CORTLAND BANCORP INC (Form: 10-K, Received: 03/15/2007 16:11:14)

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-K

(Mark One)


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

For the fiscal year ended December 31, 2006


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

For the transition period from to

Commission File Number 0-13814

CORTLAND BANCORP

(Exact Name of Registrant as Specified in its Charter)


Ohio		34-14511184

(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)

Registrant’s telephone number, including area code: (330) 637-8040

Securities registered pursuant to Section l2(b) of the Act: None

Securities registered pursuant to Section l2(g) of the Act:

Common Stock, no par value

(Title of Class)

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. o Yes þ No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. o Yes þ No

Indicate by check mark whether the registrant (l) has filed all reports required to be filed by Section l3 or l5(d) of the Securities Exchange Act of l934 during the preceding l2 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. þ Yes o No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (229.405 of the chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of the Form 10-K or any amendment to this Form 10-K þ .

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 Act). o Yes þ No

Based upon the closing price of the registrant’s common stock of June 30, 2006 the aggregate market value of the voting stock held by non-affiliates of the registrant was approximately $71,674,848. For purposes of this response directors and executive officers are considered the affiliates of the issuer at that date.

The number of shares outstanding of the issuer’s classes of common stock as of March 13, 2007: 4,511,519 shares

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Annual Shareholders Report for the year ended December 31, 2006 are incorporated by reference into Parts I, II and IV. Portions of the Proxy Statement for the annual shareholders meeting to be held April 24, 2007 are incorporated by reference into Part III.

FORM 10-K

2006

INDEX


		Page
Part I

Item l. Business:
General		I-2
Statistical Disclosure		I-4

Item 1A. Risk Factors		I-7

Item 1B. Unresolved Staff Comments		I-9

Item 2. Properties		I-9

Item 3. Legal Proceedings		I-9

Item 4. Submission of Matters to a Vote of Security Holders		I-10

Item 4A. Executive Officers of the Registrant		I-10

Part II

Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities		II-1

Item 6. Selected Financial Data		II-2

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations		II-2

Item 7A. Quantitative and Qualitative Disclosures About Market Risk		II-2

Item 8. Financial Statements and Supplementary Data		II-2

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures		II-2

Item 9A. Controls and Procedures		II-2

Item 9B. Other Information		II-2

Part III

Item l0. Directors, Executive Officers and Corporate Governance		III-1

Item ll. Executive Compensation		III-1

Item l2. Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters		III-1

Item l3. Certain Relationships and Related Transactions , and Director Independence		III-1

Item l4. Principal Accountant Fees and Services		III-1

Part IV

Item l5. Exhibits, Financial Statement Schedules		IV-1

Signatures		IV-2

Index to Exhibits		IV-3
EX-3.2
EX-10.12
EX-10.27
EX-13
EX-21
EX-23
EX-31.1
EX-31.2
EX-32

I-1

PART I

Item l. Business

General

THE CORPORATION

Information relating to Item 1 — Business General – THE CORPORATION — is set forth in the Corporation’s 2006 Annual Report to Shareholders, Page 4, Brief Description of the Business and is incorporated herein by reference.

CORTLAND BANKS

Information relating to Item 1 — Business General – CORTLAND BANKS — is set forth in the Corporation’s 2006 Annual Report to Shareholders, Page 4, Brief Description of the Business and is incorporated herein by reference.

NEW RESOURCES LEASING COMPANY

Information relating to Item 1 — Business General — NEW RESOURCES LEASING COMPANY — is set forth in the Corporation’s 2006 Annual Report to Shareholders, Page 4, Brief Description of the Business and is incorporated herein by reference.

SUPERVISION AND REGULATION

The Company is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”). As a financial holding 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). As of December 31, 2006, the Company’s bank subsidiary was rated “satisfactory” for CRA purposes, and remained well capitalized and, in management’s opinion, well managed. Cortland Bancorp owns no property. Operations are conducted at 194 West Main Street, Cortland, Ohio.

The Bank, as a state chartered banking organization and member of the Federal Reserve System, is subject to periodic examination and regulation by both the Federal Reserve Bank of Cleveland and the State of Ohio Division of Financial Institutions. These examinations, which include such areas as capital, liquidity, asset quality, management practices and other aspects of the Bank’s operations, are primarily for the protection of the Bank’s depositors. In addition to these regular examinations, the Bank must furnish periodic reports to regulatory authorities containing a full and accurate statement of its affairs. The Bank’s deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to the statutory limit of $100,000 per customer. Individual Retirement Account deposits are insured by the FDIC to $250,000 per customer.

I-2

Item l. Business

General (Continued)

On July 30, 2002, President Bush signed into law the Sarbanes-Oxley Act of 2002, which contains important new requirements for public companies in the area of financial disclosure and corporate governance. In accordance with section 302(a) of the Sarbanes-Oxley Act, written certifications by the Company’s Chief Executive Officer and Chief Financial Officer are required. These certifications attest that the Company’s quarterly and annual reports filed with the SEC do not contain any untrue statement of a material fact or omit to state a material fact. The Company has also implemented a program designed to comply with Section 404 of the Sarbanes-Oxley Act, which includes the identification of significant processes and accounts, documentation of the design of control effectiveness over process and entity level controls, and testing of the operating effectiveness of key controls.

COMPETITION

Information relating to Item 1 — Business General — COMPETITION — is set forth in the Corporation’s 2006 Annual Report to Shareholders, Page 4, Brief Description of the Business and is incorporated herein by reference.

EMPLOYEES

Information relating to Item 1 — Business General – EMPLOYEES — is set forth in the Corporation’s 2006 Annual Report to Shareholders, Page 4, Brief Description of the Business and is incorporated herein by reference

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.

I-3

Item l. Business

Statistical Disclosure

I. DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS’ EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL

Information relating to I — Distribution of Assets, Liabilities and Shareholders’ Equity; Interest Rates and Interest Differential is set forth in the Corporation’s 2006 Annual Report to Shareholders under the pages indicated below and is incorporated herein by reference:


		Pages in 2006
		Annual Report
		to Shareholders
A. Average Balance Sheet —
December 31, 2006, 2005 and 2004		32 & 33

B. Analysis of Net Interest Earnings —
Years ending December 31, 2006, 2005 and 2004		32 & 33

C. Rate and Volume Analysis —
2006 change from 2005
and 2005 change from 2004		40

II. INVESTMENT PORTFOLIO

Information relating to II – Investment Portfolio is set forth in the Corporation’s 2006 Annual Report to Shareholders under the pages indicated below and is incorporated herein by reference:


		Pages in 2006
		Annual Report
		to Shareholders
A. Book value of investments —
December 31, 2006, 2005 and 2004		49 - 50

B. Summary of securities held —
December 31, 2006		50 & 51

C. N/A

I-4

III. LOAN PORTFOLIO (ALL DOMESTIC)

A. TYPES OF LOANS

Information relating to III — Loan Portfolio — A. Types of Loans is set forth in the Corporation’s 2006 Annual Report to Shareholders, Page 47, Loan Portfolio and is incorporated herein by reference.

B. MATURITIES AND SENSITIVITIES OF LOANS TO CHANGES IN INTEREST RATES

Information relating to III — Loan Portfolio – B. Maturities and Sensitivities of Loans to Interest Rates is set forth in the Corporation’s 2006 Annual Report to Shareholders, Page 47, Loan Portfolio and is incorporated herein by reference.

C. RISK ELEMENTS

Information relating to III – Loan Portfolio – C. Risk Elements, is set forth in the Corporation’s 2006 Annual Report to Shareholders under the pages indicated below and is incorporated herein by reference:


		Pages in 2006
		Annual Report
		to Shareholders
1. Nonaccrual, Past Due and Restructured Loans

(1) Aggregate amount in each category (5 years)		37

(2) Interest income

(i) That would have been recorded		19 & 37

(ii) That was included in income		19 & 37

(3) Policy for placing loans on non-accrual status		11-13 & 19

2. Potential Problem Loans		20

3. Foreign Outstandings		N/A

4. Loan concentrations over 10% not otherwise disclosed		N/A

D. Other Interest Bearing Assets — N/A

I-5

IV. SUMMARY OF LOAN LOSS EXPERIENCE

A. Analysis of the Allowance for Loan Loss

Information relating to IV — Summary of Loan Loss Experience — A. Analysis of the Allowance for Loan Loss is set forth in the Corporation’s 2006 Annual Report to Shareholders, Pages 45-46, Loan Loss Experience and is incorporated herein by reference.

B. Breakdown of the Allowance for Loan Losses

Information relating to IV — Summary of Loan Loss Experience — B. Breakdown of the Allowance for Loan Losses is set forth in the Corporation’s 2006 Annual Report to Shareholders under the pages indicated below and is incorporated herein by reference.


		Pages in 2006
		Annual Report
		to Shareholders
Breakdown of the Allowance for Loan Losses		46

Percentage of loans in each category		45 - 47

Loan Commitments and Lines of Credit		23-24 & 55-56

V. DEPOSITS (ALL DOMESTIC)

A. Average Deposits and Average Rates Paid on Deposit Categories

Information relating to V — Deposits — A. Average Deposits and Rates is set forth in the Corporation’s 2006 Annual Report to Shareholders, Pages 32 & 33, Three Year Summary Average Balance Sheet, Yields and Rates and is incorporated herein by reference.

B. Not applicable

C. Not applicable

D. Summary of Time Deposits of $100,000 or More

Information relating to V — Deposits — D. Summary of Time Deposits of $100,000 or More by Maturity Range, is set forth in the Corporation’s 2006 Annual Report to Shareholders, Page 21, Note 6, Deposits and is incorporated herein by reference.

E. Not applicable

VI. RETURN ON EQUITY AND ASSETS

Information relating to VI — Return on Equity and Assets is set forth in the Corporation’s 2006 Annual Report to Shareholders, page 31, Selected Financial Data and is incorporated herein by reference.

VII. SHORT TERM BORROWINGS

Not required

I-6

Item 1A. Risk Factors

The material risks and uncertainties that management believes affect the Company are described below. Before making an investment decision with respect to the Company’s stock, you should carefully consider the risks and uncertainties as described below together with all of the information included herein. The risks and uncertainties described below are not the only risks and uncertainties the Company faces. Additional risks and uncertainties not presently known and that are deemed immaterial also may have a material adverse effect on the Company’s result of operations and financial condition. If any of the following risks actually occur, the Company’s common stock could decline.

Fluctuations in interest rates could adversely affect the Company’s earnings and financial condition.

As is the case for most financial institutions, the Company’s earnings are substantially dependent upon net interest income, which is the difference between (a) the rates earned on loans, securities and other earning assets and (b) the interest rates paid on borrowings and deposits. These interest rates are highly sensitive to various factors beyond the Banks control, including but not limited to:

	•		the general economic conditions;

	•		governmental monetary policy;

	•		regulatory policies;

	•		rate of inflation;

	•		rate of unemployment.

For instance, an economic downturn, increase in unemployment, or higher interest rates could decrease the demand for loans and other products and services and/or result in a deterioration in credit quality and/or loan performance.

The Company’s business may be adversely affected by changes in government policies.

The Company operates as a State Chartered Financial Institution and is subject to the Banking regulations of the Ohio Department of Commerce and the Division of Financial Institutions. The Company is also a member of the Federal Reserve Banks 6 ^th District. As such, the Company’s success depends not only on competitive factors but also on regulations that are issued by these organizations. Congress and state legislatures and federal and state regulatory agencies continually review and change banking laws, regulations and policies. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementations of statutes, regulations or policies, could affect the Company in substantial and unpredictable ways, with the potential to significantly impact the Company’s cost structure. Also, the Company’s failure to comply with laws, regulations or policies could result in sanctions by the regulatory agencies and damage its reputation.

The Company’s earnings and reputation may be adversely affected by credit risk.

A significant portion of the Company’s loan portfolio is secured by real property. Originating and underwriting loans properly are integral to the Company’s success. Credit risk is the risk of not being able to collect the contractual obligation, including all principal and interest income when the borrower is unable to repay the obligation as agreed. Credit risk could be affected by a variety of negative conditions, including, (1) general, regional or local economic conditions, (2) rapid increase in interest rates, and/or (3) a downturn in an industry sector.

I-7

Item 1A. Risk Factors (Continued)

The Company’s general and specific credit risk are significant components of the Company’s reserve for loan losses which is also based upon, among other things:

	•		historical experience;

	•		economic conditions;

	•		regular reviews of delinquencies and loan portfolio quality;

	•		industry concentrations;

	•		and results of regulatory examinations.

Based upon such factors, management makes various assumptions and judgments about the ultimate collectibility of the respective loan portfolios. Although the Company believes that the reserve for loan losses is adequate, there can be no assurance that such reserve will prove sufficient to cover future losses. These determinations are based upon estimates that are inherently subjective. As such, future adjustments will be necessary if economic conditions change or adverse developments arise with respect to nonperforming or performing loans or if regulatory supervision changes. Material losses would result in a material decrease in the Company’s net income, and possibly its capital, and could result in the inability to pay dividends, among other adverse conditions.

The Company’s industry is very competitive and intense.

The Bank competes with a variety of competition including: other commercial banks, savings and loan associations, finance companies, insurance companies, brokerage and investment banking firms and credit unions. Many of these competitors have greater resources and lending limits than the Bank and may offer certain services that the Bank does not provide. The Company’s profitability depends upon the continued ability to compete effectively in our markets with the Company’s core products.

The Company’s business could be adversely affected by a downturn in the local geographic markets where we operate and depend.

The Bank derives the majority of its loans and deposits from the communities located in Northeast Ohio region. The local economic conditions in these areas have a significant impact on the generation of the Bank’s loan and deposit portfolios; the ability of borrowers to repay these loans; and the value of collateral securing these loans. Adverse changes in the economic conditions of the Northeast Ohio region in general could result in a negative impact on the financial results of the Company’s operations and have a negative effect on our profitability.

A significant challenge for the future of the Company is recruiting and retaining top talent.

In the Company’s competitive market, success will be determined in large part by who can hire and retain the best talent. Finding and retaining high performance employees is a particular challenge for banks in the Company’s core market of Northeast Ohio.

International conflicts and terrorism could adversely impact the Company’s earnings and operations.

The potential for terrorist activity is unpredictable and could negatively impact general and economic conditions in the United States and the Bank’s local economy in particular. The impact of such terrorism could have a significant adverse impact to the Company’s earnings and operations in ways that cannot be anticipated and/or estimated.

I-8

Item 1A. Risk Factors (Continued)

The Company’s stock price is volatile.

The Company’s stock price has been volatile in the past, and several factors could cause the price to fluctuate substantially in the future. These factors include:

	•		Actual or anticipated variations in earnings;

	•		Changes in analysts recommendations or projections;

	•		Operating and stock performance of other companies deemed to be peers;

	•		News reports of trends, concerns and other issues related to the financial services industry;

	•		Low volume of stock trades.

The Bank’s stock price may fluctuate significantly in the future, and these fluctuations may be unrelated to the Bank’s performance. General market price declines or market volatility in the future could adversely affect the price of the Bank’s stock, and the current market price may not be indicative of future market prices.

Further information relating to Item 1A. Risk Factors is set forth in the Corporations 2006 Annual Report to Shareholders Management’s Discussion Analysis. Including but not limited to Page 34, Note regarding Forward-Looking Statements; pages 45-46, Loan Loss Experience; pages 58-59, Market Risk; pages 59-60, Critical Accounting Policies and page 60, Impact of Inflation, and incorporated herein by reference.

Item 1B. Unresolved Staff Comments — N/A

Item 2. Properties

CORTLAND BANCORP’S PROPERTY

Information relating to Item 2 — Properties — is set forth in the Corporation’s 2006 Annual Report to Shareholders, page 4, Brief Description of the Business – CORTLAND BANCORP – and is incorporated herein by reference.

CORTLAND BANKS’ PROPERTY

Information relating to Item 2 — Properties — is set forth in the Corporation’s 2006 Annual Report to Shareholders, page 4, Brief Description of the Business, THE CORTLAND SAVINGS AND BANKING COMPANY — and is incorporated herein by reference.

Information relating to Item 2 — Properties — Location of Offices is set forth in the Corporation’s 2006 Annual Report to Shareholders, page 64, Cortland Banks Offices and Locations and is incorporated herein by reference.

Item 3. Legal Proceedings

Information relating to Item 3 — Legal Proceedings — is set forth in the Corporation’s 2006 Annual Report to Shareholders, page 30, Note 16, Litigation, and is incorporated herein by reference.

I-9

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

No matters were submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report.

Item 4A. Identification of Executive Officers of the Registrant

The names, ages and positions of the executive officers as of March 13, 2007 are as follows:


Name	Age		Position Held
Lawrence A. Fantauzzi		59	President, Chief Executive Officer and Director

James M. Gasior		47	Senior Vice President, Secretary, Chief Financial Officer and Director

Craig M. Phythyon		45	Senior Vice President, Treasurer and Chief Investment Officer

All of the officers listed above will hold office until the next annual meeting of shareholders and until their successors are duly elected and qualified.

Principal Occupation and Business Experience of Executive Officers

During the past five years the business experience of each of the executive officers has been as follows:

Mr. Fantauzzi succeeded Mr. Platt as President and Chief Executive Officer of The Cortland Savings and Banking Company beginning October 3, 2005. Mr. Fantauzzi also succeeded Mr. Platt as President of Cortland Bancorp beginning November 1, 2005. Previously, Mr. Fantauzzi has served as Senior Vice President of the Bank since 1996. He served as Controller and Chief Financial Officer, as well as Secretary-Treasurer of both Cortland Bancorp and The Cortland Savings and Banking Company (the “Bank”). Mr. Fantauzzi has also been Vice President and Director of New Resources Leasing Corporation, a subsidiary of the Bancorp, since 1995. Mr. Fantauzzi is 59 years old and has been a member of the Board of Directors since February 9, 1999.

Mr. Gasior is Senior Vice President, Chief Financial Officer and Secretary of Cortland Bancorp. He is also Senior Vice President, Chief Financial Officer and Secretary of the Bank. Mr. Gasior is a Certified Public Accountant, a member of the American Institute of CPA’s and the Ohio Society of CPA’s, is 47 years of age and has been a member of the Board of Directors since November of 2005. Previously, Mr. Gasior served as Senior Vice President of Lending and Administration of Cortland Bancorp and its subsidiary bank from April 1999 to October 2005.

Mr. Phythyon is Senior Vice President, Chief Investment Officer and Treasurer of Cortland Bancorp. He is also Senior Vice President, Chief Investment Officer and Treasurer of the Bank. Previously, Mr. Phythyon served as Vice President – Assistant Controller of the Bank beginning in 2002 and Assistant Vice President – Assistant Controller beginning in 1997. Mr. Phythyon is 45 years old.

I-10

PART II

Information relating to Items 5, 6, 7, 7A and 8 is set forth in the Corporation’s 2006 Annual Report to Shareholders under the pages indicated below and is incorporated herein by reference:


		Pages in 2006
		Annual Report
		to Shareholders
Item 5. Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchase of Equity Securities

a) Market Information		30 & 61

b) Holders		61

c) Dividends		30, 35 & 61

d) N/A

e) Shareholder Return Performance Graph

CUMULATIVE VALUE OF $100 INVESTMENT
Comparison of Five-Year Cumulative Total Return Among Cortland Bancorp,
The Russell 2000 Index and SNL Securities Index of Banks with Assets Under $500 Million. (1)

Cortland Bancorp


	*Period Ending*
*Index*	12/31/01		12/31/02		12/31/03		12/31/04		12/31/05		12/31/06

Cortland Bancorp		100.00		129.98		158.79		135.69		117.00		125.34
Russell 2000		100.00		79.52		117.09		138.55		144.86		171.47
SNL <$500M Bank Index		100.00		128.07		186.94		215.79		228.47		240.01


(1)		Assumes that on December 31, 2001, $100 each was invested in the common shares of Cortland Bancorp, the Russell 2000 index, and the SNL Bank Index, with all subsequent dividends reinvested. Cortland Bancorp is not among the banking companies included in the SNL Bank Index, nor is it included in the Russell 2000 index. SNL Securities provided information for Cortland Bancorp, The Russell 2000 index and the SNL Bank Index. Past performance provides no guarantee or assurance that similar results can or will be achieved in the future.

II-1


Item 6. Selected Financial Data		31


Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations		34-60


Item 7A. Quantitative and Qualitative Disclosures About Market Risk		53-54, 58-59


Item 8. Financial Statements and Supplementary Data		4-33

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures

None

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures . With the supervision and participation 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.

Annual Report on Internal Control Over Financial Reporting . The Report on Management’s Assessment of Internal Control Over Financial Reporting is included on page 5 of the 2006 Annual Report to Shareholders and is incorporated herein by reference.

Attestation Report of the Registered Public Accounting Firm . The Attestation Report of the Company’s independent registered public accounting firm is included on page 6 of the 2006 Annual Report to Shareholders and is incorporated herein by reference.

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 reasonable likely to materially affect, internal control over financial reporting.

Item 9B. Other Information

Not applicable

II-2

PART III

Item l0. Directors, Executive Officers and Corporate Governance

Information relating to this item will be set forth in the Corporation’s definitive proxy statement to be filed pursuant to Regulation 14A of the Securities and Exchange Commission within 120 days after the end of our 2006 fiscal year in connection with its annual meeting of shareholders to be held April 24, 2007. Such information is incorporated herein by reference. This information will be found under the captions of “Board Nominees”, “Continuing Directors”, “The Board of Directors and Committees of the Board”, “Section 16(a) Beneficial Ownership Reporting Compliance”, “Election of Directors” and “Audit Committee Matters”.

Information relating to executive officers of the Corporation is set forth in Part I. Item 4A.

Item 11. Executive Compensation

Information relating to this item will be set forth in the Corporation’s definitive proxy statement to be filed pursuant to Regulation 14A of the Securities and Exchange Commission within 120 days after the end of our 2006 fiscal year in connection with its annual meeting of shareholders to be held April 24, 2007. Such information is incorporated herein by reference. This information will be found under the captions of “Board Compensation”, “Compensation Discussion and Analysis”, “Executive Compensation”, “Directors Compensation”, “Compensation Committee Interlocks and Insider Participation” and “Executive Compensation Committee Report”.

Item l2. Security Ownership of Certain Beneficial Owners and Management and Related Shareholders Matters

Information relating to this item will be set forth in the Corporation’s definitive proxy statement to be filed pursuant to Regulation 14A of the Securities and Exchange Commission within 120 days after the end of our 2006 fiscal year in connection with its annual meeting of shareholders to be held April 24, 2007. Such information is incorporated herein by reference. This information will be found under the captions of “Share Ownership by Directors and Executive Officers”.

Item l3. Certain Relationships and Related Transactions, and Director Independence

Information relating to this item will be set forth in the Corporation’s definitive proxy statement to be filed pursuant to Regulation 14A of the Securities and Exchange Commission within 120 days after the end of our 2006 fiscal year in connection with its annual meeting of shareholders to be held April 24, 2007. Such information is incorporated herein by reference. This information will be found under the captions of “Related Party Transactions”, “Transactions with Affiliates” and “The Board of Directors and Committees of the Board”.

Item l4. Principal Accountant Fees and Services

III-1

PART IV

Item l5. Exhibits, Financial Statement Schedules

(a) l. Financial Statements

Included in Part II of this report:

Item 8., Financial Statements and Accompanying Information, is set forth in the Corporation’s 2006 Annual Report to Shareholders and is incorporated by reference in Part II of this report.


		Pages in 2006
		Annual Report
		To Shareholders
Consolidated Financial Statements:

Report of Independent Registered Public Accounting Firm		6

Consolidated Statements of Income for the Years Ended December 31, 2006, 2005 and 2004		7

Consolidated Balance Sheets as of December 31, 2006 and 2005		8

Consolidated Statements of Shareholders’ Equity for the Years Ended December 31, 2006, 2005 and 2004		9

Consolidated Statements of Cash Flows for the Years Ended December 31, 2006, 2005 and 2004		10

Notes to Consolidated Financial Statements		11 - 30

(a) 2. Financial Statement Schedules

Included in Part IV of this report as Exhibit 23:

Independent Accountants’ Consent

Schedules:

All schedules are omitted because they are not applicable.

(a) 3. Exhibits Required by Item 601 of Regulation S-K

The exhibits filed or incorporated by reference as a part of this report are listed in the Index to Exhibits which appears at page IV-3 hereof and is incorporated herein by reference.

Exhibit 11 — Statement regarding computation of earnings per share - is set forth in the Corporation’s 2006 Annual Report to Shareholders page 14, Note 1 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES — Per Share Amounts — and is incorporated herein by reference.

IV-1

SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.


		CORTLAND BANCORP

March 13, 2007	By	/s/ Lawrence A. Fantauzzi

Date		Lawrence A. Fantauzzi,
		President, Chief Executive Officer and Director

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.


/s/ K. Ray Mahan	Director and Chairman of the Board	March 13, 2007

K. Ray Mahan		Date

/s/ Lawrence A. Fantauzzi	President, Chief Executive Officer and Director	March 13, 2007

Lawrence A. Fantauzzi		Date

/s/ James M. Gasior	Senior Vice President, Secretary and Director	March 13, 2007

James M. Gasior	(Chief Financial Officer)	Date

/s/ Jerry A. Carleton	Director	March 13, 2007

Jerry A. Carleton		Date

/s/ David C. Cole	Director	March 13, 2007

David C. Cole		Date

/s/ George E. Gessner	Director	March 13, 2007

George E. Gessner		Date

/s/ James E. Hoffman, III	Director	March 13, 2007

James E. Hoffman, III		Date

/s/ Neil J. Kaback	Director	March 13, 2007

Neil J. Kaback		Date

/s/ Richard B. Thompson	Director	March 13, 2007

Richard B. Thompson		Date

/s/ Timothy K. Woofter	Director	March 13, 2007

Timothy K. Woofter		Date

IV-2

INDEX TO EXHIBITS

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

Item 15(b). Exhibits


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. (filed with December 2005 10-K)

Exhibit 3.2		Code of Regulations, for the Bancorp as amended (filed with December 2005 10-K) Code of Regulations, Cortland Savings and Banking Company (filed herewith).

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.

* Exhibit 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.

* 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.

