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SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K



|    |  |                                                                                                                                 
|--- |  | --------------------------------------------------------------------------------------------------------------------------------
|[X] |  | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2009

OR



|     |  |                                                                                                                            
|---- |  | ---------------------------------------------------------------------------------------------------------------------------
|[  ] |  | 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 0-15366

ALLIANCE FINANCIAL CORPORATION

(Exact name of Registrant as specified in its charter)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|NewYork                                                        |  | 16-1276885                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|120 Madison Street, 18thFloor, Syracuse, NY 13202              |  | 13202                               
|(Address of principal executive offices)                       |  | (ZIP Code)                          

Registrants telephone number including area code:
(315) 475-2100

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class: Common Stock, $1.00 par value per share

Name of each exchange on which registered: The NASDAQ Stock Market LLC

Securities
registered pursuant to Section 12(g) of the Act:  None

Indicate by check mark if the registrant is a
well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

|    |  |    
|--- |  | ---
|Yes |  | NoX

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act.

|    |  |    
|--- |  | ---
|Yes |  | NoX

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for
such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

|     |  |   
|---- |  | --
|YesX |  | No

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule
405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes     No

Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K 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 this Form 10-K or any amendment to
this Form 10-K. [  ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, a non-accelerated filer, or a smaller reporting company. See definition of accelerated filer, large accelerated filer and smaller reporting company in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer [  ]            Accelerated Filer
[X]                Non-accelerated filer
[  ]            Smaller Reporting Company [  ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).    Yes            NoX

As of June 30, 2009, the aggregate market value of the voting stock held by non-affiliates of the registrant was $118.8 million based on the closing sale price as reported on
the NASDAQ Global Market.

The number of outstanding shares of the Registrants common stock, $1 par value per share, on
March 10, 2010 was 4,614,292 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the 2010 annual shareholders meeting (the Proxy Statement) are incorporated by reference in
Part III of this Annual Report on Form 10-K.



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TABLE OF CONTENTS

FORM 10-K ANNUAL REPORT

FOR THE YEAR ENDED

DECEMBER 31, 2009

ALLIANCE FINANCIAL CORPORATION



|         |  |          |  |                                                                                                                 |  |     
|-------- |  | -------- |  | --------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |          |  |                                                                                                                 |  | Page
|         |  |          | 
|PART I   |  |          |  |                                                                                                                 |  |     
|         |  |          | 
|         |  | Item 1.  |  | Business                                                                                                        |  | 1   
|         |  | Item 1A. |  | Risk Factors                                                                                                    |  | 5   
|         |  | Item 1B. |  | Unresolved Staff Comments                                                                                       |  | 9   
|         |  | Item 2.  |  | Properties                                                                                                      |  | 9   
|         |  | Item 3.  |  | Legal Proceedings                                                                                               |  | 9   
|         |  | Item 4.  |  | Reserved                                                                                                        |  | 10  
|         |  |          | 
|PART II  |  |          |  |                                                                                                                 |  |     
|         |  |          | 
|         |  | Item 5.  |  | Market for the Registrants Common Equity, Related Stockholder Matters andIssuer Purchases of Equity Securities |  | 10  
|         |  | Item 6.  |  | Selected Financial Data                                                                                         |  | 12  
|         |  | Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results ofOperations                            |  | 15  
|         |  | Item 7A. |  | Quantitative and Qualitative Disclosures about Market Risk                                                      |  | 31  
|         |  | Item 8.  |  | Financial Statements and Supplementary Data                                                                     |  | 32  
|         |  | Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and FinancialDisclosure                             |  | 72  
|         |  | Item 9A. |  | Controls and Procedures                                                                                         |  | 72  
|         |  | Item 9B. |  | Other Information                                                                                               |  | 72  
|         |  |          | 
|PART III |  |          |  |                                                                                                                 |  |     
|         |  |          | 
|         |  | Item 10. |  | Directors and Executive Officers of the Registrant and Corporate Governance                                     |  | 73  
|         |  | Item 11. |  | Executive Compensation                                                                                          |  | 73  
|         |  | Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and RelatedStockholder Matters                   |  | 73  
|         |  | Item 13. |  | Certain Relationships, Related Transactions and Director Independence                                           |  | 73  
|         |  | Item 14. |  | Principal Accountant Fees and Services                                                                          |  | 73  
|         |  |          | 
|PART IV  |  |          |  |                                                                                                                 |  |     
|         |  |          | 
|         |  | Item 15. |  | Exhibits and Financial Statement Schedules                                                                      |  | 74  



