarters)	$	4,202		$	4,234		$	4,206		$	4,280		$	4,188

PER COMMON SHARE DATA (3)
Net income, both basic and diluted	$	0.27		$	0.25		$	0.20		$	0.26		$	0.29
Net income, both basic and diluted (Rolling 4 Quarters)		0.98			1.00			1.05			1.16			1.16
Core income, both basic and diluted		0.23			0.25			0.23			0.26			0.24
Core income, both basic and diluted (Rolling 4 Quarters)		0.97			0.98			0.97			0.99			0.98
Cash dividends declared		0.22			0.44			0.21			0.21			0.21
Cash dividends declared (Rolling 4 Quarters)		1.08			1.07			1.07			1.06			1.06
Book value		11.11			11.11			11.76			11.92			11.71

BALANCE SHEET DATA
Assets	$	456,658		$	459,701		$	449,579		$	439,287		$	442,067
Investments		236,551			234,652			222,065			214,336			217,025
Net loans		187,529			186,034			190,194			191,003			192,939
Deposits		346,888			350,375			343,083			337,337			340,303
Borrowings		58,228			58,111			54,115			48,526			47,379
Shareholders equity		48,565			48,325			49,513			50,058			49,069

AVERAGE BALANCES
Assets	$	455,359		$	453,622		$	441,614		$	441,264		$	441,486
Investments		238,304			232,498			217,572			217,100			220,117
Net loans		186,083			188,426			191,060			191,584			190,260
Deposits		345,887			345,722			338,714			341,260			340,578
Borrowings		57,627			55,286			49,617			47,299			47,446
Shareholders equity		48,770			49,039			50,191			49,767			49,905

ASSET QUALITY RATIOS
Underperforming assets as a percentage of:
Total assets		0.78	%		0.83	%		0.81	%		0.93	%		0.86	%
Equity plus allowance for loan losses		6.98			7.58			7.04			7.69			7.31
Tier I capital		7.12			7.81			7.35			8.24			7.74

FINANCIAL RATIOS
Return on average equity		9.64	%		8.92	%		6.78	%		9.10	%		10.08	%
Return on average equity (Rolling 4 Quarters)		8.60			8.72			9.08			10.05			9.97
Return on average assets		1.03			0.96			0.77			1.03			1.14
Return on average assets (Rolling 4 Quarters)		0.95			0.97			1.03			1.13			1.11
Effective tax rate (4)		17.80			18.43			12.36			18.91			20.58
Net interest margin ratio		3.70			3.79			3.83			3.93			3.79


(1)		Core earnings are earnings before gains on loans sold, investment securities sold or called, trading security gains, other real estate losses and certain other non recurring items.

(2)		Rolling 4 quarters is calculated by using the current quarter plus the preceding 3 quarters.

(3)		Basic and diluted earnings per share are based on weighted average shares outstanding adjusted retroactively for stock dividends. Cash dividends per common share are based on actual cash dividends declared, adjusted retroactively for the stock dividends. Book value per common share is based on shares outstanding at each period , adjusted retroactively for the stock dividends.

(4)		The effective tax rate for 2006 is calculated before the $145 adjustment to the tax accrual estimate made in the first quarter of 2006.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

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 included elsewhere in this report.

Note Regarding Forward-looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements. In addition to historical information, certain information included in this Quarterly Report on Form 10-Q and other material filed or to be filed by the Company with the Securities and Exchange Commission (as well as information included in oral statements or other written statements made or to be made by the Company) may contain herein, the forward-looking statements that involve risks and uncertainties. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or similar terminology identify forward-looking statements. These statements reflect management’s beliefs and assumptions, and are based on information currently available to management. Economic circumstances, the Company’s operations and actual results could differ significantly from those discussed in any forward-looking statements. Some of the factors that could cause or contribute to such differences are changes in the economy and interest rates either nationally or in the Company’s market area; changes in customer preferences and consumer behavior; increased competitive pressures or changes in either the nature or composition of competitors; changes in the legal and regulatory environment; changes in factors influencing liquidity such as expectations regarding the rate of inflation or deflation, currency exchange rates, and other factors influencing market volatility; unforeseen risks associated with other global economic, political and financial factors. While actual results may differ significantly from the results discussed in the forward-looking statements, the Company undertakes no obligation to update publicly any forward-looking statement for any reason, even if new information becomes available.

