Item 1 -- Business
Cortland First Financial Corporation is a Bank Holding Company and commenced business on October 1, 1986. First National Bank of Cortland is a wholly owned subsidiary of Cortland First Financial Corporation and its only operating entity.
Government Regulation and Supervision As a holding company, Cortland First Financial Corporation is subject to supervision by the Federal Reserve system and is required to file an annual report with the Federal Reserve Board, and is subject to examination by that Board as well. Its subsidiary bank, First National Bank of Cortland, is subject to supervision by the Office of the Comptroller of the Currency as well as the Federal Deposit Insurance Corporation (FDIC). The administrative office of Cortland First Financial Corporation is located at 65 Main Street, Cortland, New York, in Cortland County.
Service Area and Competition The company conducts its banking operation primarily in Cortland County and the surrounding areas. First National Bank of Cortland currently employs 123 people in its six banking offices located in Cortland, Cortlandville, Marathon, McGraw, Cincinnatus, and Tully. A seventh banking facility was added in early 1994 in Whitney Point, which expanded our service area into neighboring Broome County and added greater convenience to those customers in the southern portion of our current market.
First National Bank of Cortland is an independent commercial bank committed to serving the financial needs of customers in the local communities. The bank is in competition with other financial institutions in the area, many of which are branches of large institutions such as Marine Midland, Fleet, and Key Bank. Other organizations compete for deposits and loans as well, and include insurance companies, money market funds, federal credit unions, and other local independent banking operations.
Services Offered In addition to providing the traditional loan and deposit service to its customers, the Bank also provides several specialized customer services including 24-hour automated teller machines in four locations: Main Office, 65 Main Street, Cortland; Groton Avenue Office, 1125 Groton Avenue, Cortlandville; Tully Office, Route 80 at I-81, Tully and our Whitney Point office on Route 11 in Whitney Point; as well as a 24-hour cash dispensing machine in our Marathon Office located at 14 East Main Street, Marathon. A full range of trust services including financial planning, estate planning, and custodial services are handled by the Bank. Other banking services include annuities, safe deposit boxes, travelers checks, money orders, wire transfers, collections, and foreign exchange. Traditional deposit products include checking accounts, Negotiable order of withdrawal (NOW) and savings accounts, time deposits, and individual retirement accounts. Lending services include residential, farm, business loans, Small Business Administration loans, installment loans, credit card loans, home equity loans, biweekly mortgages, auto, and student loans.
First National Bank of Cortland has no foreign assets except for a nominal amount of Canadian currency.
Management is not aware of any exposure to potential environmental liability under the Superfund. Management is also not aware of any known trends, events, or uncertainties that will have, or that are reasonably likely to have, a material effect on the liquidity, capital resources, or operations of the Corporation or its subsidiary.
The following pages display the statistical disclosure by bank holding companies required by the Securities Act Industry Guide 3.
MESSAGE TO SHAREHOLDERS
Established in 1986, Cortland First Financial Corporation is a relatively new company. However, its only operating subsidiary, First National Bank of Cortland, has been a community cornerstone since 1869. Celebrating 125 years of stability, integrity, and service in 1994, we took a look back at our history and found that behind every challenge lies the opportunity for continued growth. Rooted in the philosophy that got us here, the challenge today is to look for sustainable growth in a future that is far from predictable.
I am pleased to report that, while in many ways 1994 was a very challenging year, once again your bank has succeeded in achieving solid growth - growth that can be measured financially as well as growth that has been visible in our branch development, computer utilization and customer service initiatives.
First National Bank of Cortland remains an independent community bank. In today's economic climate, growth is hard fought. Market share will be won by prudent yet progressive management and dedicated employees who recognize that service quality is the only real differentiator in the highly competitive world of financial services.
First the numbers: In 1994, we were able to achieve yet another growth year in which total assets reached an all-time high closing at $198,800,000, an increase of more than $10,000,000. This increase represents a 5.3% growth over 1993 assets of $188,700,000. The Board of Directors also approved record cash dividends to shareholders in 1994. Total dividends paid to shareholders in 1994 amounted to $840,000 or $1.25 per share. The combination of gain in the market value of a share of stock purchased January 1, 1994, plus the cash dividends, produced a handsome total return of 47.9% for shareholders in 1994.
Earnings continued to be very strong in 1994. Net income of $2,700,000 produced a return on average assets of 1.37%, significantly above the national average of 1.18% reported by the FDIC, as of the end of the third quarter. On a per-share basis, net income in 1994 was $4.00 versus $4.06 in 1993. Planned expenditures for computer-related equipment and new branch construction held earnings slightly below the previous year's record earnings.
Total shareholder equity increased by 1.8% to $20,400,000, providing a very strong capital-to-assets ratio of 10.89%. Total shareholder equity and book value were impacted by Statement of Financial Accounting Standards Board (FASB) No. 115 which requires recognition of unrealized gains or losses in investment securities. The significant rise in interest rates over the past year produced an unrealized loss in those securities classified as available-for-sale which, after tax considerations, had the effect of reducing equity by $875,320. It is not anticipated that this loss will ever be realized since the bank historically does not sell its investment securities. Banking regulators have chosen not to include the unrealized losses or gains for purposes of calculating regulatory capital. (Please refer to the Management's Discussion and Analysis section for further information.)