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PART I

Cautionary Note Regarding Forward-Looking Statements

This Annual Report
on Form 10-K contains certain forward-looking statements with respect to the financial condition, results of operations and business of Alliance Financial Corporation and its subsidiaries. These forward-looking statements include: statements of our
goals, intentions and expectations; statements regarding our business plans and prospects and growth and operating strategies; estimates of our risks and future costs and benefits. These forward-looking statements, within the meaning of the Private
Securities Litigation Reform Act of 1995, involve certain risks and uncertainties. Factors that may cause actual results to differ materially from those contemplated by such forward-looking statements include, among others, the following
possibilities: an increase in competitive pressure in the banking industry; changes in the interest rate environment which may reduce margins; changes in the regulatory environment; general economic conditions, both nationally and regionally,
resulting, among other things, in a deterioration in credit quality; changes in business conditions and inflation; changes in the securities markets; changes in technology used in the banking business; the possibility that current and potential
future restrictions under the Emergency Economic Stabilization Act (as amended) on the Companys executive compensation plans will impair its ability to attract and retain key personnel; the possibility that evolving government intervention
into the financial markets negatively impacts the Companys operations; our ability to maintain and increase market share and control expenses; and other factors detailed from time to time in our SEC filings. See Item 1A of this Form 10-K.

Item 1 Business

General

Alliance Financial Corporation (the Company or
Alliance) is a New York corporation and a registered financial holding company formed on November 25, 1998 as a result of the merger of Cortland First Financial Corporation and Oneida Valley Bancshares, Inc., which were incorporated
May 30, 1986 and October 31, 1984, respectively. The Company is the holding company of Alliance Bank, N.A. (the Bank), which was formed as the result of the merger of First National Bank of Cortland and Oneida Valley National
Bank in 1999.

The Bank provides financial services from 29 retail branches and customer service facilities in the New York
counties of Cortland, Madison, Oneida, Onondaga, Oswego, and from a Trust Administration Center in Buffalo, NY. Primary services include commercial, retail and municipal banking, consumer finance, mortgage financing and servicing, trust and
investment management services. The Bank has a substantially wholly-owned subsidiary, Alliance Preferred Funding Corp., which is engaged in residential real estate activity, and a wholly-owned subsidiary, Alliance Leasing, Inc.

The Companys administrative offices are located on the 18thFloor, AXA Tower II, 120 Madison St., Syracuse, New York. Banking services are provided at the
administrative offices as well as at the Companys 29 customer service facilities.

On February 18, 2005, the Bank
acquired a portfolio of personal trust accounts and related assets under management from HSBC, USA, N.A. The Bank assumed the successor trustee role from HSBC on approximately 1,800 personal trust accounts and further assumed approximately $560
million in assets under management. Combined with its existing trust business the Bank now manages approximately $786 million of related investment assets at December 31, 2009.

On October 6, 2006, Alliance completed its acquisition of Bridge Street Financial, Inc. (Bridge Street) and its wholly-owned subsidiaries, Oswego County National
Bank (OCNB) and Ladds Agency Inc. (Ladds), an insurance agency. In connection with the acquisition, Alliance issued approximately 1,292,000 shares of common stock valued at $38.1 million, and paid cash of $13.2
million for total merger consideration of $51.3 million. At the time of the acquisition, Bridge Street had $219.3 million in assets, $148.3 million in gross loans, and $169.2 million in deposits. In the acquisition, Bridge Street was merged into
Alliance, Ladds became a wholly-owned subsidiary of Alliance, and Oswego County National Bank was merged into the Bank.

The Company formed Alliance Financial Capital Trust I and Alliance Financial Capital Trust II (collectively Capital Trusts) for the purpose of issuing corporation-obligated mandatorily redeemable capital securities to
third-party investors and investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of the Company.