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

* 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

* 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

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

* 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

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

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

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

* 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

IV-3

INDEX TO EXHIBITS (Continued)


* 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; as amended on December 26, 2006, for Directors Cole, Gessner, Hoffman, Mahan, Thompson, and Woofter; and Split Dollar Agreement and Endorsement entered into by Cortland Bancorp as of July 26, 2005 with Director Jerry A. Carleton

* 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

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

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

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

* 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

* 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

* 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

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

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

* 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

* 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

* 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

IV-4

INDEX TO EXHIBITS (Continued)


* 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

* 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

* Exhibit 10.27		Amended Split Dollar Agreement between The Cortland Savings and Banking Company and Marlene Lenio, dated as of September 9, 2002, as amended on December 11, 2006

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

* 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

* 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

* 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.

* 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

Exhibit 13		Annual Report to security holders (filed herewith)

Exhibit 21		Subsidiaries of the Registrant (filed herewith)

Exhibit 23		Consents of experts and counsel – Consent of independent registered public Accounting firm. (filed herewith)

Exhibit 31.1		Certification of the Chief Executive Officer under Rule 13a-14(a) (filed herewith)

Exhibit 31.2		Certification of the Chief Financial Officer under Rule 13a-14(a) (filed herewith)

Exhibit 32		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer required under section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)


*		Management contract or compensatory plan or arrangement (filed with 10-K for 2005 except for amendments to 10.12 and 10.27 which are filed herewith)

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

IV-5

Exhibit 3.2

CODE OF REGULATIONS
OF
THE CORTLAND SAVINGS AND BANKING COMPANY

INDEX


ARTICLE ONE

MEETINGS OF SHAREHOLDERS

Section 1.01.	Annual Meetings	1
Section 1.02.	Calling of Meetings	1
Section 1.03.	Place of Meetings	1
Section 1.04.	Notice of Meetings	1
Section 1.05.	Waiver of Notice	2
Section 1.06.	Quorum	2
Section 1.07.	Votes Required	3
Section 1.08.	Order of Business	3
Section 1.09.	Shareholders Entitled to Vote	3
Section 1.10.	Proxies	3
Section 1.11.	Inspectors of Election	3

ARTICLE TWO

DIRECTORS

Section 2.01.	Authority and Qualifications	4
Section 2.02.	Number of Directors and Term of Office	4
Section 2.03.	Election and Oath of Office	5
Section 2.04.	Removal	6
Section 2.05.	Vacancies	6
Section 2.06.	Meetings	6
Section 2.07.	Notice of Meetings	6
Section 2.08.	Waiver of Notice	7
Section 2.09.	Quorum	7
Section 2.10.	Executive Committee	7
Section 2.11.	Compensation	8
Section 2.12.	By-Laws	8

ARTICLE THREE

OFFICERS

Section 3.01.	Officers	8
Section 3.02.	Tenure of Office	8
Section 3.03.	Duties of the Chairman of the Board	8
Section 3.04.	Duties of the President	8
Section 3.05.	Duties of the Vice Presidents	9
Section 3.06.	Duties of the Secretary	9
Section 3.07.	Duties of the Treasurer	9
Section 3.08.	Bond	9

ARTICLE FOUR

SHARES

Section 4.01.	Certificates	10


Section 4.02.	Transfers	10
Section 4.03.	Transfer Agents and Registrars	10
Section 4.04.	Lost, Wrongfully Taken or Destroyed Certificates	10
Section 4.05.	Uncertificated Shares	11

ARTICLE FIVE

INDEMNIFICATION AND INSURANCE

Section 5.01.	Indemnification	11
Section 5.02.	Court-Approved Indemnification	11
Section 5.03.	Indemnification for Expenses	12
Section 5.04.	Determination Required	12
Section 5.05.	Advances for Expenses	12
Section 5.06.	Article Five Not Exclusive	13
Section 5.07.	Insurance	13
Section 5.08.	Certain Definitions	13
Section 5.09.	Venue	14
Section 5.10.	Limitations	14

ARTICLE SIX

MISCELLANEOUS

Section 6.01.	Amendments	15
Section 6.02.	Action by Shareholders or Directors Without a Meeting	15

CODE OF REGULATIONS
OF
THE CORTLAND SANVINGS AND BANKING COMPANY

ARTICLE ONE
MEETINGS OF SHAREHOLDERS

Section 1.01. Annual Meetings . The annual meeting of the shareholders for the election of directors, for the presentation of financial statements and for the transaction of such other business as may properly come before such meeting, shall be held in April, in conjunction with the Annual Meeting of Shareholders of Cortland Bancorp, each year or on such other date as may be fixed from time to time by the directors.

Section 1.02. Calling of Meetings . Meetings of the shareholders may be called only by the chairman of the board, the president or, in case of the president’s absence, death, or disability, the vice president authorized to exercise the authority of the president; the secretary; the directors by action at a meeting, or a majority of the directors acting without a meeting; or the individual authorized by Cortland Bancorp, the holder of 100% of all shares outstanding and entitled to vote thereat.

Section 1.03. Place of Meetings . All meetings of the shareholders shall be held at the principal office of the bank, unless otherwise provided by action of the directors. Meetings of shareholders may be held at any place within or without the State of Ohio. If authorized by the directors, meetings of shareholders may be held solely by means of communications equipment, as permitted by law.

Section 1.04. Notice of Meetings . (A) Written notice stating the time, place, if applicable, and purposes of a meeting of the shareholders, and the means, if applicable, by which shareholders can be present and vote at the meeting through the use of communications equipment, shall be given either by personal delivery or by mail, overnight delivery service, or any other means of communication authorized by the shareholder to whom the notice is given, not less than seven nor more than sixty days before the date of the meeting, (1) to every shareholder of record entitled to notice of the meeting, (2) by or at the direction of the president, a vice-president, the secretary or any two directors. If mailed or sent by overnight delivery service, such notice shall be sent to the shareholder at the shareholder’s address as it appears on the records of the bank. If sent by another means of communication authorized by the shareholder, the notice shall be sent to the address furnished by the shareholder for those transmissions. In the event of a transfer of shares after the record date for determining the shareholders who are entitled to receive notice of a meeting of shareholders, it shall not be necessary to give notice to the transferee. Notice of adjournment of a meeting need not be given if the time and place, if applicable, to which it is adjourned and the means, if applicable, by which shareholders can be present and vote at the meeting through the use of communications equipment are fixed and announced at the meeting.

Nothing herein contained shall prevent the setting of a record date in the manner provided by law or the Articles for the determination of shareholders who are entitled to

receive notice of or to vote at any meeting of shareholders or for any purpose required or permitted by law.

(B) Following receipt by the president or the secretary of a request in writing, specifying the purpose or purposes for which the persons properly making such request have called a meeting of the shareholders, delivered either in person or by registered mail to such officer by any persons entitled to call a meeting of shareholders, such officer shall cause to be given to the shareholders entitled thereto notice of a meeting to be held on a date not less than seven nor more than sixty days after the receipt of such request, as such officer may fix. If such notice is not given within thirty days after the receipt of such request by the president or the secretary, then, and only then, the persons properly calling the meeting may fix the time of meeting and give notice thereof in accordance with the provisions of these Regulations.

(C) Any authorization by a shareholder to send notices given pursuant to this Section 1.04 by any means other than in person or by mail or overnight delivery service is revocable by written notice to the bank either by personal delivery or by mail, overnight delivery service, or any other means of communication authorized by the bank. If sent by another means of communication authorized by the bank, the notice shall be sent to the address furnished by the bank for those transmissions. Any authorization by a shareholder to send notices given pursuant to this Section 1.04 by any means other than in person or by mail or overnight delivery service will be deemed to have been revoked by the shareholder if (1) the bank has attempted to make delivery of two consecutive notices in accordance with that authorization, and (2) the secretary or an assistant secretary of the bank, or other person responsible for giving notice, has received notice that, or otherwise believes that, delivery has not occurred; provided, however, that an inadvertent failure to treat the inability to deliver notice as a revocation will not invalidate any meeting of shareholders or other action.

Section 1.05. Waiver of Notice . Notice of the time, place, if applicable, and purpose or purposes of any meeting of shareholders may be waived in writing, either before or after the holding of such meeting, by any shareholder, which writing shall be filed with or entered upon the records of such meeting. The attendance of any shareholder, in person, by proxy or by the use of communications equipment, at any such meeting without protesting the lack of proper notice, prior to or at the commencement of the meeting, shall be deemed to be a waiver by such shareholder of notice of such meeting. A telegram, cablegram, electronic mail, or an electronic or other transmission capable of authentication that appears to have been sent by a shareholder and that contains a waiver by such shareholder is a writing for the purposes of this Section 1.05.

Section 1.06. Quorum . At any meeting of shareholders, the holders of a majority of the voting shares of the bank then outstanding and entitled to vote thereat, present in person, by proxy or by the use of communications equipment, shall constitute a quorum for such meeting. The holders of a majority of the voting shares represented at a meeting, whether or not a quorum is present, or the chairman of the board, the president, or the officer of the bank acting as chairman of the meeting, may adjourn such meeting from time to time, and if a quorum is present at such adjourned meeting any business may be transacted as if the meeting had been held as originally called.

Section 1.07. Votes Required . At all elections of directors of Cortland Bancorp the candidates receiving the greatest number of votes shall be elected. The directors elected to serve for Cortland Bancorp will be appointed directors for The Cortland Savings and Banking Company. Unless otherwise specifically required by law, the Articles or these Regulations, any matter submitted to the shareholders at a meeting for their vote shall be decided by a majority of the shares of the bank that are present in person, by proxy or by the use of communications equipment and constitute a quorum for such meeting.

Section 1.08. Order of Business . The order of business at any meeting of shareholders shall be determined by the officer of the bank acting as chairman of such meeting.

Section 1.09. Shareholders Entitled to Vote . Each shareholder of record on the books of the bank on the record date for determining the shareholders who are entitled to vote at a meeting of shareholders shall be entitled at such meeting to one vote for each share of the bank held in such shareholder’s name on the books of the bank on such record date and shall not accumulate the votes. The directors may fix a record date for the determination of the shareholders who are entitled to receive notice of and to vote at a meeting of shareholders, which record date shall not be a date earlier than the date on which the record date is fixed and which record date may be a maximum of sixty days preceding the date of the meeting of shareholders.

Section 1.10. Proxies .

(A) At meetings of the shareholders, any shareholder of record entitled to vote thereat may be represented and may vote by a proxy or proxies appointed by an instrument in writing signed by such shareholder or appointed by a verifiable communication authorized by such shareholder, but such instrument shall be filed with the secretary of the meeting before the person holding such proxy shall be allowed to vote thereunder.

(B) Any transmission that creates a record capable of authentication, including, but not limited to, a telegram, cablegram, electronic mail, or an electronic, telephonic or other transmission that appears to have been transmitted by a shareholder, and that appoints a proxy is a sufficient notifiable communication to appoint a proxy. A photographic, photostatic, facsimile transmission, or equivalent reproduction of a writing that is signed by a shareholder and that appoints a proxy is a sufficient writing to appoint a proxy.

(C) No proxy shall be valid after the expiration of eleven months after the date of its execution, unless the shareholder executing it shall have specified therein the length of time it is to continue in force.

Section 1.11. Inspectors of Election . In advance of any meeting of shareholders of Cortland Bancorp, the directors may appoint inspectors of election to act at such meeting or any adjournment thereof; if inspectors are not so appointed, the officer of the bank acting as chairman of any such meeting may make such appointment. In case any person appointed as inspector fails to appear or act, the vacancy may be filled only by appointment made by the directors in advance of such meeting or, if not so filled, at the meeting by the officer of the bank acting as chairman of such meeting. No other person or persons may appoint or require the appointment of inspectors of election.

ARTICLE TWO
DIRECTORS

Section 2.01. Authority and Qualifications .

(A) Except where the law, the Articles or these Regulations otherwise provide, all authority of the bank shall be vested in and exercised by its directors. Directors need not be shareholders of the bank.

(B) Unless otherwise permitted by law, a majority of the directors shall be outside directors; provided, that if eighty per cent or more of any class of the bank’s voting shares are owned by a company, a majority of the directors may be officers or directors of one or more affiliates (as defined in Section 1101.01(A) of the Ohio Revised Code, or any amended or successor provision thereto) of the bank. In addition, a majority of the directors shall be residents of Ohio or live within one hundred miles of Ohio. If during a term of office a director causes the total membership of the board to be in violation of this Section 2.01(B), the director forfeits the directorship, and the director’s office shall become vacant. No new director, or former director who is elected after an interruption in services, shall be elected if such election would cause the board to be in violation of this Section 2.01(B).

(C) No person who has been convicted of, or has pleaded guilty to, a felony involving dishonesty or breach of trust shall take office as a director. If during a term of office any director is convicted of, or pleads guilty to, a felony involving dishonesty or breach of trust, the director forfeits the directorship, and the director’s office shall become vacant.

Section 2.02. Number of Directors and Term of Office .

(A) The number of directors of the bank shall not be less than nine. Each director shall be elected to serve until a successor is duly elected and qualified or until such director’s earlier resignation, removal from office, or death.

(B) The number of directors may be fixed or changed at a meeting of the shareholders called for the purpose of electing directors at which a quorum is present, by the affirmative vote of the holders of not less than a majority of the voting shares which are represented at the meeting, in person, by proxy or by the use of communications equipment, and entitled to vote on such proposal; provided, that the shareholders may not reduce the number of directors to less than five.

(C) The directors may fix or change the number of directors and may fill any director’s office that is created by an increase in the number of directors; provided, that the directors may not reduce the number of directors to less than five.

(D) No reduction in the number of directors shall of itself have the effect of shortening the term of any incumbent director.

(E) If, pursuant to subsection (B) or (C) above, the number of directors is fixed at or changed to six or more, the directors may by resolution provide for the classification of the directors into either two or three classes and may determine the term of office of each such

class; provided, however, that no class shall consist of fewer than three directors and no term of office shall exceed three years.

Section 2.03. Election and Oath of Office .

(A) Any nominee for election as a director of the bank may be proposed only by the directors or by any shareholder entitled to vote for the election of directors. No person, other than a nominee proposed by the directors, may be nominated for election as a director of the bank unless such person shall have been proposed in a written notice, delivered or mailed by first-class United States mail, postage prepaid, to the secretary of the bank at the principal offices of the bank. In the case of a nominee proposed for election as a director at an annual meeting of shareholders, such written notice of a proposed nominee shall be received by the secretary of the bank not later than the close of business on the fourteenth calendar day preceding such annual meeting. In the case of a nominee proposed for election as a director at a special meeting of shareholders at which directors are to be elected, such written notice of a proposed nominee shall be received by the secretary of the bank not later than the close of business on the fourteenth calendar day preceding such special meeting.

Each such written notice of a proposed nominee shall set forth (i) the name, age, business or residence address of each nominee proposed in such notice, (ii) the principal occupation or employment of each such nominee, and (iii) the number of common shares of the bank owned beneficially and/or of record by each such nominee and the length of time any such shares have been so owned.

(B) If a shareholder shall attempt to nominate one or more persons for election as a director at any meeting at which directors are to be elected without having identified each such person in a written notice given as contemplated by, and/or without having provided therein the information specified in, subparagraph (A) of this Section 2.03, each such attempted nomination shall be invalid and shall be disregarded unless the person acting as chairman of the meeting determines that the facts warrant the acceptance of such nomination.

(C) At each annual meeting of shareholders for the election of directors, the successors to the directors whose term shall expire in that year shall be elected, but if the annual meeting is not held or if one or more of such directors are not elected thereat, they may be elected at a special meeting called for that purpose. The election of directors shall be by ballot whenever requested by the presiding officer of the meeting or by the holders of a majority of the voting shares outstanding, entitled to vote at such meeting and present in person, by proxy or by the use of communications equipment, but unless such request is made, the election shall be viva voce.

(D) To qualify as a director, each person elected shall, within sixty days after election, take and subscribe an oath to diligently and honestly perform the duties of a director and to not knowingly violate or permit to be violated any applicable federal or state banking law. Promptly upon execution, and within sixty days of the person’s election, the oath shall be filed with the secretary of the bank.

Section 2.04. Removal . A director or directors may be removed from office, with or without assigning any cause, by the vote of the holders of shares entitling them to exercise not less than 75% of the voting power of the bank to elect directors in place of those to be removed. In case of any such removal, a new director may be elected at the same meeting for the unexpired term of each director removed. Failure to elect a director to fill the unexpired term of any director removed shall be deemed to create a vacancy in the board.

The directors or superintendent of financial institutions may remove a director from office if (1) the director has filed for relief or is a debtor in a case filed under Title XI of the United States Code, or (2) a court has determined that such director is incompetent.

Section 2.05. Vacancies . If a vacancy on the board exists due to resignation, death, removal or otherwise, the remaining directors, though less than a majority of the whole authorized number of directors, may, by the vote of a majority of their number, fill such vacancy for the unexpired term. A resignation takes effect immediately unless the director specifies another time.

Section 2.06. Meetings .

(A) A meeting of the directors shall be held immediately following the adjournment of each annual meeting of shareholders at which directors are elected, and notice of such meeting need not be given. The directors also shall hold regular meetings, not less frequently than quarterly, at such time as the directors fix or determine by resolution. The directors may hold such other meetings as may be called from time to time by the chairman of the board, the president, or any two directors.

(B) All meetings of directors shall be held at the principal office of the bank or at such other place within or without the State of Ohio, as the directors may from time to time determine by a resolution. Meetings of the directors may be held through any communications equipment if all persons participating can communicate with each other and participation in a meeting pursuant to this provision shall constitute presence at such meeting.

Section 2.07. Notice of Meetings . Notice of the time and place, if applicable, of each meeting of directors for which notice is required by law, the Articles, these Regulations or the bylaws, if any, shall be given to each of the directors by at least one of the following methods:

	(A)		In a writing mailed not less than three days before such meeting and addressed to the residence or usual place of business of a director, as such address appears on the records of the bank;

	(B)		In a writing sent by overnight delivery service not less than two days before such meeting and addressed to the residence or usual place of business of a director, as such address appears on the records of the bank;

	(C)		By telegraph, cable, radio, wireless, or any other means of communication authorized by the director to the address furnished by the director for those transmissions, not later than the day before the date on which such meeting is to be held; or

	(D)		Personally or by telephone not later than the day before the date on which such meeting is to be held.

Notice given to a director by any one of the methods specified in these Regulations shall be sufficient, and the method of giving notice to all directors need not be uniform. Notice of any meeting of directors may be given only by the chairman of the board, the president or the secretary of the bank. Any such notice need not specify the purpose or purposes of the meeting. Notice of adjournment of a meeting of directors need not be given if the time and place to which it is adjourned are fixed and announced at such meeting.

Section 2.08. Waiver of Notice . Notice of any meeting of directors may be waived in writing, either before or after the holding of such meeting, by any director, which writing shall be filed with or entered upon the records of the meeting. The attendance of any director, in person or by the use of communications equipment, at any meeting of directors without protesting, prior to or at the commencement of the meeting, the lack of proper notice, shall be deemed to be a waiver by such director of notice of such meeting. A telegram, cablegram, electronic mail, or an electronic or other transmission capable of authentication that appears to have been sent by a director and that contains a waiver by such director is a writing for the purposes of this Section 2.08.

Section 2.09. Quorum . A majority of the whole authorized number of directors shall be necessary to constitute a quorum for a meeting of directors, except that a majority of the directors in office shall constitute a quorum for filling a vacancy in the board. The act of a majority of the directors present in person or by the use of communications equipment at a meeting at which a quorum is present in person or by the use of communications equipment is the act of the board, except as otherwise provided by law, the Articles or these Regulations.

Section 2.10. Executive Committee . The directors may create an executive committee or any other committee of directors, to consist of not less than three directors, and may authorize the delegation to such executive committee or other committees of any of the authority of the directors, however conferred, other than that of filling vacancies among the directors or in the executive committee or in any other committee of the directors.

Such executive committee or any other committee of directors shall serve at the pleasure of the directors, shall act only in the intervals between meetings of the directors, and shall be subject to the control and direction of the directors. Such executive committee or other committee of directors may act by a majority of its members at a meeting or by a writing or writings signed by all of its members. A telegram, cablegram, electronic mail, or an electronic or other transmission capable of authentication that appears to have been sent by a director is a writing for the purposes of this Section 2.10.

Any act or authorization of any act by the executive committee or any other committee within the authority delegated to it shall be as effective for all purposes as the act or authorization of the directors. No notice of a meeting of the executive committee or of any other committee of directors shall be required. A meeting of the executive committee or of any other committee of directors may be called only by the president or by a member of such executive or other committee of directors. Meetings of the executive committee or of any other committee of directors may be held through any communications equipment if all persons participating can communicate with each other and participation in such a meeting shall constitute presence thereat.

Section 2.11. Compensation . Directors shall be entitled to receive as compensation for services rendered and expenses incurred as directors, such amounts as the directors may determine.

Section 2.12. By-Laws . The directors may adopt, and amend from time to time, bylaws for their own government, which bylaws shall not be inconsistent with the law, the Articles or these Regulations.

ARTICLE THREE
OFFICERS

Section 3.01. Officers . The officers of the bank to be elected by the directors shall include (1) a president, (2) a secretary and (3) a treasurer or, in lieu of a treasurer, a cashier, a controller, a comptroller or other officer whose authority and duties the superintendent of financial institutions has determined to be essentially equivalent to that of a treasurer. If desired, the directors also may elect one or more vice presidents and such other officers and assistant officers as the directors may from time to time elect. The directors may elect a chairman of the board, who must be a director. Officers need not be shareholders of the bank, and may be paid such compensation as the board of directors may determine. Any two or more offices may be held by the same person, but no officer shall execute, acknowledge, or verify any instrument in more than one capacity if such instrument is required by law, the Articles or these Regulations to be executed, acknowledged, or verified by two or more officers.

Section 3.02. Tenure of Office . The officers of the bank shall hold office at the pleasure of the directors. Any officer of the bank may be removed, either with or without cause, at any time, by the affirmative vote of a majority of all the directors then in office; such removal, however, shall be without prejudice to the contract rights, if any, of the person so removed.

Section 3.03. Duties of the Chairman of the Board . The chairman of the board, if any, shall preside at all meetings of the directors. The chairman shall have such other powers and duties as the directors shall from time to time assign.

Section 3.04. Duties of the President . The president also may be the chief executive officer of the bank and shall exercise supervision over the business of the bank and shall have, among such additional powers and duties as the directors may from time to time

assign, the power and authority to sign all certificates evidencing shares of the bank and all deeds, mortgages, bonds, contracts, notes and other instruments requiring the signature of the president of the bank. It shall be the duty of the president to preside at all meetings of shareholders.

Section 3.05. Duties of the Vice Presidents . In the absence of the president or in the event of the president’s inability or refusal to act, the vice president, if any (or in the event there be more than one vice president, the vice presidents in the order designated, or in the absence of any designation, then in the order of their election), shall perform the duties of the president, and when so acting, shall have all the powers of and be subject to all restrictions upon the president. The vice presidents shall perform such other duties and have such other powers as the directors or the president may from time to time prescribe.

Section 3.06. Duties of the Secretary . It shall be the duty of the secretary, or of an assistant secretary, if any, in case of the absence or inability to act of the secretary, to keep minutes of all the proceedings of the shareholders and the directors and to make a proper record of the same; to perform such other duties as may be required by law, the Articles or these Regulations; to perform such other and further duties as may from time to time be assigned to the secretary by the directors or the president; and to deliver all books, paper and property of the bank in the secretary’s possession to the successor, or to the president.

Section 3.07. Duties of the Treasurer . The treasurer, or an assistant treasurer, if any, in case of the absence or inability to act of the treasurer, shall receive and safely keep all funds, securities and properties belonging to the bank, and shall do with or disburse the same as directed by the president or the directors; shall keep an accurate account of the finances of the bank; shall, upon the expiration of the term of office, deliver all money and other property of the bank in the treasurer’s possession or custody to the successor treasurer or the president; and shall perform such other duties as from time to time may be assigned by the directors or the president.

If the bank, in lieu of a treasurer, has a cashier, controller, comptroller or other officer whose authority and duties have been determined by the superintendent of financial institutions to be essentially equivalent to that of a treasurer, then such officer shall have each of the powers, and shall exercise each of the duties, set forth in this Section 3.07.

Section 3.08. Bond . Each officer, prior to the discharge of the officer’s duties, shall be covered by an individual, schedule, or blanket fidelity bond in favor of the bank, with terms and issuing insurer approved by the directors. The amount of the bond shall be set by the directors and shall be reasonable given the size and nature of the business of the bank.

ARTICLE FOUR
SHARES

Section 4.01. Certificates . Certificates evidencing ownership of shares of the bank shall be issued to those entitled to them. Each certificate evidencing shares of the bank shall bear a distinguishing number; the signatures of the chairman of the board, the president, or a vice president, and of the secretary, an assistant secretary, the treasurer, or an assistant treasurer (except that when any such certificate is countersigned by an incorporated transfer agent or registrar, such signatures may be facsimile, engraved, stamped or printed); and such recitals as may be required by law. Certificates evidencing shares of the bank shall be of such tenor and design as the directors may from time to time adopt and may bear such recitals as are permitted by law.

Section 4.02. Transfers . Where a certificate evidencing a share or shares of the bank is presented to the bank or its proper agents with a request to register transfer, the transfer shall be registered as requested if:

(1) An appropriate person signs on each certificate so presented or signs on a separate document an assignment or transfer of shares evidenced by each such certificate, or signs a power to assign or transfer such shares, or when the signature of an appropriate person is written without more on the back of each such certificate;

(2) Reasonable assurance is given that the endorsement of each appropriate person is genuine and effective; the bank or its agents may refuse to register a transfer of shares unless the signature of each appropriate person is guaranteed by an “eligible guarantor institution” as defined in Rule 17Ad-15 under the Securities Act of 1934 or any successor rule or regulation;

(3) All applicable laws relating to the collection of transfer or other taxes have been complied with; and

(4) The bank or its agents are not otherwise required or permitted to refuse to register such transfer.

Section 4.03. Transfer Agents and Registrars . The directors may appoint one or more agents to transfer or to register shares of the bank, or both.