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 quarterly and year-to-date financial results of operations.

Critical Accounting Policies and Estimates

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and follow general practices within the industries in which it operates. The most significant accounting policies followed by the Company are presented in “Notes to Consolidated Financial Statements Summary of Significant Accounting Policies” in the 2005 annual report on Form 10-K. Application of these principles requires management to make estimates, assumptions and judgments that affect the amounts reported in the financial statements and accompanying notes. Some of these policies and related methodologies are more critical than others. There has been no material change in critical accounting estimates since those presented in the 2005 annual report on Form 10-K.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

The Company has identified its policy on the allowance for loan losses as being critical because it requires management to make particularly difficult, subjective and/or complex judgments about matters that are inherently uncertain, and because of the likelihood that materially different amounts would be reported under different conditions or by using different assumptions. In determining the appropriate amount to reserve for potential credit losses, the Company’s banking subsidiary also considers unfunded commitments, such as loan commitments, letter of credit and unused lines of credit. During the current year, the Company refined its approach to reserving for such unfunded credit commitments, incorporating into its reserve calculations the same off-balance sheet assumptions prescribed for determining risk-based capital.

Liquidity

The central role of the Company’s liquidity management is to (1) ensure sufficient liquid funds to meet the normal transaction requirements of its customers, (2) take advantage of market opportunities requiring flexibility and speed, and (3) provide a cushion against unforeseen liquidity needs.

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

Along with its liquid assets, the Company has other sources of liquidity available to it, which help to ensure that adequate funds are available as needed. These other sources include, but are not limited to, the ability to obtain deposits through the adjustment of interest rates, the purchasing of federal funds, borrowings from the Federal Home Loan Bank of Cincinnati and access to the Federal Reserve Discount Window.

Cash and cash equivalents decreased from March 31, 2005 and from levels at year-end. The average balance, however, remained much more consistent with an average balance of $12,736 at March 31, 2006, $13,036 at December 31, 2005 and $11,304 at March 31, 2005. Operating activities provided cash of $191 and $1,887 during the three months ended March 31, 2006 and 2005, respectively. Key differences stem mainly from: 1) a decrease in net income of $83 compared to March 31, 2005; 2) loans held for sale increased by $315 at March 31, 2006 as compared to an increase of $80 at March 31, 2005. 3) gains on the sale of investments was $302 at March 31, 2005 where there was no investment gains from sales at March 31, 2006; 4) amortization on securities was $141 in 2006 compared to $270 in 2005; 5) provision for loan loss was $66 at March 31, 2006 compared to $112 at March 31, 2005; 6) a liability for Securities to Settle totaled $2,427 at March 31, 2005, an increase of $1,157 while there was no liability at March 31, 2006 or December 31, 2005. Refer to the Consolidated Statements of Cash Flows for a summary of the sources and uses of cash for March 31, 2006 and 2005, and the following table which details the cash flows from operating activities.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)


	Three Months Ended
	March 31,
	2006			2005
Net Income	$	1,175		$	1,258
Adjustments to reconcile net income to net cash flows from operating activities:
Depreciation, amortization and accretion		270			421
Provision for loan loss		66			112
Investment securities gains					(302	)
Impact of loans held for sale		(315	)		(80	)
Changes in:
Securities to settle and securities sold to settle					1,157
Other assets and liabilities		(1,005	)		(679	)

Net cash flows from operating activities	$	191		$	1,887

Capital Resources

The capital management function is a continuous process which consists of providing capital for both the current financial position and the anticipated future growth of the Company. Central to this process is internal equity generation, particularly through earnings retention. Internal capital generation is measured as the annualized rate of return on equity, exclusive of any appreciation or depreciation relating to available for sale securities, multiplied by the percentage of earnings retained. Internally generated capital retained by the Company measured 1.7% for the three months ended March 31, 2006 and 2.7% for the three months ended March 31, 2005. Overall capital (a figure which reflects earnings, dividends paid, common stock issued, treasury shares purchased, treasury shares reissued and the net change in the estimated fair value of available for sale securities) increased at an annual rate of 2.0%. Capital ratios remained well in excess of regulatory minimums.