At December 31, 2009, the Company had 337 full-time equivalent employees. The Companys employees are not represented by any collective bargaining group. The Company considers its employee
relations to be good.

The Bank is a member of the Federal Reserve System and the Federal Home Loan Bank System, and its
deposits are insured by the Federal Deposit Insurance Corporation up to applicable limits.

Services

The Company offers full-service banking with a broad range of financial products to meet the needs of its commercial, retail, government,
and investment management customers. Depository account services include interest and non-interest-bearing checking accounts, money market accounts, savings accounts, time deposit accounts, and individual retirement accounts. The Companys
lending activities include



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the making of residential and commercial mortgage loans, business lines of credit, working capital facilities and business term loans, as well as installment loans, home equity loans, and
personal lines of credit to individuals. Investment management and trust services include personal trust, employee benefit trust, investment management, custodial, and financial planning. Through UVEST Financial Services, member NASD/SIPC, the Bank
provides financial counseling and brokerage services. The Company also offers safe deposit boxes, wire transfers, collection services, drive-up banking facilities, 24-hour night depositories, automated teller machines, 24-hour telephone banking, and
on-line internet banking. Personal and commercial insurance products are offered on an agency basis through Ladds Agency, Inc., a multi-line insurance agency.

Competition

The Companys business is extremely competitive. The
Company competes not only with other commercial banks but also with other financial institutions such as thrifts, credit unions, money market and mutual funds, insurance agencies and companies, brokerage firms, and a variety of other financial
services companies.

Supervision and Regulation

The following discussion summarizes some of the laws and regulations applicable to bank holding companies and national banks and provides certain specific information relevant to the Company. This
regulatory framework is primarily intended for the protection of depositors, consumers, and the deposit insurance funds that insure bank deposits, and not for the protection of shareholders or creditors of bank holding companies and banks. To the
extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Moreover, Congress, regulatory agencies, and state legislatures frequently propose changes to the
law and regulations affecting the banking industry. The likelihood and timing of any changes and the impact such changes might have on the Company are impossible to accurately predict.A change in the statutes, regulations, or regulatory
policies applicable to the Company or its subsidiaries may have a material adverse effect on their business.

The Company is a
bank holding company registered under the Bank Holding Company Act of 1956 and, as such, is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the Federal Reserve Board or
FRB). The Bank Holding Company Act and other federal laws and regulations subject bank holding companies to restrictions on the types of activities in which they may engage, as well as to a supervisory regime that provides for possible
regulatory enforcement actions for violations of laws and regulations. The Company elected to also become a financial holding company on June 21, 2006. A bank holding company that also qualifies as a financial holding company can expand into a
wide variety of services that are deemed by the FRB to be financial in nature, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting; and merchant banking. In order for
a bank holding company to qualify for financial holding company status, each one of the bank holding companys subsidiary depository institutions must be deemed well managed and well capitalized by regulators and must
have received at least a Satisfactory rating on its last Community Reinvestment Act (CRA) examination.

The Bank
Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if
after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. In approving bank acquisitions by bank holding companies, the Federal Reserve Board is required to consider the financial and
managerial resources and future prospects of the bank holding company and the banks concerned; the convenience and needs of the communities to be served; and various competitive factors. The Change in Bank Control Act prohibits a person or group of
persons from acquiring control of a bank or bank holding company unless the Federal Reserve Board has been notified and has not objected to the transaction. In addition, any entity is required to obtain the approval of the Federal
Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of the Companys outstanding common stock, or otherwise obtaining control or a controlling
influence over the Company.

The FRB has broad authority to prohibit activities of bank holding companies and their
nonbanking subsidiaries that represent unsafe and unsound practices or which constitute violations of laws or regulations, and can bring enforcement actions, including the assessment of civil money penalties, for certain violations or practices.

Under FRB policy, a holding company is expected to act as a source of financial and managerial strength to each of its
banking subsidiaries and to commit resources to their support. The Federal Reserve Board may charge the holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. Any capital
loans by the Company to its subsidiary bank would be subordinate in right of payment to depositors and to certain other indebtedness of the subsidiary bank.