Section 4.04. Lost, Wrongfully Taken or Destroyed Certificates . Except as otherwise provided by law, where the owner of a certificate evidencing shares of the bank claims that such certificate has been lost, destroyed or wrongfully taken, the directors must cause the bank to issue a new certificate in place of the original certificate if the owner:

(1) So requests before the bank has notice that such original certificate has been acquired by a bona fide purchaser;

(2) Files with the bank, unless waived by the directors, an indemnity bond, with surety or sureties satisfactory to the bank, in such sums as the directors may, in their

discretion, deem reasonably sufficient as indemnity against any loss or liability that the bank may incur by reason of the issuance of each such new certificate; and

(3) Satisfies any other reasonable requirements which may be imposed by the directors, in their discretion.

Section 4.05. Uncertificated Shares . Anything contained in this Article Four to the contrary notwithstanding, the directors may provide by resolution that some or all of any or all classes and series of shares of the bank shall be uncertificated shares, provided that such resolution shall not apply to (A) shares of the bank represented by a certificate until such certificate is surrendered to the bank in accordance with applicable provisions of Ohio law or (B) any certificated security of the bank issued in exchange for an uncertificated security in accordance with applicable provisions of Ohio law. The rights and obligations of the holders of uncertificated shares and the rights and obligations of the holders of certificates representing shares of the same class and series shall be identical, except as otherwise expressly provided by law.

ARTICLE FIVE
INDEMNIFICATION AND INSURANCE

Section 5.01. Indemnification. The bank shall indemnify any officer or director of the bank who was or is a party or is threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (including, without limitation, any action threatened or instituted by or in the right of the bank), by reason of the fact that he or she is or was a director, officer, employee or agent of the bank or of a subsidiary of the bank, or is or was serving at the request of the bank as a director, trustee, officer, employee or agent of another corporation (domestic or foreign, nonprofit or for profit), partnership, joint venture, trust or other enterprise, against expenses (including, without limitation, attorneys’ fees, filing fees, court reporters’ fees and transcript costs), judgments, fines and amounts paid in settlement actually and reasonably incurred by such person in connection with such action, suit or proceeding if he or she acted in good faith and in a manner he or she reasonably believed to be in or not opposed to the best interests of the bank, and with respect to any criminal action or proceeding, he or she had no reasonable cause to believe his or her conduct was unlawful. A person claiming indemnification under this Section 5.01 shall be presumed, in respect of any act or omission giving rise to such claim for indemnification, to have acted in good faith and in a manner such person reasonably believed to be in or not opposed to the best interests of the bank, and with respect to any criminal matter, to have had no reasonable cause to believe his or her conduct was unlawful, and the termination of any action, suit or proceeding by judgment, order, settlement or conviction, or upon a plea of nolo contendere or its equivalent, shall not, of itself, rebut such presumption.

Section 5.02. Court-Approved Indemnification . Anything contained in the Regulations or elsewhere to the contrary notwithstanding:

(A) the bank shall not indemnify any officer or director of the bank who was a party to any completed action or suit instituted by or in the right of the bank to procure a judgment in its favor by reason of the fact that such person is or was a director, officer, employee

or agent of the bank, or is or was serving at the request of the bank as a director, trustee, officer, employee or agent of another corporation (domestic or foreign, nonprofit or for profit), partnership, joint venture, trust or other enterprise, in respect of any claim, issue or matter asserted in such action or suit as to which he or she shall have been adjudged to be liable for gross negligence or misconduct (other than negligence) in the performance of his or her duty to the bank unless and only to the extent that the Court of Common Pleas of Trumbull County, Ohio or the court in which such action or suit was brought shall determine upon application that, despite such adjudication of liability, and in view of all the circumstances of the case, he is fairly and reasonably entitled to such indemnity as such Court of Common Pleas of Trumbull County, Ohio or such other court shall deem proper; and

(B) the bank shall promptly make any such unpaid indemnification as is determined by a court to be proper as contemplated by this Section 5.02.

Section 5.03. Indemnification for Expenses . Anything contained in the Regulations or elsewhere to the contrary notwithstanding, to the extent that an officer or director of the bank has been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Section 5.01, or in defense of any claim, issue or matter therein, he shall be promptly indemnified by the bank against expenses (including, without limitation, attorneys’ fees, filing fees, court reporters’ fees and transcript costs) actually and reasonably incurred by such person in connection therewith.

Section 5.04. Determination Required . Any indemnification required under Section 5.01 and not precluded under Section 5.02 shall be made by the bank only upon a determination that such indemnification of the officer or director is proper in the circumstances because such officer or director has met the applicable standard of conduct set forth in Section 5.01. Such determination may be made only (A) by a majority vote of a quorum consisting of directors of the bank who were not and are not parties to any such action, suit or proceeding, or (B) if such a quorum is not obtainable or if a majority of a quorum of disinterested directors so directs, by independent legal counsel in a written opinion, or (C) by the shareholders, or (D) by the Court of Common Pleas of Trumbull County, Ohio or (if the bank is a party thereto) the court in which such action, suit or proceeding was brought, if any; any such determination may be made by a court under division (D) of this Section 5.04 at any time [including, without limitation, any time before, during or after the time when any such determination may be requested of, be under consideration by or have been denied or disregarded by the disinterested directors under division (A) or by independent legal counsel under division (B) or by the shareholders under division (C) of this Section 5.04]; and no failure for any reason to make any such determination, and no decision for any reason to deny any such determination, by the disinterested directors under division (A) or by independent legal counsel under division (B) or by shareholders under division (C) of this Section 5.04 shall be evidence in rebuttal of the presumption recited in Section 5.01.

Section 5.05. Advances for Expenses . Expenses (including, without limitation, attorneys’ fees, filing fees, court reporters’ fees and transcript costs) incurred in defending any action, suit or proceeding referred to in Section 5.01 shall be paid by the bank in advance of the final disposition of such action, suit or proceeding to or on behalf of the officer or director promptly as such expenses are incurred by him or her, but only if such officer or director shall

first agree, in writing, to repay all amounts so paid in respect of any claim, issue or other matter asserted in such action, suit or proceeding in defense of which he shall not have been successful on the merits or otherwise:

(A) if it shall ultimately be determined as provided in Section 5.04 that such person is not entitled to be indemnified by the bank as provided under Section 5.01; or

(B) if, in respect of any claim, issue or other matter asserted by or in the right of the bank in such action or suit, such person shall have been adjudged to be liable for gross negligence or misconduct (other than negligence) in the performance of his or her duty to the bank, unless and only to the extent that the Court of Common Pleas of Trumbull County, Ohio or the court in which such action or suit was brought shall determine upon application that, despite such adjudication of liability, and in view of all the circumstances, he or she is fairly and reasonably entitled to all or part of such indemnification.

Section 5.06. Article Five Not Exclusive . The indemnification provided by this Article Five shall not be deemed exclusive of any other rights to which any person seeking indemnification may be entitled under the Articles or any Regulation, agreement, vote of shareholders or disinterested directors, or otherwise, both as to action in his or her official capacity and as to action in another capacity while holding such office, and shall continue as to a person who has ceased to be an officer or director of the bank and shall inure to the benefit of the heirs, executors, and administrators of such a person.

Section 5.07. Insurance . The bank may purchase and maintain insurance on behalf of any person who is or was a director, officer, employee or agent of the bank, or is or was serving at the request of the bank as a director, trustee, officer, employee, or agent of another bank (domestic or foreign, nonprofit or for profit), partnership, joint venture, trust or other enterprise, against any liability asserted against such person and incurred by such person in any such capacity, or arising out of his or her status as such, whether or not the bank would have the obligation or the power to indemnify such person against such liability under the provisions of this Article Five.

Section 5.08. Certain Definitions . For purposes of this Article Five, and as examples and not by way of limitation:

(A) a person claiming indemnification under this Article Five shall be deemed to have been successful on the merits or otherwise in defense of any action, suit or proceeding referred to in Section 5.01, or in defense of any claim, issue or other matter therein, if such action, suit or proceeding shall be terminated as to such person, with or without prejudice, without the entry of a judgment or order against him or her, without a conviction, without the imposition of a fine and without his or her payment or agreement to pay any amount in settlement thereof (whether or not any such termination is based upon a judicial or other determination of the lack of merit of the claims made against him or otherwise results in a vindication of such person); and

(B) references to an “other enterprise” shall include employee benefit plans; references to a “fine” shall include any excise taxes assessed on a person with respect to an

employee benefit plan; references to “serving at the request of the bank” shall include any service as a director, officer, employee or agent of the bank which imposes duties on, or involves services by, such director, officer, employee or agent with respect to an employee benefit plan, its participants or beneficiaries; and references to “a subsidiary of the bank” shall include another bank if securities representing at least a majority of the voting power of such other bank are owned by the bank; and a person who acted in good faith and in a manner he or she reasonably believed to be in the best interests of the participants and beneficiaries of an employee benefit plan shall be deemed to have acted in a manner “not opposed to the best interests of the bank” within the meaning of that term as used in this Article Five.

Section 5.09. Venue . Any action, suit or proceeding to determine a claim for indemnification under this Article Five may be maintained by the person claiming such indemnification, or by the bank, in the Court of Common Pleas of Trumbull County, Ohio. The bank and (by claiming such indemnification) each such person consent to the exercise of jurisdiction over its or his person by the Court of Common Pleas of Trumbull County, Ohio in any such action, suit or proceeding.

Section 5.10 Limitations . Notwithstanding anything in this Article Five to the contrary, the bank shall not indemnify any of its officers, employees, or directors for any of the following: personal liability for damages to the bank, its shareholders, or other persons pursuant to Section 1105.11 of the Ohio Revised Code for knowingly violating or knowingly permitting any of the bank’s officers, agents, or employees to violate any provision of Chapters 1101. to 1127. of the Ohio Revised Code or damages pursuant to any successor law or other similar law of this state, any other state, or the United States; civil penalties assessed against the officer, employee, or director personally by the Superintendent of Financial Institutions or other regulatory authority of this state, any other state, or the United States having jurisdiction over the bank or any of its business; restitution pursuant to a cease and desist or similar order or supervisory action that is issued by the Superintendent of Financial Institutions or other regulatory authority of this state, any other state, or the United States having jurisdiction over the bank or any of its business; or the cost of defense against any action resulting in damages, civil penalties, or restitution for which there can be no indemnification under this provision or resulting in any formal or informal supervisory action against the officer, employee, or director personally that is issued by the Superintendent of Financial Institutions or other regulatory authority of this state, another state, or the United States having jurisdiction over the bank or any of its business.

ARTICLE SIX
MISCELLANEOUS

Section 6.01. Amendments . These Regulations may be amended, or new regulations may be adopted, at a meeting of shareholders held for such purpose, only by the affirmative vote of the holders of shares entitling them to exercise not less than a majority of the voting power of the bank on such proposal, or without a meeting (without regard to whether the shareholders have been provided a copy of the proposed amendments or new code of regulations at least ten days prior to the last day the shareholders could consent to or deny consent to the proposed amendments or new code of regulations) by the written consent of the holders of shares entitling them to exercise not less than a majority of the voting power of the bank on such proposal.

If the code of regulations is amended or a new code of regulations is adopted without a meeting of the shareholders, the secretary shall mail a copy of the amendment or the new code of regulations, or notice of the adoption of the amendment or new code of regulations, to each shareholder who would have been entitled to vote on the amendment or adoption.

Section 6.02. Action by Shareholders or Directors Without a Meeting . Anything contained in the Regulations to the contrary notwithstanding, except as provided in Section 6.01, any action which may be authorized or taken at a meeting of the shareholders or of the directors or of a committee of the directors, as the case may be, may be authorized or taken without a meeting with the affirmative vote or approval of, and in a writing or writings signed by, all the shareholders who would be entitled to notice of a meeting of the shareholders held for such purpose, or all the directors, or all the members of such committee of the directors, respectively, which writings shall be filed with or entered upon the records of the bank. A telegram, cablegram, electronic mail, or an electronic or other transmission capable of authentication that appears to have been sent by a shareholder or a director, as the case may be, and that contains an affirmative vote or approval of such shareholder or director is a writing for the purposes of this Section 6.02. The date on which that telegram, cablegram electronic mail, or electronic or other transmission is sent is the date on which the writing is signed.

CERTIFIED RESOLUTION
OF
THE BOARD OF DIRECTORS

The undersigned Secretary of The Cortland Savings and Banking Company, a corporation organized and existing under the laws of the State of Ohio, do hereby certify that a meeting of the of the Board of Directors of said Company, held at Cortland, Ohio, on the 23 ^rd day of January at which meeting a quorum was present, the following resolution was authorized and duly adopted, and is in full force and effect, to wit:

RESOLVED: The Code of Regulations of The Cortland Savings and Banking Company, effective as of the date of acceptance, presented to this meeting is hereby approved and adopted.

In witness whereof, I have set my hand and seal as of this 23 day of January, 2007.


		James M. Gasior, Corporate Secretary

CERTIFIED RESOLUTION
OF
THE SOLE SHAREHOLDER

I, the undersigned, K. Ray Mahan, Chairman of the Board of Directors Cortland Bancorp, which is the sole shareholder of The Cortland Savings and Banking Company, a corporation organized and existing under the laws of the State of Ohio, do hereby certify that a meeting of the of the Board of Directors of Cortland Bancorp, held at Cortland, Ohio, on the 23 ^rd day of January at which meeting a quorum was present, the following resolution was authorized, adopted, and recorded according to the Amended Articles of said Cortland Bancorp and is in full force and effect, to wit:

RESOLVED: The Code of Regulations of The Cortland Savings and Banking Company, effective as of the date of acceptance, presented to this meeting is hereby approved and adopted.

In witness whereof, I have set my hand and seal as of this 23 day of January, 2007.


		K. Ray Mahan, Chairman

Exhibit 10.12

FIRST AMENDMENT
TO THE
CORTLAND BANCORP.
SPLIT DOLLAR AGREEMENT
DATED FEBRUARY 23, 2001

THIS FIRST AMENDMENT is adopted this day of , 20 , by and between CORTLAND BANCORP., a holding company located in Cortland, Ohio (the “Company”) and David Cole (the “Director”).

On February 23, 2001, the Company and the Director executed the Split Dollar Agreement (the “Agreement”).

According to the terms of Article 7, the undersigned hereby amend, in part, said Agreement for the purpose of updating (1) the definition of Insurer and (2) the definition of Policy. Therefore,

Section 1.1 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.1 as follows:

1.1

“ Insurer ” means each life insurance carrier for which there is a Split Dollar Policy Endorsement for this Agreement.

Section 1.2 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.2 as follows:

1.2

“ Policy ” means the specific life insurance policy or policies issued by the Insurer(s).

IN WITNESS OF THE ABOVE , the Company and Director hereby consent to this First Amendment.


DIRECTOR:				CORTLAND BANCORP.

				By:
DAVID COLE				Title:

FIRST AMENDMENT
TO THE
CORTLAND BANCORP.
SPLIT DOLLAR AGREEMENT
DATED FEBRUARY 23, 2001

THIS FIRST AMENDMENT is adopted this day of , 20 , by and between CORTLAND BANCORP., a holding company located in Cortland, Ohio (the “Company”) and Timothy Woofter (the “Director”).

On February 23, 2001, the Company and the Director executed the Split Dollar Agreement (the “Agreement”).

According to the terms of Article 7, the undersigned hereby amend, in part, said Agreement for the purpose of updating (1) the definition of Insurer and (2) the definition of Policy. Therefore,

Section 1.1 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.1 as follows:

1.1

“ Insurer ” means each life insurance carrier for which there is a Split Dollar Policy Endorsement for this Agreement.

Section 1.2 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.2 as follows:

1.2

“ Policy ” means the specific life insurance policy or policies issued by the Insurer(s).

IN WITNESS OF THE ABOVE , the Company and Director hereby consent to this First Amendment.


DIRECTOR:				CORTLAND BANCORP.

				By:
TIMOTHY WOOFTER				Title:

FIRST AMENDMENT
TO THE
CORTLAND BANCORP.
SPLIT DOLLAR AGREEMENT
DATED OCTOBER 1, 2001

THIS FIRST AMENDMENT is adopted this day of , 20 , by and between CORTLAND BANCORP., a holding company located in Cortland, Ohio (the “Company”) and Richard Thompson (the “Director”).

On October 1, 2001, the Company and the Director executed the Split Dollar Agreement (the “Agreement”).

According to the terms of Article 7, the undersigned hereby amend, in part, said Agreement for the purpose of updating (1) the definition of Insurer and (2) the definition of Policy. Therefore,

Section 1.1 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.1 as follows:

1.1

“ Insurer ” means each life insurance carrier for which there is a Split Dollar Policy Endorsement for this Agreement.

Section 1.2 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.2 as follows:

1.2

“ Policy ” means the specific life insurance policy or policies issued by the Insurer(s).

IN WITNESS OF THE ABOVE , the Company and Director hereby consent to this First Amendment.


DIRECTOR:				CORTLAND BANCORP.

				By:
RICHARD THOMPSON				Title:

FIRST AMENDMENT
TO THE
CORTLAND BANCORP.
SPLIT DOLLAR AGREEMENT
DATED FEBRUARY 23, 2001

THIS FIRST AMENDMENT is adopted this day of , 20 , by and between CORTLAND BANCORP., a holding company located in Cortland, Ohio (the “Company”) and Karl Mahan (the “Director”).

On February 23, 2001, the Company and the Director executed the Split Dollar Agreement (the “Agreement”).

According to the terms of Article 7, the undersigned hereby amend, in part, said Agreement for the purpose of updating (1) the definition of Insurer and (2) the definition of Policy. Therefore,

Section 1.1 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.1 as follows:

1.1

“ Insurer ” means each life insurance carrier for which there is a Split Dollar Policy Endorsement for this Agreement.

Section 1.2 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.2 as follows:

1.2

“ Policy ” means the specific life insurance policy or policies issued by the Insurer(s).

IN WITNESS OF THE ABOVE , the Company and Director hereby consent to this First Amendment.


DIRECTOR:				CORTLAND BANCORP.

				By:
KARL MAHAN				Title:

FIRST AMENDMENT
TO THE
CORTLAND BANCORP.
SPLIT DOLLAR AGREEMENT
DATED FEBRUARY 23, 2001

THIS FIRST AMENDMENT is adopted this day of , 20 , by and between CORTLAND BANCORP., a holding company located in Cortland, Ohio (the “Company”) and James Hoffman III (the “Director”).

On February 23, 2001, the Company and the Director executed the Split Dollar Agreement (the “Agreement”).

According to the terms of Article 7, the undersigned hereby amend, in part, said Agreement for the purpose of updating (1) the definition of Insurer and (2) the definition of Policy. Therefore,

Section 1.1 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.1 as follows:

1.1

“ Insurer ” means each life insurance carrier for which there is a Split Dollar Policy Endorsement for this Agreement.

Section 1.2 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.2 as follows:

1.2

“ Policy ” means the specific life insurance policy or policies issued by the Insurer(s).

IN WITNESS OF THE ABOVE , the Company and Director hereby consent to this First Amendment.


DIRECTOR:				CORTLAND BANCORP.

				By:
JAMES HOFFMAN III				Title:

FIRST AMENDMENT
TO THE
CORTLAND BANCORP.
SPLIT DOLLAR AGREEMENT
DATED FEBRUARY 23, 2001

THIS FIRST AMENDMENT is adopted this day of , 20 , by and between CORTLAND BANCORP., a holding company located in Cortland, Ohio (the “Company”) and George Gessner (the “Director”).

On February 23, 2001, the Company and the Director executed the Split Dollar Agreement (the “Agreement”).

According to the terms of Article 7, the undersigned hereby amend, in part, said Agreement for the purpose of updating (1) the definition of Insurer and (2) the definition of Policy. Therefore,

Section 1.1 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.1 as follows:

1.1

“ Insurer ” means each life insurance carrier for which there is a Split Dollar Policy Endorsement for this Agreement.

Section 1.2 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.2 as follows:

1.2

“ Policy ” means the specific life insurance policy or policies issued by the Insurer(s).

IN WITNESS OF THE ABOVE , the Company and Director hereby consent to this First Amendment.


DIRECTOR:				CORTLAND BANCORP.

				By:
GEORGE GESSNER				Title:

Exhibit 10.27

FIRST AMENDMENT
TO THE
CORTLAND SAVINGS & BANKING COMPANY
AMENDED SPLIT DOLLAR AGREEMENT
DATED SEPTEMBER 9, 2002

THIS AMENDMENT is adopted this 11th day of December, 2006, by and between THE CORTLAND SAVINGS & BANKING COMPANY, a state-chartered commercial bank located in Cortland, Ohio (the “Bank”) and Marlene Lenio (the “Executive”).

On September 9, 2002, the Bank and the Executive executed the Amended Split Dollar Agreement (the “Agreement”).

According to the terms of Article 7, the undersigned hereby amend, in part, said Agreement for the purpose of updating (1) the definition of Insurer and (2) the definition of Policy. Therefore,

Section 1.1 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.1 as follows:

1.1

“ Insurer” means each life insurance carrier for which there is a Split Dollar Policy Endorsement for this Agreement.

Section 1.2 of the Agreement shall be deleted in its entirety and replaced by the new Section 1.2 as follows:

1.2

“Policy” means the specific life insurance policy or policies issued by the Insurer(s).

IN WITNESS OF THE ABOVE, the Company and Executive hereby consent to this First Amendment.


EXECUTIVE:	THE CORTLAND SAVINGS & BANK COMPANY

		By:
MARLENE LENIO			Stephen A. Telego, Sr.
		Title: Senior Vice President, Chief of Corporate Administration

BRIEF DESCRIPTION OF THE BUSINESS

CORTLAND BANCORP

Cortland Bancorp (the “Company”) was incorporated under the laws of the State of Ohio in 1984, as a one bank holding company registered under the Bank Holding Company Act of 1956, as amended. On March 13, 2000, the Board of Governors of the Federal Reserve system approved the Company’s application to become a financial holding company as authorized by the Gramm-Leach-Bliley Act of 1999. The principal activity of the Company is to own, manage and supervise the Cortland Savings and Banking Company (“Cortland Banks” or the “Bank”). The Company owns all of the outstanding shares of the Bank.

The business of the Company and the Bank is not seasonal to any significant extent and is not dependent on any single customer or group of customers.

NEW RESOURCES LEASING COMPANY

New Resources Leasing Company was formed in December 1988 as a separate entity to handle the function of commercial and consumer leasing. The wholly owned subsidiary has been inactive since incorporation.

THE CORTLAND SAVINGS

AND BANKING COMPANY

The Cortland Savings and Banking Company is a full service state chartered bank engaged in commercial and retail banking and trust services. The Bank’s services include checking accounts, savings accounts, time deposit accounts, commercial, mortgage and installment loans, night depository, automated teller services, safe deposit boxes and other miscellaneous services normally offered by commercial banks. Cortland Banks also offers a variety of Internet Banking products as well as discount brokerage services.

Business is conducted at a total of thirteen offices, eight of which are located in Trumbull County, Ohio. Two offices are located in the communities of Windham and Mantua, in Portage County, Ohio. One office is located in the community of Williamsfield, Ashtabula County, Ohio, while two are located in the community of Boardman, Mahoning County, Ohio.

Cortland Bank’s main office (as described in its charter) is located at 194 West Main Street, Cortland, Ohio. Administrative offices are located at the main office. The Brookfield, Windham, Hubbard, Niles Park Plaza and both Boardman offices are leased, while all of the other offices are owned by Cortland Banks.

COMPETITION

Cortland Banks actively competes with state and national banks located in Northeast Ohio and Western Pennsylvania. It also competes for deposits, loans and other service business with a large number of other financial institutions, such as savings and loan associations, credit unions, insurance companies, consumer finance companies and commercial finance companies. Also, money market mutual funds, brokerage houses and similar institutions provide in a relatively unregulated environment many of the financial services offered by banks. In the opinion of management, the principal methods of competition are the rates of interest charged on loans, the rates of interest paid on deposit funds, the fees charged for services, and the convenience, availability, timeliness and quality of the customer services offered.

EMPLOYEES

As of December 31, 2006 the Company through its subsidiary bank, employed 144 full-time and 41 part-time employees. The Company provides its employees with a full range of benefit plans, and considers its relations with its employees to be satisfactory.


4

REPORT ON MANAGEMENT’S ASSESSMENT OF

INTERNAL CONTROL OVER FINANCIAL REPORTING

Cortland Bancorp is responsible for the preparation, integrity, and fair presentation of the consolidated financial statements included in this annual report. The consolidated financial statements and notes included in this annual report have been prepared in conformity with United States generally accepted accounting principles and necessarily include some amounts that are based on management’s best estimates and judgments.

We, as management of Cortland Bancorp, are responsible for establishing and maintaining effective internal control over financial reporting that is designed to produce reliable financial statements in conformity with United States generally accepted accounting principles. The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability through a program of internal audits. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.

Management assessed the Company’s system of internal control over financial reporting as of December 31, 2006, in relation to criteria for effective internal control over financial reporting as described in Internal Control-Integrated Framework , issued by the Committee of Sponsoring Organization of the Treadway Commission. Based on this assessment, management concludes that, as of December 31, 2006, its system of internal control over financial reporting is effective and meets the criteria of the Internal Control-Integrated Framework . Packer Thomas, independent registered public accounting firm, has issued an attestation report on management’s assessment of the Company’s internal control over financial reporting.


Lawrence A. Fantauzzi President and Chief Executive Officer		James M. Gasior Secretary Chief Financial Officer

Cortland, Ohio March 7, 2007


	5

REPORT OF PACKER THOMAS

INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

SHAREHOLDERS AND BOARD OF DIRECTORS

Cortland Bancorp

We have audited the accompanying consolidated balance sheets of Cortland Bancorp and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006. We also have audited management’s assessment, included in the accompanying Report on Management’s Assessment of Internal Control Over Financial Reporting, that Cortland Bancorp and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Cortland Bancorp’s management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cortland Bancorp and subsidiaries as of December 31, 2006 and 2005, and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2006 in conformity with accounting principles generally accepted in the United States of America. Also, in our opinion, management’s assessment that Cortland Bancorp and subsidiaries maintained effective internal control over financial reporting as of December 31, 2006 is fairly stated, in all material respects, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our opinion, Cortland Bancorp and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).