Risk-based standards for measuring capital adequacy require banks and bank holding companies to maintain capital based on “risk-adjusted” assets. Categories of assets with potentially higher credit risk require more capital than assets with lower risk. In addition, banks and bank holding companies are required to maintain capital to support, on a risk-adjusted basis, certain off-balance sheet activities such as standby letters of credit and interest rate swaps.

These standards also classify capital into two tiers, referred to as Tier 1 and Tier 2. The Company’s Tier 1 capital consists of common shareholders’ equity (excluding any gain or loss on available for sale debt securities) less intangible assets and the net unrealized loss on equity securities with readily determinable fair values. Tier 2 capital is the allowance for loan and lease losses reduced for certain regulatory limitations.

Risk based capital standards require a minimum ratio of 8% of qualifying total capital to risk-adjusted total assets with at least 4% constituting Tier 1 capital. Capital qualifying as Tier 2 capital is limited to 100% of Tier 1 capital. All banks and bank holding companies are also required to maintain a minimum leverage capital ratio (Tier 1 capital to total average assets) in the range of 3% to 4%, subject to regulatory guidelines.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required banking regulatory agencies to revise risk-based capital standards to ensure that they adequately account for the following additional risks: interest rate, concentration of credit, and non traditional activities. Accordingly, regulators will subjectively consider an institution’s exposure to declines in the economic value of its capital due to changes in interest rates in evaluating capital adequacy. The table below illustrates the Company’s risk weighted capital ratios at March 31, 2006 and December 31, 2005.


	March 31, 2006			December 31, 2005
Tier 1 Capital	$	49,699		$	49,031
Tier 2 Capital		2,215			2,189

TOTAL QUALIFYING CAPITAL	$	51,914		$	51,220


Risk Adjusted
Total Assets (*)	$	241,711		$	242,106

Tier 1 Risk-Based Capital Ratio		20.56	%		20.25	%

Total Risk-Based Capital Ratio		21.48	%		21.16	%

Tier 1 Risk-Based Capital to Average Assets (Leverage Capital Ratio)		10.90	%		11.05	%


(*)		Includes off-balance sheet exposures.

Assets, less intangibles and the net unrealized market value adjustment of investment securities available for sale, averaged $456,109 for the three months ended March 31, 2006 and $443,677 for the year ended December 31, 2005.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

In management’s opinion, as supported by the data in the table below, the Company met all capital adequacy requirements to which it was subject as of March 31, 2006 and December 31, 2005. As of those dates, Cortland Bancorp was “well capitalized” under regulatory prompt corrective action provisions.


	Actual Regulatory						Regulatory Capital Ratio
	Capital Ratios as of:						requirements to be:
	March 31,			Dec 31,			Well			Adequately
	2006			2005			Capitalized			Capitalized

Total risk-based capital to risk-weighted assets		21.48	%		21.16	%		10.00	%		8.00	%

Tier 1 capital to risk-weighted assets		20.56	%		20.25	%		6.00	%		4.00	%

Tier 1 capital to average assets		10.90	%		11.05	%		5.00	%		4.00	%

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

First Three Months of 2006 as Compared to First Three Months of 2005

During the first three months of 2006, net interest income after provision for loan losses increased by $56 compared to the first three months of 2005. Total interest income increased by $658 or 11.6%, from the level recorded in 2005. This was accompanied by an increase in interest expense of $648 or 32.3%, and a decrease in the provision for loan losses of $ 46. On a fully taxable equivalent basis, net interest income after provision for loan losses increased by $45.