Once again, we are proud that the bank rating firms continued to award their highest ratings to our bank in 1994. Bauer Financial Reports, Inc. recognized the bank with its Five-Star rating; Veribanc, Inc. bestowed its Blue Ribbon rating; and, The Sheshunoff Company, Inc. awarded an "A+" rating.
Technologically speaking, 1994 provided an opportunity to consolidate the enhancements and conveniences achieved when we installed our new Unisys computer system in 1993. This system forms the basis which will keep First National in the forefront of technology for years to come.
In April, we opened our seventh banking office, located in the northern Broome County community of Whitney Point. The office, located approximately fourteen miles north of the city of Binghamton, is capably managed by Roberta Bush and her staff, and is off to an excellent beginning.
In November, we commenced a major renovation of the Main Office's adjacent building at 73 Main Street, acquired in 1990, which will house our expanded Trust and Investment Department on the ground floor and the loan department on the second floor, with the third floor available for future expansion. A new credit department supporting the bank's lending activities will occupy space on the second floor of our present building, adjacent to the loan department. The two buildings will be joined at the second floor level and serviced by the existing elevator. The building has been beautifully remodeled inside and out in keeping with the historic nature of the downtown location.
We are excited about the expansion of our Trust and Investment division. We are planning an expansion of our Trust Department in 1995 and expect significant growth in this area. With the Mutual Partners asset allocation program introduced in 1994, we expect that mutual fund investment opportunities for our customers will be an important factor in the long-term prospects for this area. This department offers a full range of personal trust, investment and custodial services as well as employee benefit programs.
In 1994, we welcomed two new members to the Board of Directors, Mary Alice Bellardini, Mayor of the Village of Homer, and John Buck, President of Buck Environmental Laboratories, Inc. Each of these individuals brings a wealth of talent and abilities to our bank.
Finally, a much-deserved salute to all of our dedicated staff, employees and Board of Directors, without whom we would have no reason for celebrating a century and a quarter of service to our community. Indeed it is a proud tradition that brings the bank to where it is today. More than pride in the past, however, we take pride in the talent and attitude of our people today, enabling us to build on the legacy we have inherited.
We encourage our staff's involvement in activities and organizations which help make our communities better places, and many of our staff members are so involved. Last year, we were especially proud of Sharon Yaple, Vice President for Marketing and Retail Customer Services. In addition to her very active involvement in our 125th anniversary celebration and new branch opening, she chaired the 1995 United Way campaign which exceeded its prior year's record fund-raising effort. Also, Bob Derksen, Vice President and CFO, was the recipient of the St. George Medal awarded by the NYS Division of the American Cancer Society. The St. George Award is the most significant division award bestowed at the national level and awarded to division volunteers for outstanding service. Denise Connor, who works in our Finance and Accounting Department, was recognized by the Cortland Rotary Club with its first annual "Pride of Workmanship Award," an award given to employees who demonstrate the ability to "Do it once - Do it well - Build a Better America."
Historically, the local economy lags the national economic cycle by six to twelve months; however, during the current recovery in the national economy, our local economy has been slower to recover, due principally to a net loss of jobs in the manufacturing sector over the past year. With interest rates continuing to rise as the Fed attempts to limit inflationary concerns, we expect 1995 to present its share of unique challenges. With our strong capitalization, well-trained and competent staff and dedicated Board of Directors, I am confident that the Bank will once again rise to meet these new challenges and opportunities.
Sincerely,
David R. Alvord President and Chief Executive Officer
Item 2

Item 2 -- Properties
The Registrant operates the following branches:
Name of Office Location County Date Established
Home Office 65 Main Street Cortland March 1, 1869 Cortland, NY
Cincinnatus Main Street Cortland January 1, 1943 Cincinnatus, NY
Groton Avenue 1125 Groton Avenue Cortland June 22, 1987 Cortland, NY
Marathon 14 E. Main Street Cortland August 15, 1957 Marathon, NY
McGraw 30 Main Street Cortland May 1, 1967 McGraw, NY
Tully Route 80 at I-81 Onondaga January 26, 1989 Tully, NY
Whitney Point 2950 NYS Route 11 Broome April 7, 1994 Whitney Point, NY
The Tully and Whitney Point offices are leased. The other banking premises are owned.
Item 3

Item 3 -- Legal Proceedings
There are no pending legal proceedings, other than routine litigation incidental to the business of the Bank, to which the Registrant or the Bank is a party or of which any of their property is the subject. In management's opinion, no pending action, if adversely decided, would materially affect the Bank's or the Registrant's financial condition.
Item 4

Item 4 -- Submission of Matters to a Vote of Security Holders
No matters were submitted for security holder vote during the fourth quarter of 1994.
PART II
Item 5

Item 5 -- Market for Registrant's Common Stock and Related Shareholders Matters
Regulatory Ratios: Total Risk-Based Capital 20.32% Tier I Risk-Based Capital 19.22 Leverage 10.76
The minimum risk-based capital per regulatory requirements for the "well capitalized" category is 10%.