	Packer Thomas

Youngstown, Ohio

March 7, 2007


6

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

Years ended December 31, 2006, 2005 and 2004

(Amounts in thousands except per share data)


					2006			2005			2004

Interest income
	Interest and fees on loans				$	14,291		$	12,941		$	12,383
	Interest and dividends on investment securities:
		Taxable interest				5,943			4,387			3,501
		Nontaxable interest				2,051			2,162			2,553
		Dividends				202			167			135
	Interest on mortgage-backed securities					3,795			3,810			3,633
	Other interest income					215			119			83

			Total interest income			26,497			23,586			22,288

Interest expense
	Deposits					8,509			6,159			5,787
	Borrowed funds					3,073			2,506			2,223

			Total interest expense			11,582			8,665			8,010

				Net interest income		14,915			14,921			14,278
				Provision for loan losses (Note 4)		225			545			415

Net interest income after provision for loan losses						14,690			14,376			13,863

Other income
	Fees for other customer services					2,239			2,254			2,327
	Investment securities gains - net					18			308			1,052
	Gain on sale of loans - net					106			89			54
	Other real estate losses - net					(47	)		(3	)		(171	)
	Earnings on bank owned life insurance					433			341			444
	Other non-interest income					86			126			125

			Total other income			2,835			3,115			3,831

Other expenses
	Salaries and employee benefits					6,776			7,052			6,722
	Net occupancy and equipment expense					1,811			1,870			1,853
	State and local taxes					552			548			544
	Office supplies					367			338			346
	Bank exam and audit expense					486			427			515
	Other operating expenses					2,029			1,965			1,881

			Total other expenses			12,021			12,200			11,861

Income before federal income taxes						5,504			5,291			5,833
Federal income taxes (Note 10)						928			957			990

Net income					$	4,576		$	4,334		$	4,843

Net income per share, both basic and diluted (Note 1)					$	1.02		$	0.98		$	1.11

Dividends declared per share					$	0.86		$	1.05		$	1.02

See accompanying notes to consolidated financial statements


	7

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

As of December 31, 2006 and 2005

(Amounts in thousands except per share data)


				2006			2005

ASSETS
Cash and due from banks				$	10,100		$	14,587
Federal funds sold					4,275			4,650

	Total cash and cash equivalents				14,375			19,237

Investment securities available for sale (Note 2)					108,484			113,247
Investment securities held to maturity (approximate market value of $124,136 in 2006 and $121,395 in 2005) (Note 2)					124,619			121,405
Total loans (Note 3)					205,208			188,202
	Less allowance for loan losses (Note 4)				(2,211	)		(2,168	)

	Net loans				202,997			186,034

Premises and equipment (Note 5)					4,780			4,088
Other assets					16,496			15,690

			Total assets	$	471,751		$	459,701


LIABILITIES
Noninterest-bearing deposits				$	60,983		$	61,782
Interest-bearing deposits (Note 6)					294,835			288,593

	Total deposits				355,818			350,375

Federal Home Loan Bank advances and other borrowings (Note 7)					62,015			58,111
Other liabilities					3,326			2,890

			Total liabilities		421,159			411,376


Commitments and contingent liabilities (Notes 8 and 16)

SHAREHOLDERS’ EQUITY
Common stock - $5.00 stated value - authorized 20,000,000 shares; issued 4,594,344 shares in 2006 and 4,504,576 shares in 2005 (Note 1)					22,972			22,523
Additional paid-in capital (Note 1)					20,835			20,211
Retained earnings					9,553			10,310
Accumulated other comprehensive (loss) income (Note 1)					(455	)		(877	)
Treasury stock, at cost, 95,809 shares in 2006 and 155,945 shares in 2005					(2,313	)		(3,842	)

		Total shareholders’ equity (Note 15)			50,592			48,325

			Total liabilities and shareholders’ equity	$	471,751		$	459,701

See accompanying notes to consolidated financial statements


8

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY

Years ended December 31, 2006, 2005 and 2004

(Amounts in thousands except per share data)


											Accumulated						Total
					Additional						Other						Share-
			Common		Paid-In			Retained			Comprehensive			Treasury			holders
			Stock		Capital			Earnings			Income (Loss)			Stock			Equity

Balance at December 31, 2003			$	21,234	$	16,469		$	15,401		$	2,203		$	(5,426	)	$	49,881
Comprehensive Income:
	Net income								4,843									4,843
	Other comprehensive income, net of tax:
		Unrealized losses on available for sale securities, net of reclassification adjustment										(1,142	)					(1,142	)

Total comprehensive income																		3,701

Common Stock Transactions:
	Treasury shares reissued net of shares repurchased					30									232			262
	Cash dividends declared ($0.81 per share)								(3,547	)								(3,547	)
	Special cash dividend ($0.21 per share)								(890	)								(890	)
	3% stock dividend			635		2,032			(2,667	)
	Cash paid in lieu of fractional shares								(9	)								(9	)

Balance at December 31, 2004				21,869		18,531			13,131			1,061			(5,194	)		49,398
Comprehensive Income:
	Net income								4,334									4,334
	Other comprehensive income, net of tax:
		Unrealized gains on available for sale securities, net of reclassification adjustment										(1,938	)					(1,938	)

Total comprehensive income																		2,396

Common Stock Transactions:
	Treasury shares reissued net of shares repurchased					(184	)								1,352			1,168
	Cash dividends declared ($0.84 per share)								(3,701	)								(3,701	)
	Special cash dividend ($0.21 per share)								(929	)								(929	)
	3% stock dividend			654		1,864			(2,518	)
	Cash paid in lieu of fractional shares								(7	)								(7	)

Balance at December 31, 2005				22,523		20,211			10,310			(877	)		(3,842	)		48,325
Comprehensive Income:
	Net income								4,576									4,576
	Other comprehensive income, net of tax:
		Unrealized gains on available for sale securities, net of reclassification adjustment										422						422

Total comprehensive income																		4,998

Common Stock Transactions:
	Treasury shares reissued net of shares repurchased					(390	)								1,529			1,139
	Cash dividends declared ($0.86 per share)								(3,865	)								(3,865	)
	2% stock dividend			449		1,014			(1,463	)
	Cash paid in lieu of fractional shares								(5	)								(5	)

Balance at December 31, 2006			$	22,972	$	20,835		$	9,553		$	(455	)	$	(2,313	)	$	50,592

DISCLOSURE OF RECLASSIFICATION FOR AVAILABLE

FOR SALE SECURITY GAINS AND LOSSES:


	2006		2005			2004

Unrealized holding gains (losses) on available for sale securities arising during the period net of tax of $224, $(894), and $(231)	$	434	$	(1,735	)	$	(448	)
Less: Reclassification adjustment for gains realized in net income, net of tax of $6, $105, and $358,		12		203			694

Net unrealized gains (losses) on available for sale securities, net of tax	$	422	$	(1,938	)	$	(1,142	)

See accompanying notes to consolidated financial statements


	9

CORTLAND BANCORP AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

Years ended December 31, 2006, 2005 and 2004

(Amounts in thousands)


					2006			2005			2004

Cash flows from operating activities
	Net income				$	4,576		$	4,334		$	4,843
	Adjustments to reconcile net income to net cash flows from operating activities:
		Depreciation, amortization and accretion				991			1,469			2,176
		Provision for loan loss				225			545			415
		Deferred tax (benefit) expense				(205	)		50			(129	)
		Investment securities gains				(18	)		(308	)		(1,052	)
		Gains on sales of loans				(106	)		(89	)		(54	)
		Loss on the sale or disposal of fixed assets				3
		Other real estate losses				47			3			171
		Loans originated for sale				(6,978	)		(6,618	)		(3,993	)
		Proceeds from sale of loans originated for sale				6,975			6,707			4,150
		Changes in:
			Interest and fees receivable			(245	)		(341	)		148
			Interest payable			185			(30	)		(111	)
			Other assets and liabilities			(368	)		(1,447	)		818

				Net cash flows from operating activities		5,082			4,275			7,382

Cash flows from investing activities
	Purchases of securities available for sale					(13,339	)		(19,593	)		(68,146	)
	Purchases of securities held to maturity					(12,017	)		(47,280	)		(43,601	)
	Proceeds from sales of securities available for sale					1,006			1,479			32,523
	Proceeds from call, maturity and principal payments on securities					26,050			53,082			73,934
	Net(increase) decrease in loans made to customers					(17,223	)		2,462			(2,812	)
	Proceeds from disposition of other real estate					143			22			815
	Purchases of premises and equipment					(1,180	)		(316	)		(127	)

				Net cash flows from investing activities		(16,560	)		(10,144	)		(7,414	)

Cash flows from financing activities
	Net increase in deposit accounts					5,443			5,456			7,363
	Net increase in borrowings					3,904			10,222			3
	Dividends paid					(3,870	)		(4,637	)		(4,446	)
	Purchases of treasury stock								(3	)		(1,032	)
	Treasury shares reissued					1,139			1,171			1,294

				Net cash flows from financing activities		6,616			12,209			3,182

	Net change in cash and cash equivalents					(4,862	)		6,340			3,150

Cash and cash equivalents
	Beginning of year					19,237			12,897			9,747

	End of year				$	14,375		$	19,237		$	12,897

See accompanying notes to consolidated financial statements


10

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Principles of Consolidation: The consolidated financial statements include the accounts of Cortland Bancorp (the Company) and its wholly-owned subsidiaries, Cortland Savings and Banking Company (the Bank) and New Resources Leasing Co. All significant intercompany balances and transactions have been eliminated.

Industry Segment Information: The Company and its subsidiaries operate in the domestic banking industry which accounts for substantially all of the Company’s assets, revenues and operating income. The Company, through its subsidiary bank, grants residential, consumer, and commercial loans and offers a variety of saving plans to customers located primarily in the Northeastern Ohio and Western Pennsylvania area.

Use of Estimates: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.

Cash Flow: Cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods. The Company reports net cash flows for customer loan transactions, deposit transactions and deposits made with other financial institutions.

The Company paid interest of $11,397,000, $8,695,000 and $8,121,000 in 2006, 2005 and 2004, respectively. Cash paid for income taxes was $1,120,000 in 2006, $993,000 in 2005 and $1,005,000 in 2004. Transfers of loans to other real estate were, $144,000 in 2006, $107,000 in 2005 and none in 2004.

Investment Securities: Investments in debt and equity securities are classified as held to maturity, trading or available for sale. Securities classified as held to maturity are those that management has the positive intent and ability to hold to maturity. Securities classified as available for sale are those that could be sold for liquidity, investment management, or similar reasons, even though management has no present intentions to do so.

Securities held to maturity are stated at cost, adjusted for amortization of premiums and accretion of discounts, with such amortization or accretion included in interest income. Securities available for sale are carried at fair value with unrealized gains and losses recorded as a separate component of shareholders’ equity, net of tax effects. Realized gains or losses on dispositions are based on net proceeds and the adjusted carrying amount of securities sold, using the specific identification method. Interest on securities is accrued and credited to operations based on the principal balance outstanding, adjusted for amortization of premiums and accretion of discounts.

Unrealized losses on corporate bonds have not been recognized into income. Management has the intent and ability to hold these securities for the foreseeable future. The fair value is expected to recover as the bonds approach their maturity date and/or market conditions become more favorable to the bonds’ intrinsic value.

Trading Securities: Trading securities are principally held with the intention of selling in the near term and are carried at market value. Realized and unrealized gains and losses on trading account securities are recognized in the Statement of Income as they occur. The Company did not hold any trading securities at December 31, 2006, 2005 or 2004. There was no trading activity in 2006, 2005 or 2004.

Loans: Loans are stated at the principal amount outstanding net of the unamortized balance of deferred loan origination fees and costs. Deferred loan origination fees and costs are amortized as an adjustment to the related loan yield over the contractual life using the level yield method. Interest income on loans is accrued over the term of the loans based on the amount of principal outstanding. The accrual of interest is discontinued on a loan when management determines that the collection of interest is doubtful. Generally a loan is placed on nonaccrual status once the borrower is 90 days past due on payments, or whenever sufficient information is received to question the collectability of the loan or any time legal proceedings are initiated involving a loan. Interest income accrued up to the date a loan is placed on nonaccrual is reversed

(Continued)


	11

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

through interest income. Cash payments received while a loan is classified as nonaccrual are recorded as a reduction to principal or reported as interest income according to management’s judgment as to the 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 judgment, collectable, or when it otherwise becomes well secured and in the process of collection. When a loan is charged-off, any interest accrued but not collected on the loan is charged against earnings.

Loans Held for Sale: The Company originates certain residential mortgage loans for sale in the secondary mortgage loan market. For the majority of loan sales, the Company concurrently sells the rights to service the related loans. In addition, the Company may periodically identify other loans which may be sold. These loans are classified as loans held for sale, and carried, in the aggregate, at the lower of cost or estimated market value based on secondary market prices. To mitigate interest rate risk, the Company may obtain fixed commitments to sell such loans at the time loans are originated or identified as being held for sale. Such a commitment would be referred to as a derivative loan commitment if the loan that will result from exercise of the commitment will be held for sale upon funding under Statement of Financial Accounting Standards No. 133 (“SFAS 133”), Accounting for Derivative Instruments and Hedging Activities, as amended by Statement of Financial Accounting Standards No. 149 (“SFAS 149”), Amendment of Statement 133 on Derivative Instruments and Hedging Activities. Loans held for sale was $109,000 at December 31, 2006, and none at December 31, 2005.

Allowance for Loan Losses and Allowance for Losses on Lending Related Commitments: Because some loans may not be repaid in full, an allowance for loan losses is recorded. Increases to the allowance consist of provisions for loan losses charged to expense and recoveries of previously charged-off loans. Reductions to the allowance result from the charge-off of loans deemed uncollectable by management. After a loan is charged-off, collection efforts continue and future recoveries may occur.

A loan is considered impaired when it appears probable that all principal and interest amounts will not be collected according to the loan contract. Allowances for loan losses on impaired loans are determined using the estimated future cash flows of the loan, discounted to their present value using the loan’s effective interest rate. Allowances for loan losses for impaired loans that are collateral dependent are generally determined based on the estimated fair value of the underlying collateral. Smaller balance homogeneous loans are evaluated for impairment in the aggregate. Such loans include one-to-four family residential, home equity and consumer loans. Commercial loans and commercial mortgage loans are evaluated individually for impairment. Impaired loans are generally classified as nonaccrual loans.

Estimating the risk of loss and the amount of loss on any loan is necessarily subjective. Accordingly, the allowance is maintained by management at a level considered adequate to cover possible losses that are currently anticipated. Management evaluates the portfolio in light of economic conditions, changes in the nature and volume of the portfolio, industry standards and other relevant factors. Specific factors considered by management in determining the amounts charged to operations include previous loss experience; the status of past due interest and principal payments; the quality of financial information supplied by customers; the cash flow coverage and trends evidenced by financial information supplied by customers; the nature and estimated value of any collateral supporting specific loan credits; risk classifications determined by the Company’s loan review systems or as the result of regulatory examination process; and general economic conditions in the lending area of the Company’s bank subsidiary. Key risk factors and assumptions are dynamically updated to reflect actual experience and changing circumstances. While management may periodically allocate portions of the allowance for specific problem loans, the entire allowance is available for any charge-offs that occur.

(Continued)


12

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

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.

Premises and Equipment: Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed generally on the straight-line method over the estimated useful lives of the various assets. Maintenance and repairs are expensed and major improvements are capitalized.

Other Real Estate: Real estate acquired through foreclosure or deed-in-lieu of foreclosure is included in other assets. Such real estate is carried at the lower of cost or fair value less estimated costs to sell. Any reduction from the carrying value of the related loan to fair value at the time of acquisition is accounted for as a loan loss. Any subsequent reduction in fair market value is reflected as a valuation allowance through a charge to income. Costs of significant property improvements are capitalized, whereas costs relating to holding and maintaining the property are charged to expense.

Intangible Asset: A core deposit intangible asset resulting from a branch acquisition is being amortized over a 15 year period. The intangible asset, net of accumulated amortization, was $134,000 and $171,000 at December 31, 2006 and 2005, respectively, and is included in other assets. The annual expense was $37,000 at December 31, 2006, 2005 and 2004. The estimated aggregate amortization expense for the next three years is $37,000 per year, and $23,000 in the fourth year.

Cash Surrender Value of Life Insurance: Bank-owned life insurance (“BOLI”) represents life insurance on the lives of certain Company employees, officers and directors who have provided positive consent allowing the Company to be the co-beneficiary of such policies. Since the Company is the owner of the insurance policies, increases in the cash value of the policies, as well as its share of insurance proceeds received, are recorded in other noninterest income, and are not subject to income taxes. The cash value of the policies is included in other assets. The Company reviews the financial strength of the insurance carriers prior to the purchase of BOLI and quarterly thereafter. The amount of BOLI with any individual carrier is limited to 15% of Tier I Capital. The Company has purchased BOLI to provide a long-term asset to offset long-term benefit liabilities, while generating competitive investment yields.

Advertising: The Company expenses advertising costs as incurred.

Income Taxes: A deferred tax liability or asset is determined at each balance sheet date. It is measured by applying currently enacted tax laws to future amounts that result from differences in the financial statement and tax bases of assets and liabilities.

Other Comprehensive Income: Accumulated other comprehensive income for the Company is comprised solely of unrealized holding gains (losses) on available for sale securities, net of tax.

Per Share Amounts: The Board of Directors declared 2% common stock dividends payable as of January 1, 2007, and 3% common stock dividends payable January 1, 2006 and 2005. The common stock dividend

(Continued)


	13

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

issued on January 1, 2007 resulted in the issuance of 89,768 shares of common stock, which have been included in the 4,594,344 shares reported as issued at December 31, 2006.

Basic and diluted earnings per share are based on weighted average shares outstanding. Average shares outstanding and per share amounts have been restated to give retroactive effect to the 2% common stock dividend of January 1, 2007. Average shares outstanding and per share amounts similarly reflect the impact of the Company’s stock repurchase program.

The following table sets forth the computation of basic earnings per common share and diluted earnings per common share:


	Years Ended December 31,

	2006		2005		2004

Net income ($000 omitted)	$	4,576	$	4,334	$	4,843
Weighted average common shares outstanding		4,478,165		4,416,776		4,363,888
Basic earnings per share	$	1.02	$	0.98	$	1.11
Diluted earnings per share	$	1.02	$	0.98	$	1.11

Off Balance Sheet Financial Instruments: Financial instruments include off-balance sheet credit instruments, such as commitments to make loans and commercial letters of credit, issued to meet customer financing needs. The face amount for these items represents the exposure to loss, before considering customer collateral or ability to repay. Such financial instruments are recorded when they are funded.

Reclassifications: Certain items in the financial statements for 2005 and 2004 have been reclassified to conform to the 2006 presentation.

New Accounting Standards

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 accounting for and reporting of 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.

In June 2006, the FASB issued FIN No. 48, “Accounting for Uncertainty in Income Taxes”, which clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes”. This interpretation prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This interpretation also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN No. 48 is effective for fiscal years beginning after December 15, 2006. The Company, has determined there will be no impact of adopting this interpretation.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and

(Continued)


14

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)

expands disclosures about fair value measurements. The provisions of this standard apply to other accounting pronouncements that require or permit fair value measurements. SFAS No. 157 is effective for financial statements issued for fiscal years beginning after November 15, 2007, and interim periods within those fiscal years. The Company believes that the adoption of SFAS No. 157 will not have a material impact on the financial statements.

In October 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans.” SFAS No. 158 requires an employer to recognize the funded status of each of its defined pension and postretirement benefit plans in the balance sheet, to recognize changes in the funded status in the year in which changes occur through comprehensive income, and to measure the funded status as of the balance sheet date. The requirement to recognize the funded status of benefit plans and the disclosure requirements are effective for fiscal years ending after December 15, 2006. The requirement to measure the funded status as of the date of the balance sheet is effective for fiscal years ending after December 15, 2008. The Company has determined that its adoption of SFAS No. 158 will not have a material impact on its earnings, cash flows and financial position.

In September 2006, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin (SAB) No. 108 which provides interpretative guidance on how the effects of the carryover or reversal of prior year misstatements should be considered in quantifying a potential current year misstatement. Prior to SAB No. 108, companies used either the income statement or balance sheet approach to evaluate the materiality of financial statement misstatements. The income statement approach focused on current year misstatements while the balance sheet approach focused on the cumulative amount of misstatement present in the balance sheet. Misstatements that would be material under one approach could be viewed as immaterial under another approach and not be corrected. SAB No. 108 now requires that companies view financial statement misstatements as material if they are material according to either the income statement or balance sheet approach. SAB No. 108 is effective for fiscal years ending after November 15, 2006. The Company has analyzed SAB No. 108 and determined that its adoption will have no impact on the reported results of operations or financial condition.

In September 2006, the Emerging Issues Task Force (EITF) reached a final consensus on Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements”. The consensus stipulates that an agreement by an employer to share a portion of the proceeds of a life insurance policy with an employee during the postretirement period is a postretirement benefit arrangement required to be accounted for under SFAS No. 106 (postretirement benefit plans) or APB No. 12 (deferred compensation plan). The consensus concludes that the purchase of a split-dollar life insurance policy does not constitute a settlement, therefore, a liability should be recognized for future benefits. Issue 06-4 is effective for years beginning after December 15, 2007. Management is currently in the process of evaluating the impact of adoption of Issue 06-4.

In September 2006, the Emerging Issues Task Force (EITF) ratified the consensus on Issue 06-5, “Accounting for Purchases of Life Insurance — Determining the Amount that Could be Realized in Accordance with FASB Technical Bulletin No. 85-4”. The consensus stipulates that the policy owner should consider the cash surrender value as well as any additional amounts included in the contractual terms of the policy in determining the amount recognized as an asset pursuant to FASB Technical Bulletin No. 85-4. The consensus in this Issue is effective for fiscal years beginning after December 15, 2006. The Company is currently evaluating the impact of adoption of Issue 06-5.

(Continued)


	15

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 2 - INVESTMENT SECURITIES

The following is a summary of investment securities:

(Amounts in thousands)


				Gross		Gross		Estimated
		Amortized		Unrealized		Unrealized		Fair
		Cost		Gains		Losses		Value

December 31, 2006 Investment securities available for sale
U.S. Government agencies and corporations		$	12,919	$	13	$	136	$	12,796
Obligations of states and political subdivisions			9,451		348		1		9,798
Mortgage-backed and related securities			55,062		192		1,057		54,197
Corporate securities			28,160		101		149		28,112

	Total debt securities		105,592		654		1,343		104,903
Other securities			3,581						3,581

	Total available for sale	$	109,173	$	654	$	1,343	$	108,484

Investment securities held to maturity
U.S. Treasury securities		$	143	$		$		$	143
U.S. Government agencies and corporations			73,743				1,239		72,504
Obligations of states and political subdivisions			31,009		1,067		13		32,063
Mortgage-backed and related securities			19,724				298		19,426

	Total held to maturity	$	124,619	$	1,067	$	1,550	$	124,136

December 31, 2005 Investment securities available for sale
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

Investment securities held to maturity
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

At December 31, 2006 and 2005, other securities consisted of $3,355,000 and $3,167,000 in Federal Home Loan Bank (FHLB) stock, respectively, and $226,000 in Federal Reserve Board (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.

(Continued)


16

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 2 - INVESTMENT SECURITIES (Continued)

The amortized cost and estimated market value of debt securities at December 31, 2005, by contractual maturity, are shown below. Actual maturities will differ from contractual maturities because issuers may have the right to call or prepay obligations with or without call or prepayment penalties.

(Amounts in thousands)


		December 31, 2006

		Amortized		Estimated
		Cost		Fair Value

Investment securities available for sale
Due in one year or less		$	2,584	$	2,574
Due after one year through five years			7,491		7,407
Due after five years through ten years			4,174		4,043
Due after ten years			36,281		36,682

	Subtotal		50,530		50,706
Mortgage-backed securities			55,062		54,197

	Total	$	105,592	$	104,903

Investment securities held to maturity
Due in one year or less		$	905	$	910
Due after one year through five years			4,432		4,386
Due after five years through ten years			34,949		34,651
Due after ten years			64,609		64,763

	Subtotal		104,895		104,710
Mortgage-backed securities			19,724		19,426

	Total	$	124,619	$	124,136

The following table sets forth the proceeds, gains and losses realized on securities sold or called for each of the years ended December 31:

(Amounts in thousands)


	2006		2005		2004

Proceeds	$	1,526	$	13,563	$	43,339
Gross realized gains		18		308		1,074
Gross realized losses						22

Investment securities with a carrying value of approximately $75,489,000 at December 31, 2006 and $64,082,000 at December 31, 2005 were pledged to secure deposits and for other purposes.

(Continued)


	17

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 2 - INVESTMENT SECURITIES (Continued)

The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at December 31, 2006:

(Amounts in thousands)

Less than 12 Months

12 Months or More

Total

Fair

Unrealized

Fair

Unrealized

Fair

Unrealized

Value

Losses

Value

Losses

Value

Losses

U.S. Government agencies and corporations

11,716

125

69,233

1,250

80,949

1,375

Obligations of states and political subdivisions

1,043

Mortgage-backed and related securities

10,812

159

52,351

1,196

63,163

1,355

Corporate securities

2,012

4,215

143

6,227

149

24,540

290

126,842

2,603

151,382

2,893

The above table represents 201 investment securities where the current value is less than the related amortized cost.

The following is a summary of the fair value of securities with unrealized losses and an aging of those unrealized losses at December 31, 2005:

(Amounts in thousands)


	Less than 12 Months				12 Months or More				Total

	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
	Value		Losses		Value		Losses		Value		Losses

U.S. Government agencies and corporations	$	53,229	$	734	$	19,359	$	405	$	72,588	$	1,139
Obligations of states and political subdivisions		893		8		857		21		1,750		29
Mortgage-backed and related securities		33,976		522		32,556		1,024		66,532		1,546
Corporate securities		9,928		840		2,996		17		12,924		857

	$	98,026	$	2,104	$	55,768	$	1,467	$	153,794	$	3,571

The above table represents 207 investment securities where the current value is less than the related amortized cost.

The unrealized losses on the Bank’s investment in U.S. Government agencies and corporations, obligations of states and political subdivisions, and mortgage-backed and related securities were caused by interest rate increases. Accordingly, it is expected that the securities would not be settled at a price less than the amortized cost of the Bank’s investment because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold those investments until a recovery of fair value, which may be maturity. The Bank does not consider those investments to be other than temporarily impaired at December 31, 2006.