The increase in net interest income after provision was the product of a 3.5% year-over-year increase in average earning assets and a decrease in the provision for loan loss of $46. The Company’s tax equivalent net interest margin for the first three months of 2006 measured 3.7% and 3.8% in the same period of 2005.

The average rate paid on interest sensitive liabilities increased by 65 basis points year-over-year. The average balance of interest sensitive liabilities increased by $15,292 or 4.6%. Compared to the first three months of last year, the average borrowings increased by $10,181, while the average rate paid on borrowings increased by 4 basis points.

Average interest-bearing demand deposits and balances on money market accounts decreased by $385, while savings deposits decreased by $5,266. The average rate paid on these products increased by 60 basis points in the aggregate. The average balance on time deposit products increased by $10,762, while the average rate paid increased by 61 basis points.

Interest and dividend income on securities registered an increase of $434, or 17.1%, during the first three months of 2006 when compared to 2005, while on a fully tax equivalent basis income on investment securities increased by $423 or 15.1%. The average invested balances increased by $18,187 from the levels of a year ago. The increase in the average balance of investment securities was accompanied by a 32 basis point increase in the tax equivalent yield of the portfolio.

Interest and fees on loans increased by $200, or 6.4%, for the first three months of 2006 compared to 2005, while on a fully tax equivalent basis income on loans also increased by $200 or 6.4%. A $4,635 decrease in the average balance of the loan portfolio, or 2.4%, was accompanied by a 69 basis point increase in the portfolio’s tax equivalent yield.

Other interest income increased by $24 from the same period a year ago. The average balance of Federal Funds sold and other money market funds increased by $1,179 or 50.8%. The yield on federal funds and other money market funds, increased by 185 basis points compared to the same period of 2005.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

The composite tax equivalent yield on earning assets increased by 46 basis points from the same quarter a year ago. The tax equivalent yield of the investment portfolio measured 5.4%, a 32 basis point increase from the same quarter a year ago, while the loan portfolio yielded 7.2%, up 69 basis points from last year’s rate. Meanwhile, the rate paid on interest-bearing liabilities increased 65 basis points compared to a year ago. The average rate on federal funds sold and other money market funds was 4.4%, up 185 basis points from last year’s rates. The net effect of these changes was that the tax equivalent net interest margin decreased by 9 basis points from 3.8% to 3.7%.

Other income from all sources decreased by $368 from the same period a year ago. Gains on 1-4 residential mortgage loans sold in the secondary mortgage market increased by $5 from the same period a year ago. Gains on securities called and net gains on the sale of available for sale investment securities decreased by $302 from year ago levels. Fees for other customer services decreased by $37 due mainly to a $50 decrease in service charge income on deposits. Other sources of non-recurring non-interest income decreased by $34 from the same period a year ago. This income category is subject to fluctuation due to non-recurring items, but the difference is due mainly to a $ 20 increase in the change in allowance for credit losses from March 31, 2005.

Loans net of the allowance for losses decreased by $5,410 during the 12-month period from March 31, 2005 to March 31, 2006, and increased by $1,495 from year-end. Gross loans as a percentage of earning assets stood at 44.3% as of March 31, 2006 and 47.1% at March 31, 2005. The loan to deposit ratio at the end of the first three months of 2006 was 54.7% and 57.5% for the same period a year ago. The investment portfolio represented 68.2% of each deposit dollar, up from 63.8% a year ago.

Loan charge-offs during the first three months were $ 63 in 2006 compared to $46 in 2005, while the recovery of previously charged-off loans amounted to $31 in 2006 compared to $39 in 2005. A provision for loan loss of $66 was charged to operations in 2006 and $112 in 2005. Non-accrual loans at March 31, 2006 represented 1.8% of the loan portfolio and 2.0% at December 31, 2005. At March 31, 2006, the loan loss allowance of $2,202 represented approximately 1.2% of outstanding loans.