The Companys ability to pay dividends to its shareholders is primarily dependent on the ability of the Bank, the Companys bank subsidiary, to pay dividends to the Company. The ability of both
the Company and the Bank to pay dividends is limited by federal statutes, regulations and policies. For example, it is the policy of the Federal Reserve Board that holding companies should pay cash dividends on common stock only out of income
available over the past year, and only if prospective earnings retention is consistent with the holding companys expected future needs and financial condition. The policy provides that holding companies should not maintain a level of cash
dividends that undermines the holding companys ability to serve as a source of strength to its banking subsidiaries. Furthermore, the Bank must obtain regulatory approval for the payment of dividends if the total of all dividends declared in
any calendar year would exceed the total of the Banks net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two years. The Bank may not pay a dividend in an amount greater
than its undivided profits then on hand after deducting its losses and bad debts, as defined by applicable regulations.



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The Federal Reserve Board has established risk-based capital guidelines that are applicable
to bank holding companies. The guidelines establish a framework intended to make regulatory capital requirements more sensitive to differences in risk profiles among banking organizations and take off-balance sheet exposures into explicit account in
assessing capital adequacy. The Federal Reserve Board guidelines define the components of capital, categorize assets into different risk classes, and include certain off-balance sheet items in the calculation of risk-weighted assets. At least half
of the total capital must be comprised of common equity, retained earnings and a limited amount of perpetual preferred stock, less goodwill (Tier 1 capital). Bank holding companies that are subject to the guidelines are required to
maintain a ratio of Tier 1 capital to risk-weighted assets of at least 4.00% and a ratio of total capital to risk-weighted assets of at least 8.00%. The appropriate regulatory authority may set higher capital requirements when an organizations
particular circumstances warrant. The remainder (Tier 2 capital) may consist of a limited amount of subordinated debt, limited-life preferred stock, certain other instruments and a limited amount of loan and lease loss reserves. The sum
of Tier 1 capital and Tier 2 capital is total risk-based capital. The Companys Tier 1 and total risk-based capital ratios as of December 31, 2009 were 12.07% and 13.14%, respectively. In addition, the Federal Reserve Board has
established a minimum leverage ratio of Tier 1 capital to quarterly average assets less goodwill (Tier 1 leverage ratio) of 3.00% for the bank holding companies with the highest supervisory ratings. All other financial holding companies
are required to maintain a Tier 1 leverage ratio of at least 4.00%. The Companys Tier 1 leverage ratio as of December 31, 2009 was 7.55%. The guidelines provide that banking organizations experiencing internal growth or making
acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.

On March 1, 2005 the Federal Reserve Board issued a final rule that allows the continued inclusion of trust preferred securities in the Tier 1 capital of bank holding companies. Trust preferred
securities, however, will be subject to stricter quantitative limits. The rule provides that trust preferred securities, together with other restricted core capital elements, can be included in a bank holding companys Tier 1
capital up to one-third of the sum of core capital elements, including restricted core capital elements, as defined in the rule. At December 31, 2009, the Companys trust preferred securities comprised 23.6% of the sum of the
Companys Tier 1 capital.

Transactions between the holding company and its subsidiary bank are subject to Sections 23A
and 23B of the Federal Reserve Act, and to Regulation W, which implements these statutory provisions (collectively, the transactions with affiliates rules). In general, the transactions with affiliates rules impose limits on the amount
of affiliate transactions, require certain levels of collateral for loans to affiliates, limit the amount of advances to third parties that are collateralized by the securities or obligations of affiliates, and require that transactions with
affiliates be on market terms.

Loans to directors, executive officers, principal shareholders and their related interests
(collectively, insiders) are restricted by the provisions of Regulation O, which apply to all insured depository institutions and their subsidiaries and holding companies. These restrictions include limits on loans to insiders and
conditions that must be met in order for such loans to be made. The insiders themselves, as well as the institutions making the loans, are subject to enforcement actions for violations of Regulation O. In addition, the Bank is subject to legal
lending limits, which restrict the amount of credit that can be extended to any one borrower, whether or not the borrower is an insider.