The Bank’s unrealized loss on investments in corporate securities relates to a $2,350,000 investment in the General Motors Corporation. The unrealized loss was primarily caused by (a) the decrease in profitability and profit forecasts by industry analysts resulting from intense competitive pressure in the automotive

(Continued)


18

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 2 - INVESTMENT SECURITIES (Continued)

industry and (b) a sector downgrade by industry analysts. The contractual terms of those investments do not permit General Motors Corporation to settle the security at a price less than the amortized cost of the investment. While the General Motors Corporation credit rating has decreased from A3 to Caa1 (Moodys), the Bank believes it is probable that it will be able to collect all amounts due according to the contractual terms of the investment. Therefore, it is expected that the bonds would not be settled at a price less than the amortized cost of the investment. Because the Bank has the ability and intent to hold the investments until a recovery of fair value, which may be maturity, it does not consider the investment in the General Motors Corporate notes to be other-than-temporarily impaired at December 31, 2006.

NOTE 3 - LOANS RECEIVABLE

The following is a summary of loans:

(Amounts in thousands)


		December 31,

		2006		2005

1-4 family residential mortgage loans		$	62,882	$	59,910
1-4 family residential mortgage loans held for sale			109
Commercial mortgage loans			106,160		90,983
Consumer loans			7,745		6,714
Commercial loans			17,505		19,767
Home equity loans			10,807		10,828

	Total loans	$	205,208	$	188,202

NOTE 4 - ALLOWANCE FOR LOAN LOSSES

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

(Amounts in thousands)


		December 31,

		2006			2005			2004

Balance at beginning of year		$	2,168		$	2,629		$	2,408
Loan charge-offs			(288	)		(1,119	)		(264	)
Recoveries			106			113			70

	Net loan charge-offs		(182	)		(1,006	)		(194	)
Provision charged to operations			225			545			415

Balance at end of year		$	2,211		$	2,168		$	2,629

Loans on which the accrual of interest has been discontinued because circumstances indicate that collection is questionable amounted to $3,923,000, $3,746,000 and $3,395,000 at December 31, 2006, 2005 and 2004, respectively. Interest income on these loans, if accrued, would have increased pretax income by approximately $315,000, $266,000 and $195,000 for 2006, 2005 and 2004, respectively.

Impaired loans are generally included in nonaccrual loans. Management does not individually evaluate certain smaller balance loans for impairment as such loans are evaluated on an aggregate basis. These loans generally include 1-4 family, consumer and home equity loans. Impaired loans are generally evaluated using

(Continued)


	19

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 4 - ALLOWANCE FOR LOAN LOSSES (Continued)

the fair value of collateral as the measurement method. At December 31, 2006, December 31, 2005 and December 31, 2004, the recorded investment in impaired loans was $1,939,000, $1,857,000 and $2,985,000 while the allocated portion of the allowance for loan losses for such loans was $815,000, $714,000 and $1,355,000, respectively. Interest income recognized on impaired loans using the cash basis was $44,000 for 2006, $51,000 for 2005 and $100,000 for 2004.

There were no renegotiated loans for which interest has been reduced and that are still accruing interest at December 31, 2006, December 31, 2005 and December 31, 2004.

As of December 31, 2006, 2005 and 2004, there were $13,765,000, $5,304,000 and $5,622,000 in loans that were neither classified as nonaccrual nor considered impaired, but which can be considered potential problem loans.

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

NOTE 5 - PREMISES AND EQUIPMENT

The following is a summary of premises and equipment:

(Amounts in thousands)


		December 31,

		2006		2005

Land		$	877	$	703
Premises			5,720		5,668
Equipment			7,488		9,430
Leasehold improvements			291		281
Construction in progress			349

			14,725		16,082
Less accumulated depreciation			9,945		11,994

	Net book value	$	4,780	$	4,088

Depreciation expense was $485,000 in 2006, $597,000 for 2005 and $630,000 for 2004.

(Continued)


20

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 6 - DEPOSITS

The following is a summary of interest-bearing deposits:

(Amounts in thousands)


			December 31,

			2006		2005

Demand			$	27,136	$	29,677
Money Market				19,117		17,866
Savings				79,585		86,359
Time:
	In denominations under $100,000			114,052		109,488
	In denominations of $100,000 or more			54,945		45,203

		Total	$	294,835	$	288,593

The following is a summary of time deposits of $100,000 or more by remaining maturities:

(Amounts in thousands)


		December 31,

		2006						2005

		Certificates		Other Time				Certificates		Other Time
		of Deposit		Deposits		Total		of Deposit		Deposits		Total

Three months or less		$	17,997	$		$	17,997	$	10,760	$	100	$	10,860
Three to six months			7,775		543		8,318		11,521		334		11,855
Six to twelve months			11,786		749		12,535		6,428		350		6,778
One through five years			8,219		2,087		10,306		7,195		1,647		8,842
Over five years			1,529		4,260		5,789		1,829		5,039		6,868

	Total	$	47,306	$	7,639	$	54,945	$	37,733	$	7,470	$	45,203

(Continued)


	21

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS

The following is a summary of total Federal Home Loan Bank advances and other borrowings:

(Amounts in thousands)

Weighted

Average

December 31,

Interest

Rate

2006

2005

Federal Home Loan Bank advances

Variable rate Prime based Federal Home Loan Bank advances, with monthly interest payments:

Due in 2007

5.6000

5,000

5,000

Variable rate LIBOR based Federal Home Loan Bank advances, with monthly interest payments:

Due 2009

5.3747

5,000

Due 2011

5.3719

3,000

Fixed rate payable and convertible fixed rate Federal Home Loan Bank advances, with monthly interest payments:

Due in 2006

2,000

Due in 2007

4.3952

11,500

10,000

Due in 2008

5.6340

5,000

5,000

Due in 2009

5.5600

5,000

10,000

Due in 2010

5.9293

13,500

13,500

Due in 2011

5.1850

5,000

9,500

Due in 2016

4.0700

2,000

Total Federal Home Loan Bank advances

5.3021

55,000

55,000

Other borrowings

Securities sold under repurchase agreements

4.3420

5,862

2,336

U.S. Treasury interest-bearing demand note

5.0440

1,153

775

Total other borrowings

4.4574

7,015

3,111

Total Federal Home Loan Bank advances and other borrowings

5.2065

62,015

58,111

Securities sold under repurchase agreements represent arrangements that the Bank has entered into with certain deposit customers within its local market areas. These borrowings are collateralized with securities. There are $10.7 million in securities, allocated for this purpose, owned by the Bank and held in safekeeping accounts at independent correspondent banks.

Federal Home Loan Bank (FHLB) advances are collateralized by the FHLB stock owned by the Bank, which had a carrying value of $3,355,000 at December 31, 2006, and a blanket lien against the Bank’s qualified mortgage loan portfolio, $12,413,000 in collateralized mortgage obligations and $10,415,000 in Federal Agency Securities. Maximum borrowing capacity from the FHLB totaled $59,942,000 at December 31, 2006.

As of December 31, 2006 and 2005, $28,500,000 and $38,000,000 of the FHLB fixed rate advances are convertible to quarterly LIBOR floating rate advances on or after certain specified dates at the option of the FHLB. Should the FHLB elect to convert, the Company acquires the right to prepay any or all of the borrowing at the time of conversion and on any interest payment due date, thereafter, without penalty.

(Continued)


22

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 7 - FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS (Continued)

As of December 31, 2006, $2,000,000 of the FHLB fixed rate advances are putable on or after certain specified dates at the option of the FHLB. Should the FHLB elect to exercise the put, the Company is required to pay the advance off on that date without penalty.

NOTE 8 - COMMITMENTS

The Bank occupies office facilities under operating leases extending to 2011. Most of these leases contain an option to renew at the then fair rental value for periods of five and ten years. These options enable the Bank to retain use of facilities in desirable operating areas. In most cases, management expects that in the normal course of business, leases will be renewed or replaced by other leases. Rental and lease expense was $299,000 for 2006, $295,000 for 2005 and $287,000 for 2004. The following is a summary of remaining future minimum lease payments under current noncancelable operating leases for office facilities:

(Amounts in thousands)


Years ending:
	December 31, 2007		$	182
	December 31, 2008			131
	December 31, 2009			84
	December 31, 2010			84
	December 31, 2011			44

		Total	$	525

At December 31, 2006, the Bank was required to maintain aggregate cash reserves amounting to $4,962,000 in order to satisfy federal regulatory requirements. These amounts do not earn interest.

The Bank grants commercial and industrial loans, commercial and residential mortgages, and consumer loans to customers in Northeast Ohio and Western Pennsylvania. Although the Bank has a diversified portfolio, exposure to credit loss can be adversely impacted by downturns in local economic and employment conditions. Approximately 1.94% of total loans are unsecured at December 31, 2006, compared to 3.31% at December 31, 2005.

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 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.

(Continued)


	23

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 8 - COMMITMENTS (Continued)

The following is a summary of such contractual commitments:

(Amounts in thousands)


			December 31,

			2006		2005

Financial instruments whose contract amounts represent credit risk:
	Commitments to extend credit
		Fixed rate	$	3,102	$	2,101
		Variable rate		44,422		39,180
	Standby letters of credit			1,810		1,195

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Generally these financial arrangements have fixed expiration dates or other termination clauses and may require payment of a fee. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment and income-producing commercial properties.

The Company’s subsidiary bank also offers limited overdraft protection as a non-contractual courtesy which is available to businesses as well as individually/jointly owned accounts in good standing for personal or household use. The Company reserves the right to discontinue this service without prior notice. The available amount of overdraft protection on depositors’ accounts at December 31, 2006, totaled $9,827,000. The total average daily balance of overdrafts used in 2006 was $151,000, or less than 2% of the total aggregate overdraft protection available to depositors.

NOTE 9 - BENEFIT PLANS

The Bank has a contributory defined contribution retirement plan (a 401(k) plan) which covers substantially all employees. Total expense under the plan was $229,000 for 2006, $224,000 for 2005 and $215,000 for 2004. The Bank matches participants’ voluntary contributions up to 5% of gross pay. Participants may make voluntary contributions to the plan up to a maximum of $15,000 with an additional $5,000 catchup deferral for plan participants over the age of 50. The Bank makes monthly contributions to this plan equal to amounts accrued for plan expense.

The Bank and Bancorp provide supplemental retirement benefit plans for the benefit of certain officers and non officer directors. The plan for officers is designed to provide post-retirement benefits to supplement other sources of retirement income such as social security and 401(k) benefits. The benefits will be paid for a period of 15 years after retirement. The amount of each officer’s benefit is determined by their salary at retirement as well as their other sources of retirement income. Director Retirement Agreements provide for a benefit of $10,000 annually on or after the director reaches normal retirement age, which is based on a combination of age and years of service. Director retirement benefits are paid over a period of 10 years following retirement. The Bank and Bancorp accrue the cost of these post-retirement benefits during the

(Continued)


24

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 9 - BENEFIT PLANS (Continued)

working careers of the officers and directors. At December 31, 2006, the cumulative expense accrued for these benefits totaled $1,484,000, with $1,214,000 accrued for the officers’ plan and $270,000 for the directors’ plan.

The following table reconciles the accumulated liability for the benefit obligation of these agreements:

(Amounts in thousands)


	Years Ended
	December 31,

	2006			2005

Beginning balance	$	1,283		$	996
Benefit expense		263			303
Benefit payments		(62	)		(16	)

Ending balance	$	1,484		$	1,283

Supplemental executive retirement agreements are unfunded plans and have no plan assets. The benefit obligation represents the vested net present value of future payments to individuals under the agreements. The benefit expense, as specified in the agreements for the entire year 2007, is expected to be under $300,000. The benefits expected to be paid in the next year is $62,000.

The Bank has purchased insurance contracts on the lives of the participants in the supplemental retirement benefit plan and has named the Bank as the beneficiary. Similarly, the Bancorp has purchased insurance contracts on the lives of the directors with the Bancorp as beneficiary. While no direct linkage exists between the supplemental retirement benefit plan and the life insurance contracts, it is management’s current intent that the revenue from the insurance contracts be used as a funding source for the plan. At December 31, 2006, the cumulative income accrued on these contracts totaled $2,079,000 on a tax equivalent basis, with $1,441,000 accrued on the officers’ contracts and $638,000 on the directors’ contracts.

NOTE 10 - FEDERAL INCOME TAXES

The composition of income tax expense is as follows:

(Amounts in thousands)


		Years Ended
		December 31,

		2006			2005		2004

Current		$	1,133		$	907	$	1,119
Deferred			(205	)		50		(129	)

	Total	$	928		$	957	$	990

(Continued)


	25

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 10 - FEDERAL INCOME TAXES (Continued)

The following is a summary of net deferred taxes included in other assets (liabilities):

(Amounts in thousands)


			December 31,

			2006			2005			2004

Gross deferred tax assets:
	Provision for loan and other real estate losses		$	428		$	413		$	570
	AMT credit*			47			29			29
	Other items			764			641			494
	Loan origination cost - net			103			28			6
	Unrealized loss (gain) on available for sale securities			235			452			(547	)
Gross deferred tax liabilities:
	Depreciation			(350	)		(387	)		(389	)
	Other items			(561	)		(498	)		(434	)

		Net deferred tax asset (liability)	$	666		$	678		$	(271	)


*	Represents the Company’s cumulative alternative minimum tax credit which can be carried forward indefinitely.

The following is a reconciliation between tax expense using the statutory tax rate of 34% and the income tax provision:

(Amounts in thousands)


		Years Ended
		December 31,

		2006			2005			2004

Statutory tax		$	1,871		$	1,798		$	1,983
Tax effect of non-taxable income			(909	)		(921	)		(1,084	)
Tax effect of non-deductible expense			111			80			91
Tax effect of change in estimate*			(145	)

	Total income taxes	$	928		$	957		$	990


*	A one time adjustment to tax accrual estimate was recorded in the first quarter of 2006.

The related income tax expense on investment securities gains and losses amounted to $6,000 for 2006 $105,000 for 2005 and $358,000 for 2004, and is included in the total federal income tax provision.

(Continued)


26

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 11 - FAIR VALUE OF FINANCIAL INSTRUMENTS

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

(Amounts in thousands)


	December 31, 2006				December 31, 2005

	Carrying		Estimated		Carrying		Estimated
	Amount		Fair Value		Amount		Fair Value

ASSETS:
Cash and cash equivalents	$	10,100	$	10,100	$	14,587	$	14,587
Federal Funds sold		4,275		4,275		4,650		4,650
Investment securities		233,792		232,620		234,652		234,642
Loans, net of allowance for loan losses		202,997		201,269		186,034		184,389
LIABILITIES:
Demand and savings deposits	$	186,821	$	186,821	$	195,684	$	195,684
Time deposits		168,997		169,113		154,691		154,608
FHLB advances		55,000		54,917		55,000		54,957
Other borrowings		7,015		7,015		3,111		3,111

For purposes of the above disclosures of estimated fair value, the following assumptions were used as of December 31, 2006 and 2005. The estimated fair value for cash and cash equivalents is considered to approximate cost. The estimated fair value for securities is based on quoted market values for individual securities or for equivalent securities when specific quoted prices are not available. Carrying value is considered to approximate fair value for loans, FHLB advances and other borrowings that reprice frequently and for deposit liabilities subject to immediate withdrawal. The fair values of loans, FHLB advances and other borrowings and time deposits that reprice less frequently are approximated by a discount rate valuation technique utilizing estimated market interest rates as of December 31, 2006 and 2005. The fair value of unrecorded commitments at December 31, 2006 and 2005, is not material.

In addition, other assets and liabilities of the Company that are not defined as financial instruments are not included in the above 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.

NOTE 12 - REGULATORY MATTERS

The Company is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain: (1) a minimum ratio of 4% both for total Tier I risk-based capital to risk-weighted assets and for

(Continued)


	27

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 12 - REGULATORY MATTERS (Continued)

Tier I risk-based capital to average assets, and (2) a minimum ratio of 8% for total risk-based capital to risk-weighted assets.

Under the regulatory framework for prompt corrective action, the Company is categorized as well capitalized, which requires minimum capital ratios of 10% for total risk-based capital to risk-weighted assets, 6% for Tier I risk-based capital to risk-weighted assets, and 5% for Tier I risk-based capital to average assets (also known as the leverage ratio). There are no conditions or events since the most recent communication from regulators that management believes would change the Company’s capital classification.


		(Amounts in thousands)
		December 31,					December 31,
		2006					2005

		Amount		Ratio			Amount		Ratio

Total Risk-Based Capital		$	53,151				$	51,220
	Ratio to Risk-Weighted Assets				19.93	%				21.16	%
Tier I Risk-Based Capital		$	50,913				$	49,031
	Ratio to Risk-Weighted Assets				19.09	%				20.25	%
	Ratio to Average Assets				11.04	%				11.05	%

Tier I risk-based capital is shareholders’ equity less intangibles and the unrealized market value adjustment of investment securities available for sale. Total risk-based capital is Tier I risk-based capital plus the qualifying portion of the allowance for loan losses. Assets and certain off balance sheet items adjusted in accordance with risk classification comprise risk-weighted assets of $266,686,000 and $242,106,000 as of December 31, 2006 and 2005, respectively. Assets less intangibles and the net unrealized market value adjustment of investment securities available for sale averaged $461,215,000 and $443,677,000 for the years ended December 31, 2006 and 2005, respectively.

NOTE 13 - RELATED PARTY TRANSACTIONS

Certain directors, executive officers and companies with which they are affiliated were loan customers during 2006. The following is an analysis of such loans:

(Amounts in thousands)


Total related-party loans at December 31, 2005		$	1,850
New related-party loans			148
Repayments or other			350

	Total related-party loans at December 31, 2006	$	1,648

(Continued)


28

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 14 - CONDENSED FINANCIAL INFORMATION

Below is condensed financial information of Cortland Bancorp (parent company only). In this information, the parent’s investment in subsidiaries is stated at cost, including equity in the undistributed earnings of the subsidiaries since inception, adjusted for any unrealized gains or losses on available for sale securities.

BALANCE SHEETS

(Amounts in thousands)


			December 31,

			2006			2005

Assets:
	Cash		$	2,949		$	3,102
	Investment securities available for sale			684			587
	Investment in bank subsidiary			44,638			42,435
	Investment in non-bank subsidiary			15			15
	Other assets			2,507			2,447

			$	50,793		$	48,586

Liabilities:
	Other liabilities		$	201		$	261

Shareholders’ equity:
	Common stock (Note 1)			22,972			22,523
	Additional paid-in capital (Note 1)			20,835			20,211
	Retained earnings			9,553			10,310
	Accumulated other comprehensive income			(455	)		(877	)
	Treasury stock			(2,313	)		(3,842	)

		Total shareholders’ equity		50,592			48,325

			$	50,793		$	48,586

STATEMENTS OF INCOME

(Amounts in thousands)


			Years ended December 31,

			2006			2005			2004

Dividends from bank subsidiary			$	2,800		$	3,500		$	3,500
Interest and dividend income				46			56			166
Investment securities gains										88
Other income				89			70			81
Other expenses				(283	)		(270	)		(299	)

	Income before income tax and equity in undistributed net income of subsidiaries			2,652			3,356			3,536
Income tax benefit (expense)				78			72			12
Equity in undistributed net income of subsidiaries				1,846			906			1,295

		Net income	$	4,576		$	4,334		$	4,843

(Continued)


	29

CORTLAND BANCORP AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

Years ended December 31, 2006, 2005 and 2004

NOTE 14 - CONDENSED FINANCIAL INFORMATION (Continued)

STATEMENTS OF CASH FLOWS

(Amounts in thousands)


				Years ended December 31,

				2006			2005			2004

Cash flows from operating activities
	Net income			$	4,576		$	4,334		$	4,843
	Adjustments to reconcile net income to net cash flows from operating activities:
		Equity in undistributed net income of subsidiaries			(1,846	)		(906	)		(1,295	)
		Investment securities gains									(88	)
		Accretion on securities			2			3			38
		Deferred tax benefit			(13	)		(7	)		(7	)
		Change in other assets and liabilities			(141	)		(148	)		(570	)

			Net cash flows from operating activities		2,578			3,276			2,921

Cash flows from investing activities
	Purchases of investment securities available for sale							(356	)
	Purchases of investment securities held to maturity
	Proceeds from sales of securities available for sale										2,295
	Proceeds from call, maturity and principal payments on securities							450

			Net cash flows from investing activities					94			2,295

Cash flows from financing activities
	Dividends paid				(3,870	)		(4,637	)		(4,446	)
	Net treasury shares (repurchased) reissued				1,139			1,168			262

			Net cash flows from financing activities		(2,731	)		(3,469	)		(4,184	)

	Net change in cash				(153	)		(99	)		1,032
Cash
	Beginning of year				3,102			3,201			2,169

	End of year			$	2,949		$	3,102		$	3,201

NOTE 15 - DIVIDEND RESTRICTIONS

The Bank is subject to regulations of the Ohio Division of Banks which restrict dividends to retained earnings (as defined by statute) of the current and prior two years. Under this restriction, at December 31, 2006, approximately $4,046,000 is available for the payment of dividends by the Bank without seeking prior regulatory approval. In addition, regulations specify that dividend payments may not reduce capital levels below minimum regulatory guidelines.

NOTE 16 - LITIGATION

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


30

CORTLAND BANCORP AND SUBSIDIARIES

SELECTED FINANCIAL DATA

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


		Years Ended December 31,

SUMMARY OF OPERATIONS		2006			2005			2004			2003			2002

Total Interest Income		$	26,497		$	23,586		$	22,288		$	22,907		$	26,911
Total Interest Expense			11,582			8,665			8,010			8,132			10,004

NET INTEREST INCOME (NII)			14,915			14,921			14,278			14,775			16,907
Provision for Loan Losses			225			545			415			240			460

NII After Loss Provision			14,690			14,376			13,863			14,535			16,447
Security gains (losses)			18			308			1,052			946			215
Gain on sale of loans			106			89			54			470			318
Total Other Income			2,711			2,718			2,725			2,433			2,167

INCOME BEFORE EXPENSE			17,525			17,491			17,694			18,384			19,147
Total Other Expenses			12,021			12,200			11,861			11,529			11,826

INCOME BEFORE TAX			5,504			5,291			5,833			6,855			7,321
Federal Income Tax			928			957			990			1,371			1,579

NET INCOME		$	4,576		$	4,334		$	4,843		$	5,484		$	5,742


BALANCE SHEET DATA
Assets		$	471,751		$	459,701		$	446,393		$	438,392		$	437,598
Investments			233,103			234,652			225,841			222,775			199,903
Total Loans			205,208			188,202			191,777			189,262			191,477
Allowance for loan losses			2,211			2,168			2,629			2,408			3,134
Deposits			355,818			350,375			344,919			337,556			335,758
Borrowings			62,015			58,111			47,889			47,886			46,669
Shareholders’ Equity			50,592			48,325			49,398			49,881			52,039

AVERAGE BALANCES
Assets		$	460,359		$	444,487		$	444,275		$	436,239		$	439,730
Investments			234,969			221,844			216,560			204,599			197,679
Net Loans			193,648			190,329			191,428			188,360			198,049
Deposits			348,581			341,575			343,969			335,133			336,792
Borrowings			59,251			49,932			46,093			44,905			47,518
Shareholders’ Equity			49,313			49,665			49,828			51,807			51,797

PER COMMON SHARE DATA (1)
Net Income, both Basic and Diluted		$	1.02		$	0.98		$	1.11		$	1.24		$	1.27
Cash Dividends Declared			0.86			1.05			1.02			0.99			0.96
Book Value			11.25			10.89			11.28			11.42			11.69

ASSET QUALITY RATIOS
Loans 30 days or more beyond their contractual due date as a percent of total loans			2.26	%		2.95	%		2.45	%		1.77	%		1.89	%
Underperforming Assets as a Percentage of:
	Total Assets		0.84			0.83			0.76			0.70			0.51
	Equity plus Allowance for Loan Losses		7.50			7.58			6.52			5.84			4.07
	Tier I Capital		7.78			7.81			7.05			6.44			4.62

FINANCIAL RATIOS
Return on Average Equity			9.28	%		8.73	%		9.72	%		10.59	%		11.09	%
Return on Average Assets			0.99			0.98			1.09			1.26			1.31
Effective Tax Rate			16.86			18.09			16.97			20.00			21.56
Average Equity to Average Assets			10.71			11.17			11.22			11.88			11.78
Equity to Asset Ratio			10.72			10.51			11.07			11.38			11.89
Tangible Equity to Tangible Asset Ratio			10.70			10.48			11.02			11.33			11.84
Cash Dividend Payout Ratio			84.31			107.00			91.45			79.85			74.83
Net Interest Margin Ratio			3.67			3.83			3.74			3.94			4.39

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


	31

THREE YEAR SUMMARY

AVERAGE BALANCE SHEET, YIELDS AND RATES

The following schedules show average balances of interest-earning and non interest-earning assets and liabilities, and Shareholders’ equity for the years indicated. Also shown are the related amounts of interest earned or paid and the related average yields or interest rates paid for the years indicated. The averages are based on daily balances.

(Fully taxable equivalent basis in thousands of dollars)

2006

Average

Interest

Yield

Balance

Earned

Outstanding

or Paid

Rate

Interest-earning assets:

Federal funds sold and other money markets

4,228

215

5.1

Investment securities:

U.S. Treasury and other U.S.
Government agencies and corporations

83,615

4,257

5.1

U.S. Government mortgage-backed
pass through certificates

79,317

3,795

4.8

States of the U.S. and political
subdivisions (Note 1, 2, 3)

42,409

2,995

7.1

Other securities

29,628

1,888

6.4

TOTAL INVESTMENT SECURITIES

234,969

12,935

5.5

Loans (Note 2, 3, 4)

195,838

14,381

7.4

TOTAL INTEREST-EARNING ASSETS

435,035

27,531

6.3

Non interest-earning assets:

Cash and due from banks

8,733

Premises and equipment

4,226

Other

12,365

TOTAL ASSETS

460,359

Interest-bearing liabilities:

Deposits:

Interest-bearing demand deposits

47,415

752

1.6

Savings

82,845

850

1.0

Time

161,050

6,907

4.3

TOTAL INTEREST-BEARING DEPOSITS

291,310

8,509

2.9

Borrowings:

Federal funds purchased

478

5.3

Securities sold under agreement to repurchase

3,991

158

4.0

Other borrowings under one year

7,924

365

4.6

Other borrowings over one year

46,858

2,525

5.4

TOTAL BORROWINGS

59,251

3,073

5.2

TOTAL INTEREST-BEARING LIABILITIES

350,561

11,582

3.3

Non interest-bearing liabilities:

Demand deposits

57,271

Other liabilities

3,214

Shareholders equity

49,313

TOTAL LIABILITIES AND SHAREHOLDERS EQUITY

460,359

Net interest income

15,949

Net interest rate spread (Note 5)

3.0

Net interest margin (Note 6)

3.7


Note 1 –	Includes both taxable and tax exempt securities.