Total other expenses in the first three months were $2,969 in 2006 compared to $2,950 in 2005, an increase of $19, or 0.6%. Full time equivalent employment averaged 158 during the first three months of 2006 and 160 at March 31, 2005. Salaries and benefits increased by $22 or 1.3%, compared to the similar period a year ago. This increase is a combination of regular staff salary and benefit increases.

For the first three months of 2006, state and local taxes increased by $1. Occupancy and equipment expense increased by $8 or 1.8%. Office supplies increased by $7. Marketing expense decreased by $11. Much of this decrease is due to the timing of marketing expenditures. Bank exam and audit expense increased by $4. All other expense categories decreased by 2.8%, or $12 as a group. This expense category is subject to fluctuation due to non-recurring items.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

Income before income tax expense amounted to $1,253 for the first three months of 2006 compared to $1,584 for the similar period of 2005. The effective tax rate for the first three months was 6.2% in 2006 compared to 20.6% in 2005, resulting in income tax expense of $78 and $326, respectively. The decrease in the effective tax rate reflects a one time adjustment to tax expense of $145 due to a change in tax accrual estimate. The effective tax rate before the $145 adjustment was 17.8%. The provision for income taxes differs from the amount of income tax determined applying the applicable U.S. statutory federal income tax rate to pre-tax income as a result of the following differences:


	March 31,
	2006			2005
Provision at statutory rate	$	426		$	539
Add (Deduct):
Tax effect of non-taxable income		(230	)		(232	)
Tax effect of non-deductible expense		27			19
Tax effect of change in estimate		(145	)

Federal income taxes	$	78		$	326

Net income for the first three months registered $1,175 in 2006 compared to $1,258 in 2005, representing per share amounts of $0.27 in 2006 and $0.29 in 2005. Dividends declared per share were $0.22 in 2006 and $0.21 in 2005.

Core earnings (earnings before gains on loans sold, investment securities sold or called, other real estate losses and certain other non-recurring items) decreased by $32, or 3.0% in the first three months of 2006 compared to 2005. Core earnings for the three months of 2006 were $1,021 compared to last year’s $1,053. Core earnings per share were $0.23 in 2006 and $0.24 in 2005. The following is a reconciliation between core earnings and earnings under generally accepted accounting principles in the United States (GAAP earnings):


	Three Months Ended
	March 31
	2006			2005
GAAP Earnings	$	1,175		$	1,258
Investment security gains					(302	)
Gain on sale of loans		(14	)		(9	)
Other non-recurring items*		(145	)
Tax effect of adjustments		5			106

Core Earnings	$	1,021		$	1,053


Core earnings per share	$	0.23		$	0.24


*		Includes a one-time change in tax accrual estimate made in the first quarter of 2006.

CORTLAND BANCORP AND SUBSIDIARIES

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

Dollars in thousands)

Regulatory Matters

On March 13, 2000, the Board of Governors of the Federal Reserve System approved the Company’s application to become a financial holding company. As a financial holding company, the Company may engage in activities that are financial in nature or incidental to a financial activity, as authorized by the Gramm-Leach-Bliley Act of 1999 (The Financial Services Reform Act). Under the Financial Services Reform Act, the Company may continue to claim the benefits of financial holding company status as long as each depository institution that it controls remains well capitalized and well managed.

The Company is required to provide notice to the Board of Governors of the Federal Reserve System when it becomes aware that any depository institution controlled by the Company ceases to be well capitalized or well managed. Furthermore, current regulation specifies that prior to initiating or engaging in any new activities that are authorized for financial holding companies, the Company’s insured depository institutions must be rated “satisfactory” or better under the Community Reinvestment Act (CRA). The Company’s bank subsidiary is rated “satisfactory” for CRA purposes, and remains well capitalized and well managed in Management’s opinion.