Common Stock Data: The common stock of Cortland First Financial Corporation is inactively traded in the over-the-counter market. Market makers for the stock are Ryan, Beck & Company (800-342-2325), Monroe Securities, Inc. (716-546-5560), and First Albany Corporation (800-336-3245). There were 526 shareholders of record as of December 31, 1994. Prices & dividends are adjusted for the stock split declared August 16, 1993. Stock prices below are based on low "offer" prices and high "bid" prices for the quarter.
Item 6

Item 6 -- Selected Financial Data Five Year Comparative Summary (In thousands of dollars)
Item 7

Item 7 -- Management's Discussion and Analysis of Financial Condition and Results of Operation
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS:
Cortland First Financial Corporation is a one-bank holding company that was formed in 1986. Its only subsidiary and operating entity is First National Bank of Cortland, chartered in 1869. First National Bank of Cortland is an independent commercial bank delivering financial services from five (5) offices in Cortland County (Cortland, Cortlandville, Marathon, McGraw, and Cincinnatus), one (1) office in southern Onondaga County (Tully), and our newest office in northern Broome County (Whitney Point) which was opened in April of 1994. The primary regulator of Cortland First Financial Corporation is the Federal Reserve Bank of New York in New York City, while its subsidiary, First National Bank of Cortland, is regulated by the Office of the Comptroller of the Currency in Washington, D.C.
CONSOLIDATED BALANCE SHEETS:
Total resources of $198,759,128 on December 31, 1994, compared to $188,683,125 at year-end 1993, an increase of $10,076,003 or 5.3%. Daily average outstandings for 1994 amounted to $195,819,527, compared to $191,445,749 for 1993, an increase of $4,373,778 or 2.3%.
Loans - Total loans at year-end 1994 were $109,908,726, less the Allowance for Loan and Lease Losses (ALLL) of $1,225,737, leaving a net balance of $108,682,989, compared to $104,619,149 in 1993, an increase of $4,063,840 or 3.9%. At year-end 1994, loans secured by real estate amounted to $63,127,003, compared to $62,074,873 on December 31, 1993, which represents 55.7% and 57.2% of total loans, respectively. The majority of these outstandings are in short-term, fixed-rate biweekly mortgages and variable-rate home equity loans. Our commercial and agricultural loans at year-end 1994 amounted to $21,805,908, compared to $21,467,717 last year, a very small increase of $338,191 or 1.6%, indicating a flat commercial loan demand in 1994. We did see an increased demand in our installment loans. Outstandings of $18,556,764 at year-end 1993 rose to $23,305,713 on December 31, 1994, an increase of $4,748,949 or 25.6%. All loans granted were to entities within Cortland County and those immediately adjoining counties which are in our local service areas.
Our ALLL represents 1.12% of our net loans outstanding as of year-end 1994, compared to 1.02% as of year-end 1993. Our 1994 net charge-offs of $153,952 compared favorably to $245,796 in the previous year, a decrease of $91,846 or 37.4%. The adequacy of our ALLL is evaluated as of the end of each quarter, and is judged to be more than adequate to absorb the inherent loss in the portfolio as of year-end. The overall excellent quality of our loan portfolio is indicated by the amount of non-performing loans as a percentage of gross loans at 0.18% on September 30, 1994, compared to 0.71% reported by our national peer group (all insured commercial banks having assets between $100 million and $300 million, with three or more banking offices, located in a non-metropolitan area), on average.
Securities - Investment securities at year-end 1994 amounted to $70,380,051, compared to $67,587,439 in 1993. As required by FASB No. 115 "Accounting for Certain Investments in Debt and Equity Securities," we classified our investment securities as held-to-maturity or available-for-sale. Held-to-maturity securities are reported at cost, while the available-for-sale securities are reported at fair value. The available-for-sale portfolio at year-end 1994 amounted to $47,082,664 (cost $48,562,493 less net unrealized loss of $1,479,829), compared to $49,991,061 at year-end 1993 (cost $48,959,887 plus net unrealized gain of $1,031,174).
Due to a general rise in market interest rates between 1993 and year-end 1994, the market value of securities available for sale declined by $2,511,003. Keep in mind, however, that the unrealized loss of $1,479,829 at year-end 1994 would only be realized upon sale or liquidation of the available-for-sale portfolio. The Bank does not have a trading portfolio and does not expect to have one in the future.
Deposits - On a daily average basis deposit growth in 1994 was relatively flat with an increase of 1.3%. However, deposits did increase from $167,302,184 at December 31, 1993 to $176,967,403 at December 31, 1994, an increase of $9,665,219 or 5.8%. The lack of growth on a daily average basis is attributed to the very modest level of economic growth occurring within the region.