Note 2 –	The amounts are presented on a fully taxable equivalent basis using the statutory tax rate of 34% in 2006, 2005 and 2004, and have been adjusted to reflect the effect of disallowed interest expense related to carrying tax exempt assets. Tax-free income from states of the U.S. and political subdivisions, and loans amounted to $2,045 and $192 for 2006, $2,156 and $209 for 2005, and $2,545 and $193 for 2004, respectively.

Note 3 –	Average balance outstanding includes the average amount outstanding of all nonaccrual investment securities and loans. States and political subdivisions consist of average total principal adjusted for amortization of premium and accretion of discount less average allowance for estimated losses, and include both taxable and tax exempt securities. Loans consist of average total loans less average unearned income.


32


(Fully taxable equivalent basis in thousands of dollars)


2005						2004

Average		Interest		Yield		Average		Interest		Yield
Balance		Earned		or		Balance		Earned		or
Outstanding		or Paid		Rate		Outstanding		or Paid		Rate



$	3,619	$	119		3.3%	$	5,623	$	83		1.5%



	67,402		3,259		4.8%		62,418		2,920		4.7%

	84,928		3,810		4.5%		85,357		3,634		4.3%

	44,756		3,184		7.1%		53,832		3,764		7.0%
	24,758		1,294		5.2%		14,953		716		4.8%

	221,844		11,547		5.2%		216,560		11,034		5.1%
	192,873		13,040		6.8%		193,927		12,474		6.4%

	418,336	$	24,706		5.9%		416,110	$	23,591		5.7%


	9,417						9,276
	4,316						4,637
	12,418						14,252

$	444,487					$	444,275


$	49,355	$	389		0.8%	$	48,945	$	263		0.5%
	89,107		647		0.7%		90,584		501		0.6%
	144,793		5,123		3.5%		147,662		5,023		3.4%

	283,255		6,159		2.2%		287,191		5,787		2.0%


	428		15		3.5%		289		4		1.4%
	2,540		59		2.3%		2,698		26		1.0%
	599		21		3.5%		2,781		37		1.3%
	46,365		2,411		5.2%		40,325		2,156		5.3%

	49,932		2,506		5.0%		46,093		2,223		4.8%

	333,187	$	8,665		2.6%		333,284	$	8,010		2.4%


	58,320						56,778
	3,315						4,385
	49,665						49,828

$	444,487					$	444,275

		$	16,041					$	15,581

					3.3%						3.3%

					3.8%						3.7%


Note 4 –	Interest earned on loans includes net loan fees of $291 in 2006, $242 in 2005 and $203 in 2004.

Note 5 –	Net interest rate spread represents the difference between the yield on earning assets and the rate paid on interest bearing liabilities.

Note 6 –	Net interest margin is calculated by dividing the difference between total interest earned and total interest expensed by total interest-earning assets.


	33

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

FINANCIAL REVIEW

The following is management’s discussion and 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; 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.

OVERVIEW and OUTLOOK

Net income for 2006 was $4,576. The performance represented an increase of $242 from the $4,334 earned in 2005. Earnings per share measured $1.02, up $0.04 or 4.1% from $0.98 in 2005.

Core earnings, which exclude the net gains on loans sold and investment securities either sold or called, loss on other real estate, and certain other non recurring items, were $4.382 million in 2006, compared to the $4.234 million earned in 2005. Core earnings per share were $0.98 in 2006 and $0.96 in 2005, up $0.02 or 2.0%.


34

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

The following is a reconciliation between core earnings and earnings under generally accepted accounting principles in the United States (GAAP earnings):


	Years Ended
	December 31,

	2006			2005

GAAP earnings	$	4,576		$	4,334
Investment security gains		(18	)		(308	)
Gain on sale of loans		(106	)		(89	)
Other real estate loss		47			3
Other non-recurring items*		(142	)		243
Tax effect of adjustments		25			51

Core earnings	$	4,382		$	4,234


*	Includes a one-time change in tax accrual estimate made in the first quarter of 2006, and a one-time cash bonus declared in the third quarter of 2005 in recognition of the Bank’s performance under the retiring C.E.O.

The Company’s net interest margin continues to be affected by a sustained flattening and subsequent inversion of the yield curve as represented by the difference between long and short term interest rates. The Company’s net interest margin, on a fully taxable equivalent basis, decreased by $92 from the preceding year, with the net interest margin ratio declining from 3.83% to 3.67%.

To mitigate the effect of this net interest margin compression the Company has continued its practice of cost containment over non-interest related expenses. Total non-interest expense decreased from $12,200 in 2005 to $12,021 in 2006, a decrease of approximately 1.47%.

As of December 31, 2006, the ratio of equity capital to total assets remained well above regulatory minimums at 10.72%, up from 10.51% a year ago. Risk-based capital measured 19.93% compared to 21.16% at December 31, 2005. All capital ratios continue to register well in excess of required regulatory minimums.

Return on average equity was 9.28% in 2006 compared to 8.73% in 2005, while the year-over-year return on average assets improved from 0.98% to 0.99%. Book value per share increased by $0.36 to $11.25. The price of the Company’s common stock traded in a range between a low of $15.74 and a high of $19.36, closing the year at $18.25 per share. Although a special cash dividend was not paid in 2006, as it had been in prior years, the Company’s dividend payout remained aggressive at 84.3% of 2006 earnings in cash dividends compared to 107.0% in the prior year. Dividends per share were $0.86 compared to $1.05 per share in 2005, which included a $0.21 per share special cash dividend.

The Company is committed to an on-going investment in technology, assuring an infrastructure that effectively delivers to consumers and small-to-medium-sized business owners leading edge financial products and services. The Company’s integrated approach to technology includes internet banking services; an Integrated Voice Response system that provides customers with remote access to banking services; platform products that enhance both productivity and customer service; and check and document-imaging products, which further capitalize on the Company’s Internet banking cash management initiative. Technology is a core ingredient for the Company, enabling it to extend services to customers beyond geographic boundaries, while increasing employee productivity. These flexible and robust product solutions also offer customers capabilities which enable them to streamline their own operations and to bank around the clock.

The Company’s Internet based banking solution, NetTeller, delivers interactive information by providing customers the following capabilities: access to account information, statement information and check imaging; on-line bill payment and electronic loan payments; and the ability to remotely transfer money between accounts and to initiate wire transfers and ACH transactions. Consumers, retail and commercial customers, alike, are offered such services 24 hours a day, 365 days a year with a high level of functionality, security and ease of operation.

The Check Clearing for the 21st Century Act, or “Check 21” as it is commonly known, became


	35

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

effective October 28, 2004. Check 21 facilitates check collection by creating a new negotiable instrument called a “substitute check,” which permits, but does not require, banks to replace original checks with substitute checks or information from the original check and process check information electronically. Banks that do use substitute checks must comply with certain notice and recredit rights. Check 21 is expected to cut the time and cost involved in physically transporting paper items and reduce float, i.e., the time between the deposit of a check in a bank and its actual payment, in those cases where items are not already being delivered same-day or overnight. The Company is utilizing the Check 21 authority, and expects to incur additional costs for technology necessary to fully realize the potential of processing check information electronically.

During 2006, the Company acquired property in the Village of Windham and is in the process of constructing a 2,500 square foot banking facility. The banking office will replace an existing leased bank location. Construction of the full service office, which is located at the intersection of Maple Grove Road and East Center Street, is expected to be completed in the Spring of 2007.

During 2006, the Company engaged a consultant to assist management and the Board of Directors in developing a Strategic Plan. The Strategic Plan, which covers the period 2007-2010, was completed in October 2006. It establishes the Company’s Mission Statement, which is “to earn the enthusiastic, long-term loyalty of customers by being responsive to their needs for products, convenience and personal service in a manner that routinely exceeds expectations.” Several strategic initiatives are expected to be implemented during 2007, and will require a relentless focus on identifying and meeting the wants and needs of our customers, shareholders and the communities in which we operate. Incremental noninterest expenses in 2007 will be required to implement these strategic initiatives, with benefits accruing primarily to subsequent years.

BALANCE SHEET COMPOSITION

The following table illustrates, during the years presented, the mix of the Company’s funding sources and the assets in which those funds are invested as a percentage of the Company’s average total assets for the period indicated. Average assets totaled $460,359 in 2006 compared to $444,487 in 2005 and $444,275 in 2004.


				2006			2005			2004

Sources of Funds:
	Deposits:
		Non-interest-bearing			12.4	%		13.1	%		12.8	%
		Interest-bearing			63.3			63.7			64.6
	Federal funds purchased and repurchase agreements				1.0			0.7			0.7
	Long-term debt and other borrowings				11.9			10.6			9.7
	Other non-interest-bearing liabilities				0.7			0.7			1.0
	Equity capital				10.7			11.2			11.2

			Total		100.0	%		100.0	%		100.0	%

Uses of Funds:
	Loans				42.6	%		43.4	%		43.7	%
	Securities				51.0			49.9			48.7
	Federal funds sold, and other money market instruments				0.9			0.8			1.3
	Bank owned life insurance				2.5			2.5			2.3
	Other non-interest-earning assets				3.0			3.4			4.0

			Total		100	%		100.0	%		100.0	%

Deposits continue to be the Company’s primary source of funding. During 2006, the relative mix of deposits has remained steady with interest-bearing being the main source. Average non-interest bearing deposits totaled 16.4% of total average deposits in 2006 compared to 17.1% in 2005 and 16.5% in 2004. (Also see section captioned “Deposits” included elsewhere in this discussion.)

The Company primarily invests funds in loans and securities. Securities have been the largest component of the Company’s mix of invested assets. During 2006 average securities increased by $13,125 or 5.9%, while average loans increased by $2,965 or 1.5%.

The Company has also purchased bank owned life insurance policies on the lives of directors, certain employees and key members of management in conjunction with the Company’s benefit plans. The average balance increased from $10,336 in 2004 to $11,500 in 2006, reflecting the purchase of additional policies and the buildup of cash surrender


36

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

value. (See additional information regarding the Company’s loan and securities portfolio in the sections captioned “Loan Portfolio” and “Investment Securities” included elsewhere in this discussion.)

ASSET QUALITY

The Company’s management regularly monitors and evaluates trends and developments in asset quality. Loan review systems require detailed monthly analysis of delinquencies, nonperforming assets and other sensitive credits. Mortgage, commercial and consumer loans are moved to nonaccrual status once they reach 90 days past due or when analysis of a borrower’s creditworthiness indicates the collection of interest and principal is in doubt.

In addition to nonperforming loans, total nonperforming assets include nonperforming investment securities and real estate acquired in satisfaction of debts previously contracted. Total underperforming assets add to this amount loans which have been restructured to provide for a reduction of interest or principal because of a deterioration in the financial condition of the borrower. Also included as underperforming assets are loans which are more than 89 days past due that continue to accrue interest income. The following table depicts the trend in these potentially problematic asset categories.


		2006		2005		2004		2003		2002

Nonaccrual loans:
	1-4 residential mortgages	$	887	$	719	$	661	$	529	$	474
	Commercial mortgages		2,497		2,472		2,734		1,538		600
	Commercial loans		188		210						327
	Consumer loans		129		41						5
	Home equity loans		222		304

Total Nonaccrual Loans			3,923		3,746		3,395		2,067		1,406
Other real estate owned			35		82				986		811

Nonperforming Assets			3,958		3,828		3,395		3,053		2,217
Restructured loans											26

Underperforming Assets		$	3,958	$	3,828	$	3,395	$	3,053	$	2,243

The following table provides a number of asset quality ratios based on this data. Overall, asset quality reflected the cumulative effects of a general economic weakness evidenced since 2002 in the local area markets where the Company operates, but remained within limits that management considers acceptable.


	2006		2005		2004		2003		2002

Nonperforming loans as a percentage of total loans		1.91%		1.99%		1.77%		1.09%		0.73%
Nonperforming assets as a percentage of total assets		0.84%		0.83%		0.76%		0.70%		0.51%
Underperforming assets as a percentage of total assets		0.84%		0.83%		0.76%		0.70%		0.51%
Underperforming assets as a percentage of equity capital plus allowance for loan losses		7.50%		7.58%		6.52%		5.84%		4.07%

Gross income that would have been recorded in 2006 on these loans, had they been in compliance with their original terms, was $398. Interest income that actually was included in income on these loans amounted to $83.

Additionally, as part of the Company’s loan review process, management seeks to evaluate potential risks which could potentially affect the ability to collect loan balances in their entirety. Reviews of individual credits as well as any concentration of credits in particular industries are subject to a detailed loan review.

RESULTS OF OPERATIONS

Analysis of Net Interest Income Years Ended December 31, 2006 and 2005

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. The net interest margin ratio registered 3.67% in 2006, 3.83% in 2005, and 3.74% in 2004.

Compression in the Company’s net interest margin resulted from a sustained flattening and subsequent inversion of the yield curve and, in part, from an increased level of nonperforming assets which has occurred over the past three years.


	37

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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


		NET INTEREST MARGIN FOR YEAR ENDED

		December 31, 2006						December 31, 2005

		Average				Average		Average				Average
		Balance(1)		Interest		Rate		Balance(1)		Interest		Rate

INTEREST-EARNING ASSETS
	Federal funds sold and other money market funds	$	4,228	$	215		5.1%	$	3,619	$	119		3.3%
	Investment securities(1)(2)		234,969		12,935		5.5%		221,844		11,547		5.2%
	Loans(2)(3)		195,838		14,381		7.4%		192,873		13,040		6.8%

Total interest-earning assets		$	435,035	$	27,531		6.3%	$	418,336	$	24,706		5.9%

INTEREST-BEARING LIABILITIES
	Interest-bearing demand deposits	$	47,415	$	752		1.6%	$	49,355	$	389		0.8%
	Savings		82,845		850		1.0%		89,107		647		0.7%
	Time		161,050		6,907		4.3%		144,793		5,123		3.5%

Total interest-bearing deposits			291,310		8,509		2.9%		283,255		6,159		2.2%
	Federal funds purchased		478		25		5.3%		428		15		3.5%
	Other borrowings		58,773		3,048		5.2%		49,504		2,491		5.0%

Total interest-bearing liabilities		$	350,561	$	11,582		3.3%	$	333,187	$	8,665		2.6%

Net interest income				$	15,949					$	16,041

Net interest rate spread(4)							3.0%						3.3%

Net interest margin(5)							3.7%						3.8%

(1) Includes both taxable and tax exempt securities.


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

(3)	Includes loan origination and commitment fees.

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


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

The increase in interest income was the product of a 4.0% year-over-year increase in average earning assets and a 43 basis point increase in interest rates earned, while the increase in interest expense was a product of a 5.2% increase in interest-bearing liabilities and a 70 basis point increase in rates paid. The net result was a 0.6% decrease in net interest income on a fully tax equivalent basis and a 16 basis point decrease in the net interest margin.

Interest and dividend income on securities registered an increase of $1,465, or 13.9%, during the year ended December 31, 2006 when compared to 2005. On a fully tax equivalent basis, income on investment securities increased by $1,388, or 12.0%. The average invested balances increased by $13,125 from the levels of a year ago. The increase in the average balance of investment securities was accompanied by a 30 basis point increase in the tax equivalent yield of the portfolio.

Interest and fees on loans increased by $1,341 on a fully tax equivalent basis, or 10.3%, for the twelve months of 2006 compared to 2005. A $2,965 increase in the average balance of the loan portfolio, or 1.5%, was accompanied by a 60 basis point increase in the portfolio’s tax equivalent yield. Also contributing to the increase in loan income in 2006 was $185 in back interest and loan fees collected on three loans which had been in foreclosure.

Other interest income increased by $96 from the same period a year ago. The average balance of federal funds sold and other money market funds increased by $609, or 16.8%. The yield increased by 180 basis points during 2006 compared to 2005.

Average interest-bearing demand deposits and money market accounts decreased by $1,940, and savings decreased by $6,262. The average rate paid on these products increased by 48 basis points in the aggregate. The average balance on time deposit products increased by $16,257, as the average rate paid increased by 75 basis points, from 3.5% to 4.3%.

Compared to last year, average borrowings and federal funds purchased increased by $9,319 while the average rate paid on borrowings increased by 17 basis points.


38

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

Analysis of Net Interest Income — Years Ended December 31, 2005 and 2004


		NET INTEREST MARGIN FOR YEAR ENDED

		December 31, 2005						December 31, 2004

		Average				Average		Average				Average
		Balance(1)		Interest		Rate		Balance(1)		Interest		Rate

INTEREST-EARNING ASSETS
	Federal funds sold and other money market funds	$	3,619	$	119		3.3%	$	5,623	$	83		1.5%
	Investment securities(1)(2)		221,844		11,547		5.2%		216,560		11,034		5.1%
	Loans(2)(3)		192,873		13,040		6.8%		193,927		12,474		6.4%

Total interest-earning assets		$	418,336	$	24,706		5.9%	$	416,110	$	23,591		5.7%

INTEREST-BEARING LIABILITIES
	Interest-bearing demand deposits	$	49,355	$	389		0.8%	$	48,945	$	263		0.5%
	Savings		89,107		647		0.7%		90,584		501		0.6%
	Time		144,793		5,123		3.5%		147,662		5,023		3.4%

Total interest-bearing deposits			283,255		6,159		2.2%		287,191		5,787		2.0%
	Federal funds purchased		428		15		3.5%		289		4		1.4%
	Other borrowings		49,504		2,491		5.0%		45,804		2,219		4.8%

Total interest-bearing liabilities		$	333,187	$	8,665		2.6%	$	333,284	$	8,010		2.4%

Net interest income				$	16,041					$	15,581

Net interest rate spread(4)							3.3%						3.3%

Net interest margin(5)							3.8%						3.7%

(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.

The increase in net interest income was the product of a 0.5% year-over-year increase in average earning assets and a 24 basis point increase in interest rates earned.

Interest and dividend income on securities registered an increase of $704, or 7.2%, during the year ended December 31, 2005 when compared to 2004. On a fully tax equivalent basis, income on investment securities increased by $513, or 4.6%. The average invested balances increased by $5,284 from the levels of a year ago. The increase in the average balance of investment securities was accompanied by an 11 basis point increase in the tax equivalent yield of the portfolio.

Interest and fees on loans increased by $566 on a fully tax equivalent basis, or 4.5%, for the twelve months of 2005 compared to 2004. A $1,054 decrease in the average balance of the loan portfolio, or 0.5%, was accompanied by a 33 basis point increase in the portfolio’s tax equivalent yield.

Other interest income increased by $36 from the same period a year ago. The average balance of Federal Funds sold and other money market funds decreased by $2,004, or 35.6%. The yield increased by 181 basis points during 2005 compared to 2004.

Average interest-bearing demand deposits and money market accounts increased by $410, while savings decreased by $1,477. The average rate paid on these products increased by 20 basis points in the aggregate. The average balance on time deposit products decreased by $2,869, as the average rate paid increased by 14 basis points, from 3.4% to 3.5%.

The average rate paid on interest sensitive liabilities increased by 20 basis points year-over-year. The average balance of interest sensitive liabilities decreased by only $97. Compared to last year, average borrowings increased by $3,839 while the average rate paid on borrowings increased by 20 basis points.


	39

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

The following table provides a detailed analysis of changes in net interest income, identifying that portion of the change that is due to a change in the volume of average assets and liabilities outstanding versus that portion which is due to a change in the average yields on earning assets and average rates on interest-bearing liabilities. Changes in interest due to both rate and volume which cannot be segregated have been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Analysis of Net Interest Income Changes (Taxable Equivalent Basis)


			2006 Compared to 2005									2005 Compared to 2004
				Volume			Rate			Total			Volume			Rate			Total

Increase (Decrease) in Interest Income:
	Federal funds sold and other money markets		$	23		$	73		$	96		$	(38	)	$	74		$	36
	Investment Securities
		U.S. Treasury and other U.S. Government agencies and corporations		818			180			998			239			100			339
		U.S. Government mortgage-backed pass-through certificates		(260	)		245			(15	)		(18	)		194			176
		States of the U.S. and political subdivisions		(166	)		(23	)		(189	)		(645	)		65			(580	)
		Other securities		281			313			594			507			71			578
	Loans			203			1,138			1,341			(68	)		634			566

Total Interest Income Change				899			1,926			2,825			(23	)		1,138			1,115

Increase (Decrease) in Interest Expense:
	Interest-bearing demand deposits			(16	)		379			363			2			124			126
	Savings deposits			(48	)		251			203			(8	)		154			146
	Time deposits			617			1,167			1,784			(99	)		199			100
	Federal funds purchased			2			8			10			3			8			11
	Securities sold under agreements to repurchase			44			55			99			(1	)		34			33
	Other borrowings under one year			335			9			344			(44	)		28			(16	)
	Other borrowings over one year			26			88			114			315			(60	)		255

Total Interest Expense Change				960			1,957			2,917			168			487			655

Increase (Decrease) in Net Interest Income on a Taxable Equivalent Basis			$	(61	)	$	(31	)	$	(92	)	$	(191	)	$	651		$	460


40

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

Analysis of Other Income, Other Expense and Federal Income Tax

Total other income for 2006 decreased $280, or 9.0% compared to a decrease of $716, or 18.7% in 2005. Fees for customer services decreased by $15, or 0.7%, compared to a decrease of $73 in the prior year. The decrease is primarily due to a decline in service charge income.

Loans originated for sale in the secondary market showed gains of $106 in 2006, compared to $89 and $54 in 2005 and 2004, respectively. The early call of held to maturity securities, and transactions involving available for sale securities, combined to produce net gains of $18 in 2006, $308 in 2005 and $1,052 in 2004.

Other real estate losses amounted to $47 in 2006, $3 in 2005 and $171 in 2004. Earnings on bank owned life insurance showed an increase of $92 in 2006 compared to a decrease of $103 in 2005. Other non-interest income decreased by $40 during 2006 following a $1 increase in 2005. This income category is subject to fluctuation due to nonrecurring items.


Other Income
		2006			2005			2004

Fees for other customer services	$	2,239		$	2,254		$	2,327
Gain on sale of loans		106			89			54
Other real estate losses		(47	)		(3	)		(171	)
Earnings on bank owned life insurance		433			341			444
Other operating income		86			126			125

		2,817			2,807			2,779
Investment securities net gains		18			308			1,052

Total other income	$	2,835		$	3,115		$	3,831

Total other expenses decreased by $179 or 1.5% in 2006. This compares to an increase of $339 or 2.9% in 2005. During 2006, expenditures for salaries and employee benefits decreased by $276 or 3.9%, compared to an increase of $330 or 4.9% in 2005. This is due mainly to a one time cash bonus of $243 awarded to the retiring President and CEO in 2005. Occupancy and equipment expense decreased by $59, or 3.2%, during 2006 and increased by $17, or 0.9%, in 2005. The decrease in 2006 is due mainly to a $112 decrease in depreciation expense as some assets became fully depreciated, and a $36 increase in equipment and building maintenance.

State and local taxes stayed fairly consistent from 2004 to 2006. Bank exam and audit expense increased by $59 or 13.8% in 2006 following a decrease of $88 or 17.1% in 2005 primarily due to expenses associated with the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. All other categories of non-interest expense increased by $93 in 2006 following an increase of $76 in 2005. This expense category is subject to fluctuation due to non-recurring items. The increase in 2006 is due partly to an increase in collection and foreclosure expense of $41, a one-time sundry charge-off of $22, and a $29 increase in office supplies expense.


Non-Interest Expense
		2006		2005		2004

Salaries and benefits	$	6,776	$	7,052	$	6,722
Net occupancy and equipment expense		1,811		1,870		1,853
State and local taxes		552		548		544
Office supplies		367		338		346
Bank exam and audit		486		427		515
Other operating expense		2,029		1,965		1,881

Total other expenses	$	12,021	$	12,200	$	11,861


	41

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

Salaries and employee benefits represented 56.4% of all non-interest expenses in 2006, 57.8% in 2005 and 56.7% in 2004. Salaries and employee benefits decreased by $276 in 2006 following an increase of $330 in 2005. The following details components of these increases:


	Analysis of Changes in Salaries & Benefits
	Amounts											Percent

		2006			2005			2004		2006			2005		2004

Salaries	$	(176	)	$	317		$	(28	)	(3.2	)%		6.1	%	(1.14	)%
Benefits		(77	)		(29	)		85		(4.6	)		(1.7	)	5.2

		(253	)		288			57		(3.5	)		4.2		0.8
Def’d Loan Origination		(23	)		42			79		(16.7	)		23.3		30.5

	$	(276	)	$	330		$	136		(3.9	)		4.9	%	2.1	%

Wage and salary expense per employee averaged $33,063 in 2006, $33,942 in 2005 and $31,981 in 2004. Excluding the one-time retirement bonus, the average per employee would have been $32,444 in 2005. Full-time equivalent employment averaged 161 employees in 2006 and 162 employees in 2005 and 2004. Average earning assets per employee measured $2,702 in 2006 and $2,582 in 2005, $2,569 in 2004.

Income before income tax expense amounted to $5,504 for the year ended 2006 compared to $5,291 and $5,833 for the similar periods of 2005 and 2004, respectively. The effective tax rate was 16.9% in 2006 compared to 18.1% and 17.0% in 2005 and 2004, respectively, resulting in income tax expenses of $928, $957 and $990, 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 19.5%. This would be an increase from prior years because of a reduction in tax free income. 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:


	December 31,

	2006			2005			2004

Provision at statutory rate	$	1,871		$	1,798		$	1,983
Add (Deduct):
Tax effect of non-taxable income		(909	)		(921	)		(1,084	)
Tax effect of non-deductible expense		111			80			91
Tax effect of change in estimate*		(145	)

Federal income taxes	$	928		$	957		$	990


*	One time adjustment to tax accrual estimate

Net income registered $4,576 in 2006 compared to $4,334 in 2005 and $4,843 in 2004, representing per share amounts of $1.02 in 2006, $0.98 in 2005 and $1.11 in 2004. Dividends declared per share were $0.86 in 2006, $1.05 in 2005 and $1.02 in 2004. The decrease in 2006 is due to elimination of the special dividend. Per share amounts have been restated to give retroactive effect to the 2% common stock dividend of January 1, 2007.