CORTLAND BANCORP AND SUBSIDIARIES

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

(Dollars in thousands)

New Accounting Standards

In November 2005, the Financial Accounting Standards Board (FASB) issued FASB Staff Position (FSP) 115-and 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments”. This FSP provides guidance on when an investment in a debt or equity security should be considered impaired, when that impairment should be considered other-than-temporary, and measurement of the impairment loss. An investment is considered impaired if the fair value of the investment is less than its cost. If, after consideration of all available evidence to evaluate the realizable value of the investment, impairment is determined to be other-than-temporary, then an impairment loss should be recognized equal to the difference between the investment’s cost and its fair value. The guidance also clarifies that an impairment loss should be recognized no later than when the impairment is deemed other-than-temporary, even if a decision to sell has not been made. This FSP nullifies certain provisions of Emerging Issues Task Force (EITF) Issue No. 03-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments,” while retaining the disclosure requirements of EITF 03-1 which were adopted in 2003. FSP 115-1 and 124-1 is effective for reporting periods beginning after December 15, 2005. The Company applied the guidance in this FSP in 2005.

In May 2005, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 154 “Accounting Changes and Error Corrections,” a replacement of APB Opinion No. 20, “Accounting Changes” and FASB Statement No. 3, “Reporting Accounting Changes in Interim Financial Statements.” SFAS No. 154 applies to all voluntary changes in accounting principle and changes the requirements for accounting for and reporting a change in accounting principle. SFAS No. 154 requires retrospective application to prior periods’ financial statements of a voluntary change in accounting principle unless it is impracticable. APB No. 20 previously required that most voluntary changes in accounting principle be recognized by including in net income of the period of the change the cumulative effect of changing to the new accounting principle. SFAS No. 154 is effective for accounting changes made in fiscal years beginning after December 15, 2005. The Company’s adoption of SFAS No. 154 did not have a material impact on its earnings, cash flows and/or financial position.

Available Information

The Company files an annual report on Form 10K, quarterly reports on Form 10Q, current reports on Form 8K and amendments to those reports with the Securities and Exchange Commission (SEC) pursuant to Section 13 (a) or (15)d of the Exchange Act. The Company’s Internet address is www.cortland-banks.com. The Company makes available through this address, free of charge, the reports filed, as soon as reasonably practicable after such material is electronically filed, or furnished to, the SEC. The SEC also maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

CORTLAND BANCORP AND SUBSIDIARIES

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

(Dollars in thousands)

Management considers interest rate risk to be the Company’s principal source of 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 typically 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 most significant assumptions used in the simulation relate to the cash flows and re-pricing characteristics of the Company’s balance sheet. Re-pricing and runoff rate assumptions are based on a detailed interface with actual customer information and investment data stored on the subsidiary bank’s information systems. Consensus prepayments speeds derived from an independent third party source are used to adjust the runoff cash flows for the impact of the specific interest rate environments under consideration. Simulated results are benchmarked against historical results. 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 table on the following page shows the Company’s current estimate of interest rate sensitivity based on the composition of the balance sheet at March 31, 2006, and December 31, 2005. 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 subsequent twelve months reaching a level 300 basis points higher (lower) than the rates in effect at March 31, 2006 and December 31, 2005 for the respective simulations. Under both the rising rate scenario and the falling rate scenario, the yield curve is assumed to exhibit a parallel shift.

CORTLAND BANCORP AND SUBSIDIARIES

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

(CONTINUED)

(Dollars in thousands)

Over the past twelve months, the Federal Reserve has increased its target rate for overnight federal funds by 200 basis points. At March 31, 2006, the difference between the yield on the ten-year Treasury and the three-month Treasury had decreased to a positive 23 basis points from the positive 31 basis points that existed at December 31, 2005. The change denotes a “flattening” of the yield curve. The yield curve, however, remains positively sloping, as interest rates increase with a lengthening of maturities, with rates peaking at the long-end of the Treasury 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 $15,382 for the twelve month period ending March 31, 2007.