Shareholders' Equity - Shareholders' equity increased from $20,062,562 at December 31, 1993, to $20,423,557 in 1994, an increase of 1.8% in spite of the accounting treatment required by FASB No. 115 for recognition of market value in the investment securities portfolio. In recent years, shareholders' equity has grown at an average rate of almost 10% per annum and, without the effect of FASB No. 115, would have increased by 9.5% in 1994. In fact, banking regulators do not require market value adjustments when calculating capital. Capital for regulatory purposes at year-end was $21,298,877 in 1994 and $19,449,016 at year-end 1993. The Bank has the ability and intent to hold its securities to maturity, thereby not incurring actual losses in the securities accounts. Book value per share increased to $30.39 in 1994, up from $29.86 in 1993, also an increase of 1.8%. The same principles just described also impact book values. Book value per share based on regulatory capital would have been $31.69 in 1994, up from $28.94 in 1993 and $26.08 in 1992. The degree of regulatory action, the availability of funding through brokered deposits, and the level of FDIC risk-based premiums are all dictated by capital ratios. Cortland First Financial Corporation's risk-based capital ratios far exceed the minimum requirements even for the highest capital level (well capitalized).
Liquidity - Liquidity management involves the ability to meet the cash-flow requirements of customers who may be either depositors wanting to withdraw funds or borrowers needing assurance that sufficient funds will be available to meet their credit needs. Securities available-for-sale amounted to $47,082,664 as of December 31, 1994, compared to $49,991,061 at year-end 1993. This, coupled with being a substantial net seller of federal funds in the amount of $8,278,000 on a daily average basis in 1994, compared to $6,485,000 in 1993, indicates a highly liquid position.
Trust Department - At year-end 1994, the book value of the assets held in this department amounted to $49,872,335, compared to $50,129,768 in 1993. Trust Department assets are not part of the consolidated balance sheets.
Interest Rate Risk - IRR exposure arises when a change in interest rates results in a change in the value of a financial instrument. The Asset/Liability Committee of the Bank monitors its interest risk exposure on a regular basis. The interest rate shock report as of December 31, 1994, showed net interest income for the Bank would decrease by $309,600 (after tax) if interest rates increase by 200 basis points in 1995, and it would increase by $355,800 (after tax) if interest rates decline by 200 basis points, suggesting that the Bank has an acceptable rate risk exposure.
CONSOLIDATED STATEMENTS OF INCOME:
Cortland First Financial Corporation reported net income of $2,689,861 for 1994, compared to $2,729,403 in 1993 and $2,208,076 in 1992. Return on average assets (ROA) of 1.37% at year-end compared to 1.43% in 1993 and 1.40% (before FASB No. 106 accounting change) in 1992. Our return on average shareholders' equity (ROE) of 13.25% in 1994 compared to 14.70% in 1993 and 12.99% (after FASB No. 106 accounting change) in 1992. For 1994, we were able to maintain a high net interest margin of 5.51%, compared to 5.50% in 1993 and 5.45% in 1992. Our budgeted net interest margin for 1995 is 5.35%, as we do not expect to maintain our 1994 levels due to increased pressure on the cost of interest- bearing liabilities. We expect that this negative impact on earnings may be offset by higher loan volume and increased deposits in 1995 as funds begin to flow back to CDs from competing investment vehicles. As a well-capitalized and financially sound institution, we continue to pay the lowest possible FDIC premium, which amounted to $384,282 in 1994, compared to $377,957 in 1993 and $356,985 in 1992. All indications are that the FDIC will reduce this premium by the end of 1995, which would give us a reduction in premium for 1995 or 1996. Salaries, wages, and employee benefits amounted to $3,595,566 in 1994, compared to $3,342,654 in 1993 and $3,229,601 in 1992. Occupancy expense of bank premises of $505,396 in 1994 increased $54,280 or 12.0% from $451,116 in 1993, compared to $430,806 in 1992. Most of the $54,280 increase in occupancy expense in 1994 was due to the opening of our Whitney Point branch in April of that year and heavy snow removal expenses for the winter of 1994. Computer and equipment expenses amounted to $593,697 in 1994, compared to $553,747 in 1993 and $460,015 in 1992. The purchase of new hardware and software in April 1993 accounts for an additional increase of three-month depreciation in 1994.
We continue to monitor our expenditures very closely in a commitment to cost control, and we expect, in spite of additional expenses in 1995 due to a major expansion into the Cullen building next door, to continue to have excellent income potential for 1995.
Item 8

Item 8 -- Financial Statements and Supplementary Data The consolidated financial statements, footnotes, and suplementary data follow:
Included in 1994 proceeds from maturities of investment securities are $5,074,752 and $11,794,119 relating to held-to-maturity securities and available-for-sale securities, respectively. Purchases of investment securities for 1994 include $11,779,528 and $10,904,485 relating to held-to-maturity securities and available-for-sale securities, respectively.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS For the years ended Dec. 31, 1994, 1993, 1992
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation: The accompanying financial statements include the accounts of Cortland First Financial Corporation (the Company) and its wholly owned subsidiary, First National Bank of Cortland (the Bank). Intercompany transactions have been eliminated in consolidation.
Cash Flows: Cash equivalents include amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.
Accounting For Postretirement Benefits: The Bank provides postretirement medical and life insurance plans that cover substantially all of its employees. The plans are non-contributory; however, retiree contributions may be required if certain age and length of service criteria are not met.