42

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

FOURTH QUARTER 2006 AS
COMPARED TO FOURTH QUARTER 2005


	NET INTEREST MARGIN FOR QUARTER ENDED

	December 31, 2006						December 31, 2005

	Average				Average		Average				Average
	Balance(1)		Interest		Rate		Balance(1)		Interest		Rate
(Unaudited)
INTEREST-EARNING ASSETS
Federal funds sold and other money market funds	$	9,882	$	132		5.3%	$	4,409	$	44		3.9%
Investment securities(1)(2)		231,009		3,231		5.6%		232,498		3,104		5.3%
Loans(2)(3)		202,709		3,773		7.3%		190,592		3,340		7.0%

Total interest-earning assets	$	443,600	$	7,136		6.4%	$	427,499	$	6,488		6.1%

INTEREST-BEARING LIABILITIES
Interest-bearing demand deposits	$	48,286	$	225		1.9%	$	50,587	$	136		1.1%
Savings		80,207		207		1.0%		86,974		209		1.0%
Time		169,222		1,942		4.6%		148,925		1,398		3.7%

Total interest-bearing deposits		297,715		2,374		3.2%		286,486		1,743		2.4%

Federal funds purchased						%		644		7		4.2%
Other borrowings		59,795		792		5.2%		54,642		689		5.0%

Total interest-bearing liabilities	$	357,510	$	3,166		3.5%	$	341,772	$	2,439		2.8%

Net interest income			$	3,970					$	4,049

Net interest rate spread(4)						2.9%						3.3%

Net interest margin(5)						3.5%						3.8%


(1)	Includes both taxable and tax exempt securities.

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

(3)	Includes loan origination and commitment fees.

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

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

Tax equivalent net interest income for the Company during the fourth quarter of 2006 decreased by $79, a 2.0% decrease from the fourth quarter of 2005. The yield on earning assets increased by 33 basis points while fourth quarter average earning assets increased by 3.8%, or $16,101, when compared to a year ago. This was due partly to $60 in back interest realized in the fourth quarter of 2006 on a loan which had been in foreclosure. The result was an increase in tax equivalent interest income of $648. The rate paid on interest-bearing liabilities increased by 68 basis points, while fourth quarter average interest-bearing liabilities increased by $15,738 when compared to a year ago, resulting in an increase in total interest expense of $727. The net interest margin for the quarter registered 3.55%, down 24 basis points from the same quarter a year ago.


	43

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

The following table shows financial results by quarter for the years ending December 31, 2006 and 2005:

FINANCIAL RESULTS BY QUARTER

(Unaudited)


	2006												2005

	For the Quarter Ended												For the Quarter Ended

	Dec. 31			Sept. 30			June 30			March 31			Dec. 31			Sept. 30			June 30			March 31

Interest Income	$	6,889		$	6,796		$	6,493		$	6,319		$	6,212		$	5,884		$	5,829		$	5,661
Interest Expense		3,166			2,980			2,783			2,653			2,439			2,197			2,024			2,005

Net Interest Income		3,723			3,816			3,710			3,666			3,773			3,687			3,805			3,656
Loan Loss Provision		(50	)		(45	)		(64	)		(66	)		(135	)		(160	)		(138	)		(112	)
Net Security Gains								18									4			2			302
Net Gain on Loans		37			13			42			14			30			28			22			9
Other real estate losses		(12	)		(7	)		(28	)					(3	)
Other Income		747			703			700			608			665			700			677			679
Other Expenses		(2,962	)		(3,041	)		(3,049	)		(2,969	)		(2,990	)		(3,288	)		(2,972	)		(2,950	)

Income Before Tax		1,483			1,439			1,329			1,253			1,340			971			1,396			1,584
Federal Income Tax		301			296			253			78			247			120			264			326

Net Income	$	1,182		$	1,143		$	1,076		$	1,175		$	1,093		$	851		$	1,132		$	1,258
Net Income Per Share	$	0.26		$	0.26		$	0.24		$	0.26		$	0.25		$	0.19		$	0.26		$	0.28
Net Core Income	$	1,166		$	1,139		$	1,057		$	1,020		$	1,075		$	990		$	1,116		$	1,053
Net Core Income Per Share	$	0.26		$	0.25		$	0.24		$	0.23		$	0.24		$	0.22		$	0.26		$	0.24
Net Interest Income (fully taxable equivalent basis)	$	3,970		$	4,067		$	3,973		$	3,939		$	4,049		$	3,964		$	4,088		$	3,940
Net Interest Rate Spread		2.9%			3.1%			3.0%			3.1%			3.3%			3.3%			3.4%			3.2%
Net Interest Margin		3.5%			3.7%			3.7%			3.7%			3.8%			3.8%			3.9%			3.8%

Loan charge-offs during the quarter were $67 in 2006 compared to $185 in 2005, while the recovery of previously charged-off loans amounted to $19 during the fourth quarter of 2006 compared to $14 in the same period of 2005. The Company’s provision for loan losses during the quarter was $50 compared to $135 a year ago.

Other income increased by $82 from a year ago, due primarily to an increase in service charge income of $32 and a $55 increase in non-taxable income on bank owned life insurance policies, reflecting increases in the investment yields associated with these policies. The net gain on loans sold during the quarter amounted to $37, compared to $30 a year ago. Loss on the sale of other real estate increased from $3 in 2005 to $12 in 2006.

Total other non-interest expenses in the fourth quarter were $2,962 in 2006 compared to $2,990 in 2005, a decrease of $28 or 0.9%. Salaries and benefits constituted a $34 decrease, or 2.0%. Bank exam and audit fees decreased by $14 or 10.4% mainly due to the timing of expenses associated with the implementation of the requirements of Section 404 of the Sarbanes-Oxley Act of 2002. Other expenses increased by $20 or 1.8%.

Income before income tax during the fourth quarter amounted to $1,483 in 2006 compared to $1,340 in 2005. Income tax expense for the fourth quarter of 2006 was $301 as compared to $247 in 2005. Fourth quarter net income was $1,182 in 2006 compared to $1,093 in 2005, representing an increase of $89, or 8.1%.

Earnings per share for the fourth quarter, adjusted for the 2% stock dividend paid January 1, 2007, were $0.26 in 2006 and $0.25 in 2005.

Core earnings (earnings before gains on loans sold, investment securities sold or called and certain other non recurring items) increased by 8.5% in the fourth quarter of 2006 compared to 2005. Core earnings for the fourth quarter of 2006 were $1,166 compared to last year’s $1,075. Core earnings per share were $0.26 in 2006 and $0.24 in 2005. The


44

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

following is a reconciliation between core earnings and earnings under generally accepted accounting principles in the United States (GAAP earnings):


	Three Months Ended
	December 31,

	2006			2005

GAAP Earnings	$	1,182		$	1,093
Gain on sale of loans		(37	)		(30	)
Other real estate loss		12			3
Tax effect of adjustments		9			9

Core Earnings	$	1,166		$	1,075

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


	Three		Twelve
	Months		Months
	December 31,		December 31,
	2006		2006

Proceeds on securities sold or called	$	40	$	1,526
Gross realized gains				18
Gross realized losses

LOAN LOSS EXPERIENCE

For each year presented in the table on the following page, the provision for loan losses charged to operations is based on management’s judgment after taking into consideration all known factors connected with the collectability 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 cashflow 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.

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.


	45

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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


		2006			2005			2004			2003			2002

Balance at beginning of year		$	2,168		$	2,629		$	2,408		$	3,134		$	2,998
Loan losses:
	1-4 family residential mortgages		(29	)		(87	)		(80	)		(101	)		(97	)
	Commercial mortgages		(20	)		(734	)		(108	)		(589	)
	Consumer and other loans		(199	)		(203	)		(66	)		(160	)		(157	)
	Commercial loans		(40	)		(89	)		(10	)		(270	)		(187	)
	Home equity loans					(6	)

			(288	)		(1,119	)		(264	)		(1,120	)		(441	)

Recoveries on previous loan losses:
	1-4 family residential mortgages
	Commercial mortgages											40
	Consumer and other loans		99			100			65			108			93
	Commercial loans		7			13			5			6			24
	Home equity loans

			106			113			70			154			117

Net loan losses			(182	)		(1,006	)		(194	)		(966	)		(324	)

Provision charged to operations			225			545			415			240			460

Balance at end of year		$	2,211		$	2,168		$	2,629		$	2,408		$	3,134

Ratio of net loan losses to average net loans outstanding			0.09%			0.53%			0.10%			0.51%			0.16%

Ratio of loan loss allowance to total loans			1.08%			1.15%			1.37%			1.27%			1.64%

The spike in charge-offs during 2005 and 2003 primarily reflected certain impaired commercial loan credits for which specific loss reserves had previously been established. Based on its analysis and review of all known factors, management has determined the current level of the allowance to be adequate.

The following is an allocation of the allowance for loan losses. The allowance has been allocated according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within the following categories of loans as of December 31, for the years indicated:


	2006		2005		2004		2003		2002

Types of Loans
1-4 family residential mortgages	$	209	$	243	$	265	$	241	$	370
Commercial mortgages		1,441		1,397		1,808		1,932		2,239
Consumer loans		183		160		50		58		109
Commercial loans		376		364		505		176		393
Home equity loans		2		4		1		1		23

	$	2,211	$	2,168	$	2,629	$	2,408	$	3,134

The allocations of the allowance as shown in the table above should not be interpreted as an indication that future loan losses will occur in the same proportions or that the allocations indicate future loan loss trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories since the total allowance is applicable to the entire portfolio.


46

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

LOAN PORTFOLIO

The following table represents the composition of the loan portfolio as of December 31, for the years indicated:


	2006				2005				2004				2003				2002

	Balance		%		Balance		%		Balance		%		Balance		%		Balance		%
Types of Loans
1-4 family residential mortgages	$	62,882		30.6	$	59,910		31.8	$	61,238		31.9	$	57,854		30.6	$	62,365		32.6
Commercial mortgages		106,160		51.7		90,983		48.3		94,019		49.0		92,822		49.0		86,929		45.4
Consumer loans		7,745		3.8		6,714		3.6		6,087		3.2		7,231		3.8		9,792		5.1
Commercial loans		17,505		8.5		19,767		10.5		19,188		10.0		21,711		11.5		22,016		11.5
Home equity loans		10,807		5.3		10,828		5.8		11,245		5.9		9,541		5.0		8,353		4.4
1-4 family residential loans held for sale		109		0.1										103		0.1		2,022		1.0

Total loans	$	205,208			$	188,202			$	191,777			$	189,262			$	191,477

The following schedule sets forth maturities based on remaining scheduled repayments of principal or next repricing opportunity for loans (excluding mortgage and consumer loans) as of December 31, 2006:

1 Year

1 to

Over

or Less

5 Years

Total

Types of Loans

Commercial loans

6,834

4,753

5,918

17,505

Home Equity

10,807

Total loans (excluding mortgage and consumer loans)

17,641

4,753

5,918

28,312

The following schedule sets forth loans as of December 31, 2006 based on next repricing opportunity for floating and adjustable interest rate products, and by remaining scheduled principal payments for loan products with fixed rates of interest. Mortgage and consumer loans have again been excluded.

1 Year

Over

or Less

1 Year

Total

Types of Loans

Floating or adjustable rates of interest

17,077

730

17,807

Fixed rates of interest

564

9,941

10,505

Total loans

17,641

10,671

28,312


	47

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

The Company recorded an increase of $17,006 in the loan portfolio from the level of $188,202 recorded at December 31, 2005.

Between 2005 and 2006, the balance of residential mortgage loans remained relatively unchanged. 1-4 family residential mortgages represent 30.7% of total loans in the loan portfolio compared to 31.8% in 2005. The portion of the loan portfolio represented by commercial loans (including commercial real estate) increased from 58.8% in 2005 to 60.2%. Consumer loans (including home equity loans) decreased from 9.4% in 2005 to 9.1%.

Real estate loans which include residential loans and commercial loans continue to comprise the largest share of the Company’s loan portfolio. At the end of 2006, residential loans and commercial loans comprised a combined 90.9% of the portfolio, compared to 89.0% five years ago. Home equity loans at 5.3% and consumer installment at 3.8% comprise the remainder of the portfolio in 2006. Five years ago in 2001, home equity loans comprised 3.8% of the overall loan portfolio, while consumer installment loans comprised 7.2%.

During 2006, approximately $15,200 in new mortgage loans were originated by the Company, an increase of $1,000 from 2005. The Company’s product offerings continue to include a service release sales program, which permits the Company to offer competitive long-term fixed interest rates without incurring additional credit or interest rate risk.

The following shows the disposition of mortgage loans originated during 2006 and 2005 (in millions):


	2006		2005

Retained in Portfolio	$	8.3	$	7.6
Loans Sold to Investors with Servicing Rights Released	$	6.9	$	6.6

During 2006, the Company originated and retained in portfolio a larger percentage of residential mortgage loans than it sold in the secondary market. These retained loans met the Company’s asset quality criteria. Although management anticipates that secondary market originations will continue as an important aspect of loan administration, loans which are retained by the Bank portfolio will become more predominant as portfolio lending strategies are developed to enhance overall customer relationships.

The Bank is also active in home equity financing. Home Equity term loans and credit lines remain popular with consumers wishing to finance home improvements, educational costs, vacations and consumer goods purchased at favorable interest rates.

In order to improve customer retention and provide better overall balance, management also will continue to revamp and reposition the Company’s In-Portfolio product offerings during 2007.

The balance of the commercial loan portfolio as of December 31, 2006 was $123,700, an increase of $12,900 from the balance of $110,800 recorded at December 31, 2005. Short term, asset based, commercial loans including lines of credit decreased by $2,300. Commercial real estate loans increased by $15,200 during the same period. The increase in these loans has primarily resulted from a marketing campaign designed to increase market share for commercial and small business loans secured by real estate.

Management is expanding commercial real estate product offerings in an effort to establish new business relationships and capture additional market share. Loan personnel will continue to aggressively pursue both commercial and small business opportunities supported by product incentives and


48

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

marketing efforts. The Bank’s lending function continues to provide business services to a wide array of medium and small businesses, including but not limited to commercial and residential real estate builders, automobile dealers, manufacturers, trucking companies, nursing homes, physicians and medical groups, funeral homes, general contractors, service contractors, restaurants, hotels/motels, retailers, wholesalers, as well as area educational institutions and other political subdivisions. For those businesses electing to finance business assets through a lease instrument the Bank also offers lease financing through a third party vendor.

Small business loans are originated by loan personnel assigned to the Community Bank offices. These loans are processed in accordance with established business loan underwriting standards and practices.

The following table provides an overview of commercial loans by various business sectors reflecting the areas of largest concentration. It should be noted that these are open balances and do not reflect existing commitments that may be currently outstanding but unfunded.

Commercial Loan Concentrations

2006

2005

% of

% of

Sector

Balances

Portfolio

Balances

Portfolio

Non Residential Building/ Apartment Building

17.963

14.82%

8,534

7.76%

Hotels/Motels

12,374

10.21%

15,005

13.65%

Real Property Lessors

8,315

6.86%

8,155

7.42%

Eating Places

7,575

6.25%

5,669

5.16%

Steel Related Industries

5,200

4.29%

5,317

4.84%

Trucking and Courier Services

4,722

3.90%

3,506

3.19%

The single largest customer balance at year end had a balance of $4,900 in 2006 compared to $4,500 in 2005. This balance represented approximately 4.0% of the total commercial portfolio, compared to 4.1% in 2005.

In the consumer lending area, the Company provides financing for a variety of consumer purchases: fixed rate amortizing mortgage products that consumers utilize for home improvements; the purchase of consumer goods of all types; education, travel and other personal expenditures. The consolidation of credit card and other existing debt into term payout continues to remain a popular financing option among consumers.

Additional information regarding the loan portfolio can be found in the Notes to the Consolidated Financial Statements (NOTES 1, 3, 8, 11 and 13).

INVESTMENT SECURITIES

In accordance with Statement of Financial Accounting Standards No. 115 (SFAS 115), “Accounting for Certain Investments in Debt and Equity Securities,” investment securities are segregated into three separate portfolios: held to maturity, available for sale, and trading. Each portfolio type has its own method of accounting.

Held to maturity securities are recorded at historical cost, adjusted for amortization of premiums and accretion of discounts. Trading securities are marked-to-market, with any gain or loss reflected in the determination of income. Securities designated as available for sale are similarly carried at their fair market value. However, any unrealized gain or loss (net of tax) is recorded as an adjustment to shareholders’ equity as a component of Other Comprehensive Income.

One effect of SFAS 115 is to expose shareholders’ equity to fluctuations resulting from market volatility related to the available for sale portfolio. The potential adverse impact of this volatility is somewhat mitigated as bank regulatory agencies measure capital adequacy for regulatory purposes without regard to the effects of SFAS 115.

Securities designated by the Company as held to maturity tend to be higher yielding but less liquid either due to maturity, size or other characteristics of the issue. The Company must have both the intent and the ability to hold such securities to maturity.


	49

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

Securities the Company has designated as available for sale may be sold prior to maturity in order to fund loan demand, to adjust for interest rate sensitivity, to reallocate bank resources, or to reposition the portfolio to reflect changing economic conditions and shifts in the relative values of market sectors. Available for sale securities tend to be more liquid investments and generally exhibit less price volatility as interest rates fluctuate.

The following table shows the book value of investment securities by type of obligation at the dates indicated:


	December 31,

	2006		2005		2004

U.S. Treasury and other U.S. Government agencies and corporations	$	86,682	$	80,053	$	69,670
U.S. Government mortgage-backed pass-through certificates		73,921		82,992		91,226
States of the U.S. and political subdivisions		40,807		44,714		45,689
Other securities		31,693		26,893		19,256

	$	233,103	$	234,652	$	225,841

A summary of securities held at December 31, 2006, classified according to the earlier of next repricing or the maturity date and the weighted average yield for each range of maturities, is set forth below. Fixed rate mortgage-backed securities are classified by their estimated contractual cash flow, adjusted for current prepayment assumptions. Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


			December 31, 2006

			Book		Weighted
Type and Maturity or Repricing Grouping			Value		Average Yield(1)

U.S. Treasury and other U.S. Government agencies and corporations:
	Maturing or repricing within one year		$	2,050		4.545	%
	Maturing or repricing after one year but within five years			11,301		4.512
	Maturing or repricing after five years but within ten years			29,614		5.439
	Maturing or repricing after ten years			43,717		6.033

		Total U.S. Treasury and other U.S. Government agencies and corporations	$	86,682		5.596	%

U.S. Government mortgage-backed pass-through certificates, REMICS & CMO’s:
	Maturing or repricing within one year		$	28,359		5.137	%
	Maturing or repricing after one year but within five years			39,000		4.777
	Maturing or repricing after five years but within ten years			5,413		4.763
	Maturing or repricing after ten years			1,149		4.880

		Total U.S. Government mortgage-backed pass-through certificates, REMICS & CMO’s	$	73,921		4.916	%

States of the U.S. and political subdivisions:
	Maturing or repricing within one year		$	2,097		7.370	%
	Maturing or repricing after one year but within five years			538		7.712
	Maturing or repricing after five years but within ten years			7,099		7.307
	Maturing or repricing after ten years			31,073		7.325

		Total States of the U.S. and political subdivisions	$	40,807		7.329	%

Other securities:
	Maturing or repricing within one year		$	18,379		7.136	%
	Maturing or repricing after one year but within five years			7,518		5.501
	Maturing or repricing after five years but within ten years			2,215		7.183
	Maturing or repricing after ten years			3,581		6.000

		Total other securities	$	31,693		6.623	%


	(1)	The weighted average yield has been computed by dividing the total interest income adjusted for amortization of premium or accretion of discount over the life of the security by the amortized cost of the securities outstanding. The weighted average yield of tax-exempt obligations of states of the U.S. and political subdivisions has been calculated on a fully taxable equivalent basis. The amounts of adjustments to interest which are based on the statutory tax rate of 34% were $50, $13, $162 and $711 for the four ranges of maturities.


50

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

As of December 31, 2006, there were $20,154 in callable U.S. Government Agencies, $6,424 in callable obligations of states and political subdivisions that given current and expected interest rate environments are likely to be called within the one year time horizon. These securities are categorized according to their contractual maturities, with $201 classified as maturing after one year but within five years, $5,159 classified as maturing after five years but within ten years, and $21,218 classified as maturing after 10 years.

Additionally, as of December 31, 2006, there were $11,343 in callable U.S. Government Agencies and $23,902 in callable obligations of states and political subdivisions that given current and expected interest rate environments are likely to be called within the time frame defined as after one year but within five years. These securities are categorized according to their contractual maturities, with $7,693 maturing after five years but within ten years and $27,552 maturing after 10 years.

As of December 31, 2006, the carrying value of all investment securities, both available for sale and held to maturity, tallied $233,103, a decrease of $1,549 or 0.66% from the prior year. The allocation between single maturity investment securities and mortgage-backed securities shifted to a 68/32 split versus the 64/36 division of the previous year, as mortgage-backed securities decreased by $9,071, or 10.9%.

Holdings of obligations of states and political subdivisions showed a decrease of $3,907, or 8.7%, as several bonds were called during the year.

Amortization of purchase premium resulted in the decrease of holdings of U.S. Treasury securities by approximately $5, or 3.4%. Investments in U.S. government agencies and sponsored corporations increased by approximately $6,634, or 8.3%. The Company also purchased $6,026 in corporate debt securities during 2006 primarily to take advantage of floating rate repricing characteristics. The purchases were partially offset by $1,125 in debt securities that were called and $1,006 that were sold during 2006. Additionally, a $668 reversal in unrealized losses on General Motors bonds was reflected at December 31, 2006. The net result was an increase in the corporate portfolio of $4,612

Holdings of other securities increased by $188, primarily reflecting stock dividends received from the Federal Home Loan Bank of Cincinnati.

The mix of mortgage-backed securities remained weighted in favor of fixed rate securities in 2006. The portion of the mortgage-backed portfolio allocated to fixed rate securities rose to 67% in 2006 versus 64% in 2005. Floating rate and adjustable rate mortgage-backed securities provide some degree of protection against rising interest rates, while fixed rate securities perform better in periods of stable to slightly declining interest rates. Included in the mortgage-backed securities portfolio are investments in collateralized mortgage obligations which totalled $18,184 and $20,554 at December 31, 2006 and 2005, respectively. No collateralized mortgage obligations were sold in 2006.

At December 31, 2006, a net unrealized loss of $455, net of tax, was included in shareholders’ equity as a component of Other Comprehensive Income, as compared to a net unrealized loss of $877, net of tax, as of December 31, 2005. This $422 improvement reflects the increased market value of debt securities resulting from changes in the shape of the yield curve and the level of interest rates that occurred during the year, as well as improvement in the perceived credit quality of the General Motors issues. Lower interest rates generally translate into more favorable market prices for debt securities; conversely rising interest rates generally result in a depreciation in the market value of debt securities.

The Company had $8,715 in investments considered to be structured notes as of December 31, 2006, an increase of $35, or 0.40%. The Company had no investments in inverse floating rate securities or other derivative products.

Additional information regarding investments can be found in the Notes to the Consolidated Financial Statements (NOTES 1 and 2).


	51

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

DEPOSITS

The Company’s deposits are derived from the individuals and businesses located in its primary market area. Total deposits at year-end exhibited an increase of 1.6% to $355,818 at December 31, 2006, as compared to $350,375 at December 31, 2005.

The Company’s deposit base consists of demand deposits, savings, money market and time deposit accounts. Average noninterest-bearing deposits decreased 1.8% during 2006, while average interest-bearing deposits increased by 2.8%.

During 2006, noninterest-bearing deposits averaged $57,271 or 16.4% of total average deposits as compared to $58,320 or 17.1% of total deposits in 2005. Core deposits averaged $299,749 for the year ended December 31, 2006, a decrease of $6,877 from the average level of 2005. During 2005, core deposits had averaged $306,626, a decrease of $4,674 from the preceding year.

Historically, the deposit base of the Company has been characterized by a significant aggregate amount of core deposits. Core deposits represented 86.0% of average total deposits in 2006 compared to 89.8% in 2005 and 90.3% in 2004. Non core deposits are represented by Jumbo CD’s, certificates of deposit in the amount of $100 or more. The Company’s portfolio of Jumbo CD’s are sourced primarily from customers in the subsidiary bank’s immediate market area, and does not include any brokered deposits.

Over the past five years, the Company has successfully increased the share of deposits represented by noninterest-bearing and NOW checking accounts. These products now comprise 24.4% of total deposits compared to 23.1% five years ago. The following depicts how the deposit mix has shifted during this five-year time frame.

Additional information regarding interest-bearing deposits is presented in the Notes to the Consolidated Financial Statements (NOTE 6).


52

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

ASSET-LIABILITY MANAGEMENT

The Company’s executive management and Board of Directors routinely review the Company’s balance sheet structure for stability, liquidity and capital adequacy. The Company has defined a set of key control parameters which provide various measures of the Company’s exposure to changes in interest rates. The Company’s asset-liability management goal is to produce a net interest margin that is relatively stable despite interest rate volatility while maintaining an acceptable level of earnings. Net Interest Margin is the difference between total interest earned on a fully taxable equivalent basis and total interest expensed. The Net Interest Margin Ratio expresses this difference as a percentage of average earning assets. In the past five years, the net interest margin ratio has averaged 3.91% ranging between 3.67% and 4.39%.

Included among the various measurement techniques used by the Company to identify and manage exposure to changing interest rates is the use of computer based simulation models. Computerized simulation techniques enable the Company to explore and measure net interest income volatility under alternative asset deployment strategies, different interest rate environments, various product offerings and changing growth patterns.