	Simulated Net Interest Income (NII) Scenarios
	Fully Taxable Equivalent Basis
	For the Twelve Months Ending
	Net Interest Income				$ Change in NII						% Change in NII
Changes in	March 31,		Dec. 31,		March 31,			Dec. 31,			March 31,			Dec. 31,
Interest Rates	2007		2006		2007			2006			2007			2006

Graduated increase of + 300 basis points	$	15,636	$	15,385	$	254		$	8			1.7	%		0.1	%
Short term rates unchanged		15,382		15,377
Graduated decrease of -300 basis points		15,015		14,643		(367	)		(734	)		(2.4	)%		(4.8	)%

The level of interest rate risk indicated is within limits that Management considers acceptable. However, given that interest rate movements can be sudden and unanticipated, and are increasingly influenced by global events and circumstances beyond the purview of the Federal Reserve, no assurance can be made that interest rate movements will not impact key assumptions and parameters in a manner not presently embodied by the model.

It is Management’s opinion that hedging instruments currently available are not a cost effective means of controlling interest rate risk for the Company. Accordingly, the Company does not currently use financial derivatives, such as interest rate options, swaps, or other similar instruments.

CORTLAND BANCORP AND SUBSIDIARIES

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 principal 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 principal financial officer have 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 16, 2006

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

Not applicable

Item 3. Defaults upon Senior Securities

Not applicable

Item 4. Submission of Matters to a Vote of Security Holders

Not applicable

Item 5. Other Information

Not applicable

Item 6. Exhibits


	Exhibit 2	Not applicable

	Exhibit 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. (1)

	Exhibit 3.2	Code of Regulations, as amended (1)

	Exhibit 4	The rights of holders of equity securities are defined in portions of the Articles of Incorporation and Code of Regulations as referenced in 3.1 and 3.2. (1)

*	Exhibit 10.1	Group Term Carve Out Plan dated February 23,2001 and form of endorsement entered into in 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 (1)

*	Exhibit 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. (1)

*	Exhibit 10.3	Director Retirement Agreement between Cortland Bancorp and Jerry A. Carleton, dated as of July 26, 2005 (1)

*	Exhibit 10.4	Director Retirement Agreement between Cortland Bancorp and David C. Cole, dated as of March 1, 2001, as amended by letter amendment dated February 12, 2004 (1)

*	Exhibit 10.5	Director Retirement Agreement between Cortland Bancorp and George E. Gessner, dated as of March 1, 2001, as amended by letter amendment dated February 12, 2004 (1)

*	Exhibit 10.6	Amended Director Retirement Agreement between Cortland Bancorp and William A. Hagood, dated as of October 12, 2003 (1)

CORTLAND BANCORP AND SUBSIDIARIES

PART II — OTHER INFORMATION (Continued)


* Exhibit 10.7		Director Retirement Agreement between Cortland Bancorp and James E. Hoffman III, dated as of March 1, 2001, as amended by letter amendment dated February 12, 2004 (1)

* Exhibit 10.8		Director Retirement Agreement between Cortland Bancorp and Neil J. Kaback, dated as of March 1, 2004 (1)

* Exhibit 10.9		Director Retirement Agreement between Cortland Bancorp and K. Ray Mahan, dated as of March 1, 2001 (1)

* Exhibit 10.10		Amended and Restated Director Retirement Agreement between Cortland Bancorp and Richard B. Thompson, dated as of May 1, 2004 (1)

* Exhibit 10.11		Director Retirement Agreement between Cortland Bancorp and Timothy K. Woofter, dated as of March 1, 2001, as amended by letter amendment dated February 12, 2004 (1)

* Exhibit 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; and Split Dollar Agreement and Endorsement entered into by Cortland Bancorp as of July 26, 2005 with Director Jerry A. Carleton (1)

* Exhibit 10.13		Split Dollar Agreement between The Cortland Savings and Banking Company and Rodger W. Platt dated of as February 23, 2001, as amended on August 15, 2002 and September 29, 2005 (1)

* Exhibit 10.14		Endorsement Split Dollar Agreement between The Cortland Savings and Banking Company and Rodger W. Platt dated as of September 29, 2005 (1)

* Exhibit 10.15		Form of Indemnification Agreement entered into by Cortland Bancorp with each of its directors as of May 24, 2005 (1)

* Exhibit 10.16		Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Rodger W. Platt, dated as of August 15, 2002 (1)