In December of 1992, the Bank adopted Statement of Financial Accounting Standard No. 106, "Employers Accounting for Postretirement Benefits Other Than Pensions," which requires accrual basis accounting.
The Bank elected to recognize, as of January 1, 1992, the entire accumulated postretirement benefit obligation of $540,615. The cumulative effect on prior years of $319,877 (after reduction for income tax benefit) of this change in accounting principle is included in net income for 1992. The effect of the change in 1992 was to decrease income before the cumulative effect adjustment by approximately $14,000 or $.02 per share (adjusted for 1993 stock split).
The following sets forth the plan's funded status reconciled with the amounts reported in the company's statement of financial position at December 31, for the combined medical and life insurance plans:
A 12% annual rate of increase in the per capita costs of covered health care benefits was assumed for 1994, gradually decreasing to 6% by the year 2032. Increasing the assumed health care cost trend rates by one percentage point in each year would increase the accumulated postretirement benefit obligation as of December 31, 1994, by $90,359 and increase the aggregate of the service cost and interest cost components of net periodic postretirement benefit cost for 1994 by $15,127. A discount rate of 7.5% was used to determine the accumulated postretirement benefit obligation.
Fair Value of Financial Instruments: Statement of Financial Accounting Standard No. 107, "Disclosures about Fair Value of Financial Instruments," requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet, for which it is practicable to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumption used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instrument. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Bank.
The following methods and assumptions were used by the Bank in estimating its fair value disclosures for financial instruments:
Cash and Cash equivalents: The carrying amounts reported in the balance sheet for cash and short-term instruments approximate those assets' fair value.
Investment securities: Fair values for investment securities are based on quoted market prices or dealer quotes.
Loans: Fair values for loans are estimated using discounted cash flow analysis, based on interest rates approximating those currently being offered for loans with similar terms and credit quality. The fair value of accrued interest approximates carrying value.
Deposits: The fair values disclosed for non-interest bearing accounts and accounts with no stated maturity are, by definition, equal to the amount payable on demand at the reporting date. The fair value of time deposits was estimated by discounting expected monthly maturities at interest rates approximating thosecurrently being offered on time deposits of similar terms. The fair value of accrued interest approximates carrying value.
Short-term borrowings: These funds reprice daily and, therefore, current book value was used as an estimate of fair value.
Off-balance sheet instruments: Off-balance sheet financial instruments consist of standby letters of credit, with fair value based on fees currently charged to enter into agreements with similar terms and credit quality.
The net carrying amounts and fair values of financial instruments as of December 31, 1994 are as follows:
The fair value of off-balance sheet financial instruments, principally standby letters of credit, is not significant.
Trust Assets: Property (other than cash deposits) held by the Bank in fiduciary or agency capacities for its customers is not included in the accompanying balance sheets, since such items are not assets of the Bank.
Investment Securities: Effective December 31, 1993 the Bank has adopted Statement of Financial Accounting Standards No. 115, "Accounting for Certain Investments in Debt and Equity Securities." As required by this pronouncement, the Bank has classified its investments in debt securities as held-to-maturity or available-for-sale. Held-to-maturity securities are those for which the Bank has the positive intent and ability to hold to maturity, and are reported at cost, adjusted for amortization of premiums and accretion of discounts. Debt securities not classified as held-to-maturity are classified as available-for-sale and reported at fair value, with net unrealized gains and losses reflected as a separate component of shareholders' equity, net of the applicable income tax effect. None of the Bank's investment securities have been classified as trading securities.
Purchases and sales of investment securities are recorded as of settlement date; gains and losses are based on identification of specific securities.
Fees on Loans: Loan origination fees and certain direct loan origination costs are deferred and the net amount is amortized as a yield adjustment. The Bank is generally amortizing these amounts over the contractual life of the related loans. However, for fixed-rate mort-gage loans that are generally made for a 20-year term, the Bank has anticipated prepayments and used an estimated life of 7.5 years.
Allowance for Possible Loan Losses: The allowance for possible loan losses is maintained at a level considered adequate to provide for potential loan losses. The allowance is increased by provisions charged to operating expenses and reduced by net charge-offs. The level of the allowance is based on management's evaluation of potential losses in the loan portfolio, as well as prevailing economic conditions.
Effective January 1, 1995, the Bank is required to adopt Statement of Financial Accounting Standards No. 114, "Accounting by Creditors for Impairment of a Loan." This pronouncement requires certain impaired loans to be measured based on discounted cash flows or, if collateral dependent, on the fair value of collateral. Adoption of this pronouncement is not expected to have a significant effect on the Bank's financial statements for 1995.
Bank Premises, Furniture and Equipment: Bank premises, furniture and equipment are stated at cost less accumulated depreciation. Annual provisions for depreciation are computed by the straight-line or declining balance methods over the estimated useful lives of the assets. Repairs and maintenance are charged to expenses as incurred, whereas capital additions and betterments are capitalized.
Other Real Estate: Other real estate is carried at cost or fair value, less estimated disposal costs, whichever is lower.