GAP TABLE

December 31, 2006

Maturity or Repricing Interval

Non Rate

Sensitive

3 Months

3 to 12

1 to 5

or > 5

or Less

Months

Years

Total

Interest-Earning Assets

Interest-Bearing Balance from Depository Institution

Investments

33,741

43,722

93,401

62,239

233,103

Loans & Leases

51,604

37,076

88,084

28,444

205,208

Federal Fund Sold

4,275

Total Earning Assets

89,644

80,798

181,485

90,683

442,610

Other Assets

29,141

Total Assets

89,644

80,798

181,485

119,824

471,751

Interest-Bearing Liabilities

Interest-bearing Checking

27,136

Money Market Accounts

19,117

Passbook Savings

79,585

Time Deposits ³ 100,000

18,602

20,460

10,093

5,790

54,945

Time Deposits <100,000

22,152

41,826

32,011

18,063

114,052

Repurchase Agreements

5,862

U.S. Treasury Demand

1,153

Other Borrowings

13,000

11,500

28,500

2,000

55,000

Total Interest-Bearing Liabilities

186,607

73,786

70,604

25,853

356,850

Demand Deposits

60,983

Other Liabilities

3,326

Shareholders’ Equity

50,592

Total Liabilities & Equity

186,607

73,786

70,604

140,754

471,751

Rate Sensitivity Gap

(96,963

)

7,012

110,881

64,830

Cumulative Gap

(96,963

)

(89,951

)

20,930

85,760

Cumulative Gap to Total Assets

(20.6

(19.1

4.4

18.2


	53

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

The preceding Gap Table presents an analysis of the Company’s earliest repricing opportunity for each of its interest-earning assets and interest-bearing liabilities. Assets are distributed according to the earlier of interest rate repricing opportunity or expected cash flows. Time deposits and liabilities with defined maturities are distributed according to the earlier of the repricing interval or contractual maturity. Other core deposit accounts (Interest-bearing checking, Money Market and Savings accounts) are shown as being available for repricing in the earliest time frame, although management can exert considerable influence over the timing and manner of repricing such core deposits. Therefore, these accounts may reprice in later time intervals and reflect smaller incremental changes than other interest-earning assets and interest-bearing liabilities. Since management may reprice these accounts at its discretion, the impact of changing rates on net interest income is likely to be considerably different than inferred by this table.

During 2006, the effective maturities of earning assets tended to lengthen as short and intermediate rates in the credit markets rose sharply. Federal Reserve policy makers increased short-term interest rates four times during the year, from 4.25% to 5.25% in an attempt to avoid an unwelcome rise in inflation. With rates rising during the year, the volume of investment securities eligible to be called decreased, while prepayments on loans and mortgage-backed securities similarly decreased, causing the effective maturities of existing earning assets to lengthen. Management invested excess overnight funds (federal funds sold balances), with an increased allocation towards adjustable and floating rate corporate bonds, and U.S. Government agencies purchased at a discount that contain a lock-out period prior to the first call date.

While the preceding Gap Table provides a general indication of the potential effect that changing interest rates may have on net interest income, it does not by itself present a complete picture of interest rate sensitivity. Because the repricing of the various categories of assets and liabilities is subject to competitive pressures, customer preferences and other factors, such assets and liabilities may in fact reprice in different time periods and in different increments than assumed.

The computerized simulation techniques utilized by management provide a more sophisticated measure of the degree to which the Company’s interest sensitive assets and liabilities may be impacted by changes in the general level of interest rates. These analyses show the Company’s net interest income remaining relatively neutral within the economic and interest rate scenarios anticipated by management. As previously noted, the Company’s net interest margin has remained in the range of 3.67% to 4.39% over the past five years, a period characterized by significant shifts in the mix of earning assets and the direction and level of interest rates. The targeted federal funds rate during that period ranged from 1.00% to 5.25%, as Federal Reserve monetary policy turned from guarding against deflation to warding off inflationary threats.

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


54

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

loans, investment securities and mortgage-backed securities.

Anticipated principal repayments on mortgage-backed securities along with investment securities maturing, repricing, or expected to be called in one year or less amounted to $77,463 at December 31, 2006, representing 33.2% of the total combined portfolio, as compared to $73,603 or 31.4% of the portfolio a year ago.

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, and access to the Federal Reserve Discount Window. The Company is also a member of the Federal Home Loan Bank of Cincinnati, which provides yet another source of liquidity.

Cash and cash equivalents increased from $12,897 in 2004 to $19,237 in 2005, then subsided to $14,375 in 2006. Operating activities provided cash of $5,082 in 2006, $4,275 in 2005 and $7,382 in 2004. Key differences stem mainly from: 1) a decrease in net income of $509 between 2005 and 2004 and a $242 increase between 2005 and 2006; 2) there were no loans held for sale at December 31, 2005 and 2004 and $109 at 2006; 3) gains on the sale of investments was $308 at December 31, 2005, $1,052 at December 31, 2004 and $18 in 2006; 4) amortization on securities was $506 in 2006 compared to $872 in 2005 and $1,546 in 2004; 5) loss on the sale of other real estate totaled $47 in 2006 and $171 in 2004 compared to $3 in 2005; 6) the purchase of an additional $500 of insurance contracts on the lives of participants in the supplemental post retirement benefit plan in 2004 compared to $128 in 2006 and none in 2005; 7) a liability for securities purchased yet to settle totaled $1,270 at December 31, 2004, with none at December 31, 2005 or 2006. Refer to the Consolidated Statements of Cash Flows for a summary of the sources and uses of cash for 2006, 2005 and 2004. The following table details the cash flows from operating activities.


			December 31,

			2006			2005			2004

Net income			$	4,576		$	4,334		$	4,843
Adjustments to reconcile net income to net cash flows from operating activities:
	Depreciation, amortization and accretion			991			1,469			2,176
	Provision for loan loss			225			545			415
	Investment securities gains			(18	)		(308	)		(1,052	)
	Other real estate losses			47			3			171
	Impact of loans held for sale			(109	)					103
	Changes in:
		Securities to settle and securities sold to settle					(1,270	)		1,270
		Purchase of insurance contracts		(128	)					(500	)
		Other assets and liabilities		(502	)		(498	)		(44	)

Net cash flows from operating activities			$	5,082		$	4,275		$	7,382

CONTRACTUAL OBLIGATIONS AND COMMITMENTS

The Corporation has various obligations, including contractual obligations and commitments that may require future cash payments.

Contractual Obligations: The following table presents, as of December 31, 2006, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.


	55

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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


				Contractual Obligations
				as of December 31, 2006

				Payments Due in

				One			One to			Three			Over
		See		Year			Three			to Five			Five
		Note		or Less			Years			Years			Years			Total

Non-interest bearing deposits				$	60,983		$			$			$			$	60,983
Interest bearing deposits(a)			6		125,838												125,838
	Average Rate(b)				1.29	%											1.29	%
Certificates of deposit(a)			6		94,999			38,638			10,797			24,563			168,997
	Average Rate(b)				4.54	%		4.57	%		4.80	%		4.82	%		4.61	%
Federal funds purchased and security repurchase agreements(a)			7		5,862												5,862
	Average Rate(b)				4.34	%											4.34	%
U.S. Treasury interest-bearing demand note(a)			7		1,153												1,153
	Average Rate(b)				5.04	%											5.04	%
Federal Home Loan Bank advances(a)			7		16,500			15,000			21,500			2,000			55,000
	Average Rate(b)				4.76	%		5.52	%		5.68	%		4.07	%		5.30	%
Operating leases			8		182			215			128						525


	(a)	Excludes present and future accrued interest.

	(b)	Variable rate obligations reflect interest rates in effect at December 31, 2006.

The Corporation’s operating lease obligations represent short and long-term lease and rental payments for the subsidiary bank’s branch facilities.

The Corporation also has obligations under its supplemental retirement plans as described in Note 9 to the consolidated financial statements. The postretirement benefit payments represent actuarially determined future benefit payments to eligible plan participants. The Corporation does not have any commitments or obligations to the defined contribution retirement plan (401(k) plan) at December 31, 2006 due to the funded status of the plan. (See further discussion in Note 9.)

Commitments: The following table details the amounts and expected maturities of significant commitments as of December 31, 2006. (Further discussion of these commitments is included in Note 8 to the consolidated financial statements.)


		Expected Maturities of Commitments
		as of December 31, 2006

		One		One to		Three		Over
		Year		Three		to Five		Five
		or Less		Years		Years		Years		Total

Commitments to extend credit:
	Commercial	$	22,466	$	2,459	$	687	$	11,167	$	36,779
	Residential real estate		280								280
	Revolving home equity		9,939								9,939
	Overdraft protection		9,827								9,827
	Other		526								526
Standby letters of credit			1,810								1,810

Commitments to extend credit, including loan commitments, standby letters of credit, and commercial letters of credit do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon.

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


56

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

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, and minority interests less goodwill. Tier 2 capital consists of a limited amount of the allowance for loan and lease losses, perpetual preferred stock (not included in Tier 1), hybrid capital instruments, term subordinated debt, and intermediate-term preferred stock.

The following graph, which is not “risk-adjusted,” depicts Tier 1 capital as a percentage of total average assets over the past several years. This measure of capital adequacy is known as the “leverage ratio.” The ratio was 11.05% in 2005 and 11.04% in 2006, and remains well above regulatory minimums.

The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) required banking regulatory agencies to revise risk-based capital standards to ensure that they take adequate account of interest rate risk. Accordingly, regulators 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 risk-weighted capital ratios at December 31, 2006 and 2005. Banks are required to maintain a minimum ratio of 8% of qualifying total capital to risk-adjusted total assets. The Tier 1 capital ratio must be at least 4%. Capital qualifying as Tier 2 capital is limited to 100% of Tier 1 capital. As the table indicates, the Company maintains both Tier 1 and total risk-based capital well in excess of the required regulatory minimum ratios.


Risk-Based Capital

	December 31,		December 31,
	2006		2005

Tier 1 Capital	$	50,913	$	49,031
Tier 2 Capital		2,238		2,189

QUALIFYING CAPITAL	$	53,151	$	51,220

Risk-Adjusted Total Assets(*)	$	266,686	$	242,106

Tier 1 Risk-Based Capital Ratio		19.09%		20.25%
Total Risk-Based Capital Ratio		19.93%		21.16%
Total Leverage Capital Ratio		11.04%		11.05%

(*) Includes off-balance sheet exposures

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 December 31, 2006 and December 31, 2005. As of those dates, the Company was “well capitalized” under regulatory prompt corrective action provisions.

Actual Regulatory

Regulatory Capital Ratio

Capital Ratios as of:

requirements to be:

Dec. 31,

Well

Adequately

2006

2005

Capitalized

Total risk-based capital to risk-weighted assets

19.93%

21.16%

10.00%

8.00%

Tier I capital to risk-weighted assets

19.09%

20.25%

6.00%

4.00%

Tier I capital to average assets

11.04%

11.05%

5.00%

4.00%

SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities,” requires that investments designated as available for sale be marked-to-market with corresponding entries to the deferred tax account and shareholders’ equity. Regulatory agencies, however, exclude these ad-


	57

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

justments in computing risk-based capital, as their inclusion would tend to increase the volatility of this important measure of capital adequacy. Additional information regarding regulatory matters can be found in the Notes to the Consolidated Financial Statements (NOTE 12.)

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). As of December 31, 2006, the Company’s bank subsidiary was rated “satisfactory” for CRA purposes, and remained well capitalized and well managed, in management’s opinion.

MARKET RISK

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 repricing risk, basis risk and yield curve risk. Repricing risk arises due to timing differences in the repricing of assets and liabilities as interest rate changes occur. Basis risk occurs when repricing 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 repricing 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 repricing intervals and maturities of investments and loans, and emphasize the acquisition of fixed rate assets over floating rate assets.

Run off rate assumptions are obtained from a service that provides forecasted prepayment speeds based on the median forecast of 11 dealer firms for various mortgage types. Repricing 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.


58

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

The following table shows the Company’s current estimate of interest rate sensitivity based on the composition of its balance sheet at December 31, 2006. 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 December 31, 2006. Under both the rising rate scenario and the falling rate scenario, the yield curve is assumed to exhibit a parallel shift.

During 2006, the Federal Reserve increased its target rate for overnight federal funds by 100 basis points. At year end December 31, 2006, the difference between the yield on the ten-year Treasury and the three-month Treasury had decreased to a negative 31 basis points from the positive 31 basis points that existed at December 31, 2005, indicating that the yield curve had inverted. At December 31, 2006, rates peaked at the six-month point on the Treasury yield curve. Interest rate yields for one year through thirty years were all below the maximum reached at the six-month point.

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 $15,354 for the year ending December 31, 2007.


Simulated Net Interest Income Sensitivity
For the Twelve Months Ending December 31, 2007
	Net Interest
Change in Interest Rates	Income		$ Change		% Change

Graduated increase of +300 basis points	$	15,357	$	3		0.0	%
Short term rates unchanged (base case)		15,354
Graduated decrease of -300 basis points		15,391		37		0.3	%

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.

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.

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.” 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. 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.

The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of subjective measurements including management’s assessment of the internal risk classifications of loans, changes in the nature


	59

CORTLAND BANCORP AND SUBSIDIARIES

MANAGEMENT’S DISCUSSION AND ANALYSIS

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

of the loan portfolio, industry concentrations and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

Accordingly, the Company has developed and maintains a comprehensive, systematic and consistently applied process to determine the appropriate amounts of the allowance for loan losses, and resultant provision for loan losses, necessary to absorb estimated credit losses inherent in the loan portfolio. The allowance for loan losses represents management’s best estimate from within an acceptable range of estimated losses that it considers appropriate and prudent, but not excessive.

While management’s evaluation of the allowance for loan losses as of December 31, 2006 has determined the allowance to be adequate, under adversely different conditions or assumptions, the Company would most likely need to increase the allowance. The assumptions and estimates used by the Company in its internal review of non-performing loans and potential problem loans, as well as the associated evaluation of the related collateral coverage for these loans, can have a significant impact on the overall assessment of the adequacy of the allowance for loan losses. While management has concluded that the current valuation of loan collateral is reasonable under present circumstances, if collateral valuations were significantly reduced due to either new information or other changing circumstances, additional provisions to the allowance for loan losses would most likely be necessary.

All accounting policies are important and the reader of these financial statements is encouraged to review the summary of significant accounting policies described in Note 1 of the Consolidated Financial Statements, in order to gain a better understanding of how the Company’s financial performance is reported.

For additional information regarding the allowance for loan losses, its relation to the provision for loan losses and risk related to asset quality, see sections of the “Notes to the Consolidated Financial Statements” and “Management Discussion and Analysis” related to the allowance for loan losses.

IMPACT OF INFLATION

Consolidated financial information included herein has been prepared in accordance with generally accepted accounting principles, which require the Company to measure financial position and operating results in terms of historical dollars. Changes in the relative value of money due to inflation are generally not considered. Neither the price, timing nor the magnitude of changes directly coincide with changes in interest rates.


60

INFORMATION AS TO STOCK PRICES AND DIVIDENDS OF CORTLAND BANCORP

OTHER INFORMATION

The Company files quarterly reports, (Forms 10-Q), an annual report (Form 10-K), current reports on Form 8-K and proxy statements, as well as any amendments to those reports with the Securities and Exchange Commission (SEC) pursuant to section 13(a) or (15)d of the Exchange Act. In 2007, the quarterly reports will be filed within 40 days of the end of each quarter, while the annual report is filed within 75 days of the end of the year. Any individual requesting copies of such reports may obtain these free of charge, as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC by visiting our web site at www.cortland-banks.com or by writing to:

Deborah L. Eazor

Cortland Bancorp

194 West Main Street

Cortland, Ohio 44410

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.

The Company’s stock trades on the NASDAQ OTC market under the symbol CLDB. The following brokerage firms are known to be relatively active in trading the Company’s stock:

Community Banc Investments, Inc.

Columbus, Ohio

Contact: Greig A. McDonald

Telephone: 1-800-224-1013

Ferris Baker Watts, Incorporated

655 Metro Place South

Metro Center V, Suite 330

Dublin Ohio 43017

Telephone: 1-866-313-4803

Smith Barney Citigroup, Inc.

5048 Belmont Ave.

Youngstown, Ohio 44505

Telephone: 1-800-535-0017

Stifel, Nicholas & Co., Inc.

655 Metro Place South

Suite 200

Dublin, Ohio 43017

Telephone: 1-877-875-9352

UBS Financial Services

3701 Boardman Canfield Rd

P.O. Box 100

Canfield, Ohio 44406

Telephone: 330-533-7191

The following table shows the prices at which the common stock of the Company has actually been purchased and sold in market transactions during the periods indicated. The range of market price is compiled from data provided by brokers based on limited trading. Also shown in the table are the dividends per share on the outstanding common stock. All figures shown have been adjusted to give retroactive effect to the 2% stock dividend paid as of January 1, 2007 and the 3% stock dividend paid January 1, 2006 and 2005. The Company currently has approximately 1,696 shareholders.


HIGH OR LOW TRADING PRICE PER QUARTER
	Price Per Share
					Cash
					Dividends
	High		Low		Per Share

2006
Fourth Quarter	$	18.25	$	15.74	$	0.22
Third Quarter		17.89		15.74		0.22
Second Quarter		18.38		17.35		0.21
First Quarter		19.36		17.65		0.21

2005
Fourth Quarter	$	19.99	$	17.16	$	0.42
Third Quarter		19.99		18.09		0.21
Second Quarter		21.33		19.04		0.21
First Quarter		22.14		20.18		0.21

2004
Fourth Quarter	$	23.11	$	20.01	$	0.42
Third Quarter		22.87		19.55		0.20
Second Quarter		25.19		20.33		0.20
First Quarter		28.20		24.04		0.20

For the convenience of shareholders, the Company has established a plan whereby shareholders may have their dividends automatically reinvested in the common stock of Cortland Bancorp. Participation in the plan is completely voluntary and shareholders may withdraw at any time.

For current stock prices you may access our home page at www.cortland-banks.com.

For more information on the dividend reinvestment plan, you may contact Deborah L. Eazor at the following telephone number: (330) 637-8040 Ext. 130 or E-mail address DLEAZOR@cortland-banks.com.


	61

CORTLAND BANCORP

BOARD OF DIRECTORS

K. RAY MAHAN

Chairman

JERRY A. CARLETON

DAVID C. COLE

LAWRENCE A. FANTAUZZI

JAMES M. GASIOR

GEORGE E. GESSNER

JAMES E. HOFFMAN III

NEIL J. KABACK

RICHARD B. THOMPSON

TIMOTHY K. WOOFTER

WILLIAM A. HAGOOD

Director Emeritus

RODGER W. PLATT

Director Emeritus

OFFICERS

LAWRENCE A. FANTAUZZI

President and

Chief Executive Officer

JAMES M. GASIOR

Senior Vice President

Chief Financial Officer and

Corporate Secretary

CRAIG M. PHYTHYON

Senior Vice President

Chief Investment Officer

and Treasurer


62

THE CORTLAND SAVINGS AND BANKING COMPANY

BOARD OF DIRECTORS

JERRY A. CARLETON

President, Carleton Enterprises Inc.

DAVID C. COLE

Partner and President

Cole Valley Motor Company

LAWRENCE A. FANTAUZZI

President and Chief Executive Officer

JAMES M. GASIOR

Senior Vice President, Chief Financial Officer

and Secretary

GEORGE E. GESSNER

Attorney

JAMES E. HOFFMAN III

Attorney

NEIL J. KABACK

Partner, Cohen & Company

K. RAY MAHAN

President, Mahan Packing Co.

and Chairman of the Board

RICHARD B. THOMPSON

Executive, Therm-O-Link, Inc.

TIMOTHY K. WOOFTER

President, Stan-Wade Metal Products

* * * * *

WILLIAM A. HAGOOD

Director Emeritus

RODGER W. PLATT

Director Emeritus

* * * * *

OFFICERS

LAWRENCE A. FANTAUZZI

President and Chief Executive Officer

JAMES M. GASIOR

Senior Vice President, Chief Financial Officer

and Secretary

STEPHEN A. TELEGO, SR.

Senior Vice President and Director of Human Resources and Corporate Administration

TIMOTHY CARNEY

Senior Vice President & Chief Operations Officer

CRAIG M. PHYTHYON

Senior Vice President, Chief Investment Officer and Treasurer

DANNY L. WHITE

Senior Vice President and Chief Lending Officer

CHARLES J. COMMONS

Vice President

MARLENE LENIO

Vice President

EMMA JEAN WOLLAM

Vice President

ROBERT J. HORVATH

Vice President

JUDY RUSSELL

Vice President

JAMES DUFF

Vice President

KEITH MROZEK

Vice President

DEBORAH L. EAZOR

Vice President

KAREN CLOWER

Vice President

ROBERT A. COGGESHALL

Vice President

GREG YURCO

Vice President

JOAN M. FRANGIAMORE

Vice President

BARBARA R. SANDROCK

Vice President

WILLIAM J. HOLLAND

Vice President

MICHAEL MATTOCKS

Vice President

DEAN S. EVANS

Vice President

MARCEL P. ARNAL

Assistant Vice President

GRACE J. BACOT

Assistant Vice President

SHIRLEY F. ROOT

Assistant Vice President

DARLENE MACK

Assistant Vice President

and Trust Officer

JANET K. HOUSER

Assistant Vice President

RUSSELL E. TAYLOR

Assistant Vice President

BARBARA McKENZIE

Assistant Vice President

JAMES HUGHES

Assistant Vice President

SHIRLEY A. WADE

Assistant Vice President

DESIREE SORBER

Assistant Vice President

LANA MUIR

Assistant Secretary-Treasurer

HEATHER J. BOWSER

Assistant Secretary-Treasurer

KAREN MILLER

Assistant Secretary


	63

CORTLAND BANKS OFFICES AND LOCATIONS

Thirteen Offices Serving These Fine Communities

BOARDMAN

8580 South Avenue

Youngstown, Ohio 44514

330-758-5884

BOARDMAN

Victor Hills Plaza

6538 South Avenue

Boardman, Ohio 44512

330-629-9151

BRISTOL

6090 State Route 45

Bristolville, Ohio 44402

330-889-3062

BROOKFIELD

7325 Warren-Sharon Road

Brookfield, Ohio 44403

330-448-6814

CORTLAND

194 West Main Street

Cortland, Ohio 44410

330-637-8040

HUBBARD

890 West Liberty Street

Hubbard, Ohio 44425

330-534-2265

MANTUA

11661 State Route 44

Mantua, Ohio 44255

330-274-3111

NILES PARK PLAZA

815 Youngstown-Warren Road

Suite 1

Niles, Ohio 44446

330-652-8700

NORTH BLOOMFIELD

8837 State Route 45

North Bloomfield, Ohio 44450

440-685-4731

VIENNA

4434 Warren-Sharon Road

Vienna, Ohio 44473

330-394-1438

WARREN

2935 Elm Road

Warren, Ohio 44483

330-372-1520

WILLIAMSFIELD

5917 U.S. Route 322

Williamsfield, Ohio 44093

440-293-7502

WINDHAM

9690 East Center Street

Windham, Ohio 44288

330-326-2340

Member

Federal Reserve System

and

Federal Deposit Insurance Corporation

Visit us at our home page on the world wide web at

www.cortland-banks.com

or e-mail us at cbinfo@cortland-banks.com


64

Exhibit 21

SUBSIDIARIES OF THE REGISTRANT

The following lists the subsidiaries of the registrant and the state of incorporation of each:


NAME		INCORPORATED
1) The Cortland Savings and Banking Company		Ohio

2) New Resources Leasing Company		Ohio

Exhibit 23

CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

We consent to the incorporation by reference in the Prospectuses constituting part of the Registration Statements on Form S-8 for the Cortland Savings and Banking 401 (k) Plan and Form S-3 for the Cortland Bancorp Dividend Reinvestment Plan of our report dated March 7, 2007, with respect to the consolidated balance sheets of Cortland Bancorp and subsidiaries as of December 31, 2006 and 2005 and the related consolidated statements of income, stockholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2006, and management’s assessment of the effectiveness of internal control over financial reporting as of December 31, 2006, and the effectiveness of internal control over financial reporting as of December 31, 2006, included in this Annual Report on Form 10-K of Cortland Bancorp for the year ended December 31, 2006.




Youngstown, Ohio		PACKER THOMAS
March 13, 2007

Exhibit 31.1

CERTIFICATION

I, Lawrence A. Fantauzzi, certify that:

1. I have reviewed this annual report on Form 10-K of Cortland Bancorp;

2. Based on my knowledge, this annual report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this annual report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

b) Designed such internal controls over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter(the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):

a) All significant deficiencies and material weaknesses in the design or operation of internal controls over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 13, 2007.



	/s/ Lawrence A. Fantauzzi
	Lawrence A. Fantauzzi
	Title:	Chief Executive Officer

Exhibit 31.2

CERTIFICATION

I, James M. Gasior, certify that:

1. I have reviewed this annual report on Form 10-K of Cortland Bancorp;

d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

Date: March 13, 2007



	/s/ James M. Gasior
	James M. Gasior,
	Title:	Chief Financial Officer

Exhibit 32

CERTIFICATIONS OF CHIEF EXECUTIVE OFFICER AND
CHIEF FINANCIAL OFFICER PURSUANT TO TITLE 18, UNITED
STATES CODE, SECTION 1350, AS ADOPTED PURSUANT
TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Annual Report of Cortland Bancorp (the “Company”) on Form 10-K for the annual period ended December 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Lawrence A. Fantauzzi, the Chief Executive Officer of the Company, certify, pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

	(1)		The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

	(2)		The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


		/s/ Lawrence A. Fantauzzi * Print Name: Lawrence A. Fantauzzi
		Title: Chief Executive Officer
		Date: March 13, 2007

In connection with the Annual Report of Cortland Bancorp (the “Company”) on Form 10-K for the annual period ended December 31, 2006 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, James M. Gasior, the Chief Financial Officer of the Company, certify, pursuant to Title 18, United States Code, Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:

	(1)		The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

	(2)		The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.


		/s/ James M. Gasior * Print Name: James M. Gasior
		Title: Chief Financial Officer
		Date: March 13, 2007


*		This certification is being furnished as required by Rule 13a-14(b) under the Securities Exchange Act of 1934 (the “Exchange Act”) and Section 1350 of Chapter 63 of Title 18 of the United States Code, and shall not be deemed “filed” for purposes of Section 18 of the Exchange Act or otherwise subject to the liability of that Section. This certification shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Exchange Act, except as otherwise stated in such filing.

A signed original of this written statement required by Section 906, or other document authenticating, acknowledging, or otherwise adopting the signature that appears in typed form within the electronic version of this written statement required by Section 906, has been provided to and is being retained by Cortland Bancorp and will be forwarded to the Securities and Exchange Commission or its staff upon request.

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