* Exhibit 10.17		Second Amended and Restated Salary Continuation Agreement between The Cortland Savings and Banking Company and Timothy Carney, dated as of December 17, 2003 (1)

* Exhibit 10.18		Second Amended and Restated Salary Continuation Agreement between The Cortland Savings and Banking Company and Lawrence A. Fantauzzi, dated as of December 16, 2003 (1)

* Exhibit 10.19		Second Amended and Restated Salary Continuation Agreement between The Cortland Savings and Banking Company and James M. Gasior, dated as of December 15, 2003 (1)

CORTLAND BANCORP AND SUBSIDIARIES

PART II — OTHER INFORMATION (Continued)


* Exhibit 10.20		Amended Salary Continuation Agreement between The Cortland Savings and Banking Company and Marlene Lenio, dated as of September 9, 2002 (1)

* Exhibit 10.21		Salary Continuation Agreement between The Cortland Savings and Banking Company and Craig Phythyon, dated as of December 15, 2003 (1)

* Exhibit 10.22		Second Amended and Restated Salary Continuation Agreement between The Cortland Savings and Banking Company and Stephen A. Telego, Sr., dated as of December 15, 2003 (1)

* Exhibit 10.23		Second Amended and Restated Salary Continuation Agreement between The Cortland Savings and Banking Company and Danny L. White, dated as of December 15, 2003 (1)

* Exhibit 10.24		Second Amended Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Timothy Carney, dated as of December 17, 2003 (1)

* Exhibit 10.25		Second Amended Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Lawrence A. Fantauzzi, dated as of December 16, 2003 (1)

* Exhibit 10.26		Second Amended Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and James M. Gasior, dated as of December 15, 2003 (1)

* Exhibit 10.27		Amended Split Dollar Agreement between The Cortland Savings and Banking Company and Marlene Lenio, dated as of September 9, 2002 (1)

* Exhibit 10.28		Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Craig Phythyon, dated as of December 15, 2003 (1)

* Exhibit 10.29		Second Amended Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Stephen A. Telego, Sr., dated as of December 15, 2003 (1)

* Exhibit 10.30		Second Amended Split Dollar Agreement and Endorsement between The Cortland Savings and Banking Company and Danny L. White, dated as of December 15, 2003 (1)

* Exhibit 10.31		Severance Agreement Due to Change in Control of Cortland Bancorp entered by Cortland Bancorp and The Cortland Savings and Banking Company in January 2001 with each of Timothy Carney, Lawrence A. Fantauzzi, James M. Gasior, and Stephen A. Telego, Sr. (1)

CORTLAND BANCORP AND SUBSIDIARIES

PART II — OTHER INFORMATION (Continued)


*	Exhibit 10.32	Severance Agreement Due to Change in Control of Cortland Bancorp entered by Cortland Bancorp and The Cortland Savings and Banking Company in January 2001 with each of Marlene Lenio, Barbara Sandrock, and Danny L. White (1)

	Exhibit 11	See Note (6) of the Financial Statements

	Exhibit 15	Not applicable

	Exhibit 18	Not applicable

	Exhibit 19	Not applicable

	Exhibit 22	Not applicable

	Exhibit 23	Not applicable

	Exhibit 24	Not applicable

	Exhibit 31.1	CEO certification (Filed herewith)

	Exhibit 31.2	CFO certification (Filed herewith)

	Exhibit 32	Certifications of Chief Executive Officer and Chief Financial Officer required under Section 906 of Sarbanes-Oxley Act of 2002 (Filed herewith)


*		Management contract or compensatory plan or arrangement

(1)		Filed previously as an Exhibit to form 10-K filed on March 16, 2006

SIGNATURES

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


		Cortland Bancorp (Registrant)

DATED: May 9, 2006		/s/ Rodger W. Platt Rodger W. Platt
		Interim President
		(Interim Chief Executive Officer)

DATED: May 9, 2006		/s/ James M. Gasior James M. Gasior
		Secretary
		(Chief Financial Officer)