Income Taxes: Effective January 1, 1993, the Bank adopted FASB Statement No. 109 "Accounting for Income Taxes" which requires an asset and liability approach to recognizing the tax effects of temporary differences between tax and financial reporting. In prior years, the Bank accounted for the tax effects of timing differences between tax and financial reporting using Accounting Principles Board opinion No. 11. This change had no significant effect on the 1993 financial statements.
Retirement Benefits: The Bank has a defined contribution pension plan, administered by its Trust Department, for all eligible employees. Contributions to the plan are determined based upon percentages of compensation for eligible employees and are funded as accrued. Pension expense for 1994, 1993, and 1992 was $97,101, $112,906 and $110,576, respectively. The Bank also has a defined contribution 401(k) savings plan, administered by its Trust Department, for all eligible employees. Contributions to the plan are determined by the Board of Directors, at its discretion, and are funded as accrued. Up to certain limitations, employees may also contribute to this plan. Expense under this plan was $81,523 in 1994, $72,155 in 1993, and $76,569 in 1992.
The Bank maintains a supplemental retirement plan for its President and Chief Executive Officer. The Bank has transferred funds to its Trust Department to fund the estimated benefit liability upon retirement. Plan expense of $58,005, $21,443 and $9,844 was recognized for the years ended December 31, 1994, 1993, and 1992, respectively.
Stock Split: During August 1993, the Company effected a two-for-one stock split through the issuance of one additional share of $5 par value common stock for every share then outstanding.
Per-Share Amounts: Earnings per share are computed on the basis of weighted average shares outstanding, retroactively adjusted for the stock split (672,000 for 1994, 1993, and 1992). Cash dividends per share are based on declared rates, retroactively adjusted for the stock split.
INVESTMENT SECURITIES The amortized cost and approximate fair value of investment securities at December 31, 1994 and 1993 are as follows:
At December 31, 1994 securities having a book value of $43,756,344 were pledged to collateralize public fund deposits as required by law.
The amortized cost and estimated market value of investment securities at December 31, 1994, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.
ALLOWANCE FOR POSSIBLE LOAN LOSSES Changes in the loan loss allowance during the years ended December 31, 1994, 1993 and 1992 are summarized as follows:
Substantially all of the Bank's borrowers are concentrated within Cortland and adjacent counties.
BANK PREMISES, FURNITURE AND EQUIPMENT Bank premises, furniture and equipment are comprised of the following:
COMMITMENTS, CONTINGENT LIABILITIES AND RESTRICTIONS The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit and letters of credit which involve, to varying degrees, elements of credit risk in excess of amounts recognized in the consolidated balance sheet. The contract amount of those commitments and letters of credit reflects the extent of involvement the Bank has in those particular classes of financial instruments. The Bank's exposure to credit loss in the event of nonperformance by the counterparty to the financial instrument for commitments to extend credit and letters of credit is represented by the contractual amount of the instruments. The Bank uses the same credit policies in making commitments and letters of credit as it does for on-balance-sheet instruments.
Financial instruments whose contract amounts represent credit risk:
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. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitment amounts are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit written are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements, including bond financing and similar transactions.
The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. Since the letters of credit are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements.
For both commitments to extend credit and letters of credit, the amount of collateral obtained, if deemed necessary by the Bank upon the extension of credit, is based on management's credit evaluation of the counterparty. Collateral held varies, but includes residential and commercial real estate.
The Bank's current risk-based capital ratio, which included the aforementioned commitments, is more than twice the minimum of 8.00% required by the regulators.
Principal operating leases are for bank premises. At December 31, 1994, aggregate future minimum lease payments under non-cancelable operating leases with initial or remaining terms equal to or exceeding one year consist of the following: 1995 - $51,620; 1996 - $51,620; 1997 - $51,620; 1998 - $51,620; and 1999 - $51,620 and $551,480 thereafter. Total rental expense amounted to $53,575 in 1994, $41,799 in 1993, and $56,299 in 1992.
The Bank is subject to legal limitation on the amount of dividends that can be paid to the Company. Dividends are limited to retained net profits, as defined. At December 31, 1994, approximately $5,400,000 was available for the declaration of dividends by the Bank.
INCOME TAXES The income tax provision for 1994, 1993, and 1992 is summarized as follows:
The provision for income taxes includes the following:
The components of deferred income taxes at December 31, 1994 and 1993 are as follows:
For 1992, deferred income taxes resulting from timing differences in the recognition of income and expense for tax and financial reporting purposes related principally to provision for loan losses, loan fees and compensation expense.
A reconciliation between the statutory federal income tax rate and the effective income tax rate for 1994, 1993, 1992 is as follows:
A deferred tax benefit of $220,738 was recognized in 1992 in connection with the cumulative effect of accounting for postretirement benefits.
RELATED PARTY TRANSACTIONS Directors and executive officers of the Bank and their affiliated companies were customers of, and had other transactions with, the Bank in the ordinary course of business during 1994. It is the Bank's policy that all loans and commitments included in such transactions are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other persons and do not involve more than the normal risk of collectibility or present other unfavorable features. Loan transactions with related parties are summarized as follows:
Balance at December 31, 1993 $2,992,026 New loans and advances 2,635,674 Loan payments 1,227,570 Balance at December 31, 1994 $4,400,130
LINES OF CREDIT At December 31, 1994, the Bank had available lines of credit totaling $3,000,000 which were unused.
PARENT COMPANY FINANCIAL INFORMATION Condensed financial statement information of Cortland First Financial Corporation is as follows:
REPORT OF INDEPENDENT AUDITORS Board of Directors and Shareholders Cortland First Financial Corporation and Subsidiary
We have audited the accompanying consolidated balance sheets of Cortland First Financial Corporation and Subsidiary as of December 31, 1994 and 1993, and the related consolidated statements of income, changes in shareholders' equity and cash flows for each of the three years in the period ended December 31, 1994. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audit in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Cortland First Financial Corporation and Subsidiary at December 31, 1994 and 1993, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 1994, in conformity with generally accepted accounting principles.
As further discussed in the notes to financial statements, the Company adopted SFAS No. 109 (Accounting for Income Taxes) and SFAS No. 115 (Accounting for Investments in Certain Debt and Equity Securities) in 1993 and SFAS No. 106 (Accounting for Postretirement Benefits Other Than Pensions) in 1992.
COOPERS & LYBRAND L.L.P. Syracuse, New York January 13, 1995
Distribution of Assets, Liabilities, and Shareholders' Equity: The following table sets forth the amounts of the Corporation's daily average assets, liabilities, and shareholders' equity for the period indicated, the amounts of the interest earned and interest paid thereon, the average interest rate earned for each type of earning asset, and the average rate paid for each type of interest bearing liability. Interest earned on non-accruing loans is included in the interest earned on loans only when collected. The average balances of non-accruing loans are included in the average balances of loans. Taxable equivalent adjustments have been made based on applicable marginal Federal and State tax rates.
Interest Rates and Interest Differential:
The following table sets forth for the periods indicated a survey of the changes in interest earned and interest paid resulting from changes in volume and changes in rates. Interest earned on non- accruing loans is included in the interest earned on loans only when collected, i.e., on the cash basis, but the average balances of such loans are included in the average balances of loans. The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
INVESTMENT PORTFOLIO - MATURITY SCHEDULE
The following schedule sets forth the maturities of both available-for-sale and held-to-maturity securities at December 31, 1994. Amounts and weighted average yields of such securities are based on amortized cost for all securities. Yield of tax exempt securities have been computed on a tax equivalent basis using a marginal Federal and State income tax rate. (Excludes Federal Reserve Bank and other stock of $207,000.)
At December 31, 1994, 78% of the state and municipal securities portfolio, based upon par value was rated "A" or higher, and 77% "AA" or higher. Obligations of the State of New York and its political subdivisions constituted $17,765,998 par value or 25% of the portfolio at that date, with a market value of $17,800,655.
There were no securities of a single issuer which constituted more than 10% of shareholders equity as of December 31, 1994.
Gap analysis indicates the sensitivity to fluctuations in interest rates by providing information regarding maturity repricing and cash flows for both assets and liabilities. Cash and Federal funds sold are assigned to immediate repricing since they represent overnight sales. Investment securities are scheduled according to the final maturity date in the case of fixed rate issues and by next repricing date for variable rate securities. Loans are assigned by final maturity for fixed rate loans with no scheduled amortizing payments, while loans with amortizing payments are scheduled according to amortized paybacksince this would represent a repricing opportunity on funds received as payments. Variable rate loans are assigned to the next repricing date. Demand loans are categorized as immediately repriceable. Non-interest bearing deposits repricing within three months are at least equal to the amount of cash and due from banks. The remaining interest bearing, savings, and money market accounts which represent core deposits are spread across the Gap buckets to yield a 3 1/2 year average maturity. Fixed rate certificates of deposit are assigned by final maturity date, while variable rate are assigned as of the next repricing date. Fixed assets, other assets, other liabilities, and equity are assigned to the over five year category since they represent stable, non-repricing components.
Non-accruing Loans
The Company does not accrue interest on certain non-performing loans. Non- accrual status is normally reserved for loans 90 days or more past due unless both well secured and in the process of collection.
Potential Problem Loans
At December 31, 1994, the Company had $7,457,000 in commercial and consumer loans for which payments are presently current, but the borrowers are currently experiencing financial difficulties. Those loans are subject to constant management attention and are reviewed weekly. The Registrant had no restructured loans as defined by SFAS 15 in the portfolio. Loans which are current for which collection is doubtful are not normally placed in non-accrual status. Such loans are on a watch list to allow monitoring by management.
Loans classified for regulatory purposes as loss, doubtful, substandard, or special mention that are not included above, do not represent or result from trends or uncertainties which management reasonably expects will materially impact future operating results, liquidity, or capital resources, nor do they represent material credits about which management is aware of information which causes management to have serious doubts as to the ability of such borrowers to comply with the loan repayment terms.
Loan Concentration
There are no concentrations of loans which amount to more than 10% of total loans other than those which have been separately disclosed, i.e., rental estate, consumer, commercial, agricultural, and municipal. All loans granted are to entities within Cortland County and those immediately adjoining counties which are in our local service area. We have no outside area loans in our portfolio.
Allowance for Possible Loan Losses
The allowance for possible loan losses is maintained at a level considered adequate to provide for potential loan losses. The allowance is increased by provisions charged to operating expenses and reduced by net charge-offs. The adequacy of the allowance is based on management evaluation of the last three years historical loss experience, specific allocations for losses detailed in the loan loss review, and an additional allocation based on the total outstandings in the loan portfolio. Additional factors considered in the evaluation include the levels and trends in delinquencies and non-accruals, underwriting guidelines and collection procedures, the experience and ability of the lending staff, and current economic conditions within our lending area. The Company has a diverse customer base with no known significant concentrations of credit that would affect the allowance.
Summary of Loan Loss Experience
The following table summarizes the Company's loan loss experience for the two years ended December 31, 1994.
Deposits
The exhibit below presents daily average amounts and rates of deposits by type for the years ended December 31, 1994 and December 31, 1993.
Maturities of time certificates of deposit of $100,000 or more outstanding at December 31, 1994, are summarized as follows:
Amount (in thousands of dollars) 3 months or less $2,554 Over 3 through 6 months 918 Over 6 through 12 months 1,648 Over 12 months 907 Total $6,027
Non-interest bearing deposits disclosed represent all demand deposits which are non-interest bearing. These deposits are held by individuals, partnerships, corporations, and municipalities. There are no significant deposits from trust activities.
Return on Equity and Assets
The following table shows operating and capital ratios for the last two years. Year Ended December 31, 1994 1993 Return on Assets Net Income/Average Total Assets 1.37% 1.43%
Return on Equity Net Income/Average Shareholder Equity 13.25% 14.70%
Dividend Payout Ratio Cash Dividends Declared/Net Income 31.23% 29.55%
Capital Ratio Average Shareholder Equity/ Average Total Assets 10.37% 9.70%
Item 9

Item 9 -- Changes In and Disagreements with Accountants on Accounting and Financial Disclosure Not Applicable.
PART III
Item 10

Item 10 -- Directors and Executive Officers of the Registrant Directors are listed in the Annual Proxy Statement, dated February 28, 1995, pages 2 through 4, incorporated herein by reference.
Item 11

Item 11 -- Executive Compensation Annual Proxy Statement, dated February 28, 1995, pages 6 through 10, incorporated herein by reference.
Item 12

Item 12 -- Security Ownership of Certain Beneficial Owners and Management Annual Proxy Statement, dated February 28, 1995, pages 2 through 4, incorporated herein by reference.
Item 13

Item 13 -- Certain Relationships and Related Transactions Annual Proxy Statement, dated February 28, 1995, pages 4 and 10, incorporated herein by reference.
PART IV Item 14

Item 14 -- Exhibits, Financial Statement Schedules, and Reports on 8-K
(a) Documents filed as part of this report:
(2) Financial statement schedules are omitted from this Form 10-K since the required information is not applicable to the Registrant. (3) Listing of Exhibits:
The following documents are attached as Exhibits to this Form 10-K as indicated by the page number or exhibit or are incorporated by reference to the prior filings of the Registrant with the Commission.
Form 10-K Exhibit Number Exhibit Page
3.1 Certificate of Incorporation of Cortland First Financial Corporation *
3.2 Bylaws of the Company *
4 Specimen Stock Certificates *
22 List of Registrant's Subsidiary E-1
* Exhibit is incorporated herein by reference to the identically numbered exhibit to the Form S-4 Registration Statement filed by the Company with the Securities an Exchange Commission on August 18, 1986.
Item 14 (b) There were no reports filed on Form 8-K during the fourth quarter of 1994.
Item 14 (c) See Item 14 (a) (3) above.
Item 14 (d) See Item 14 (a) (2) above.
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 FIRST FINANCIAL CORPORATION (Registrant) Date March 27, 1995 By \s\ David R. Alvord
David R. Alvord, President and Chief Executive Officer
Date March 27, 1995 By \s\ Bob Derksen
Bob Derksen, Vice President and Chief Financial Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant, and in the capacities and on the dates indicated.
David R. Alvord, President, CEO and Director Date March 27, 1995
Donald S. Ames, Director Date March 27, 1995
Mary Alice Bellardini, Director Date March 27, 1995
John S. Buck, Director Date March 27, 1995
Robert M. Lovell, Director Date March 27, 1995
Harry D. Newcomb, Director Date March 27, 1995
Richard J. Shay, Director Date March 27, 1995
Charles H. Spaulding, Director Date March 27, 1995
David J. Taylor, Director Date March 27, 1995
Esther F. Twentyman, Director Date March 27, 1995
Stuart Young, Director Date March 27, 1995
Exhibit 22 -- Subsidiaries
Subsidiary of the Registrant
First National Bank of Cortland is a wholly owned subsidiary of Cortland First Financial Corporation.