As a national bank, the Bank is subject to primary supervision, regulation, and examination by the Office of the Comptroller of the Currency (OCC). The Bank must file periodic reports with the
OCC concerning its activities and financial condition, and must obtain regulatory approval to enter into certain transactions or conduct certain activities. Like other federal banking regulators, the OCC has broad authority to examine and supervise
the Bank and to evaluate the Banks compliance with applicable laws, regulations and guidance. The OCC may initiate enforcement actions to sanction, remedy, or prevent unsafe or unsound banking practices, breaches of fiduciary duty, and/or
violations of law.

The Bank is subject to a wide variety of statutes and regulations that significantly affect its business
and activities. Such statutes and regulations include those relating to capital requirements, allowable investments, underwriting of loans, reserves against deposits, trust activities, mergers and consolidations, payment of dividends, establishment
of branches and certain other facilities, limitations on loans to one borrower and loans to affiliated persons, and numerous other aspects of the business of banks. Additionally, bank holding companies and their affiliates are prohibited from tying
the provision of certain services, such as extensions of credit, to other services offered by a holding company or its affiliates. The Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in
transactions with banks. These laws and regulations include, among others, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Fair Credit Reporting Act, provisions of the
Gramm-Leach-Bliley Act of 1999 relating to privacy and safeguarding of consumer information, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act. These laws and
regulations mandate certain disclosures and, in certain cases, restrict the terms on which the Bank may offer products and services to consumers.

Additionally, the Bank is subject to the Community Reinvestment Act of 1977 (CRA) and the regulations issued thereunder, which are intended to encourage banks to help meet the credit needs of
their service area, including low-to-moderate-income (LMI) neighborhoods, consistent with safe and sound operations. The CRA also provides for regulatory assessment of a banks record in meeting the needs of its service area when
considering applications regarding establishing branches, mergers or other bank or branch acquisitions. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the
filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction. The Bank received a rating of
Satisfactory at its last CRA exam.

The Bank and Company are also subject to certain laws and regulations designed
to prevent money laundering and terrorist financing, including the Bank Secrecy Act and the USA PATRIOT Act. These impose certain recordkeeping and reporting requirements for certain financial transactions that are of primary money laundering
concern, due diligence requirements concerning the beneficial ownership of certain types of accounts, and restrictions or prohibitions on certain types of accounts with foreign financial institutions. Covered financial



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institutions also are barred from dealing with foreign shell banks. The federal banking agencies consider the effectiveness of a financial institutions anti-money-laundering
activities when reviewing regulatory applications such as those for bank mergers and acquisitions. The Bank has in place a comprehensive program to ensure compliance with these requirements. In 2009, the Bank engaged in a very limited number of
transactions covered by the Bank Secrecy Act of any kind with foreign financial institutions or foreign persons.

Under the
Prompt Corrective Action (PCA) provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA), federal banking regulators are required to take prompt corrective action regarding
depository institutions that do not meet certain minimum capital requirements. The PCA provisions impose progressively more restrictive constraints on banks as their capital levels decline. The PCA provisions identify the following capital
categories for financial institutions: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Rules adopted by the
federal banking agencies implementing PCA provide that an institution is deemed to be well capitalized if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based ratio of 6.0% or greater, and a leverage ratio of
5.0% or greater, and the institution is not subject to an order, written agreement, capital directive, or PCA directive to meet and maintain a specific level for any capital measure. Additionally, under FDIC regulations, no FDIC-insured bank can
accept brokered deposits unless it is well capitalized, or is adequately capitalized and receives a waiver from the FDIC. In addition, these regulations prohibit any bank that is not well capitalized from paying an interest rate on brokered deposits
in excess of three-quarters of one percentage point over certain prevailing market rates. At December 31, 2009, the Company and the Bank were in the well capitalized category.

The Bank must pay assessments to the FDIC for federal deposit insurance. The FDIC has adopted a risk-based assessment system under which FDIC-insured depository institutions pay
insurance premiums at rates based on their risk classification. Institutions assigned to higher risk classifications pay assessments at higher rates than institutions that pose a lower risk. An institutions risk classification is assigned
based on its capital level and the level of supervisory concern the institution poses to the regulators. In addition, the FDIC can impose special assessments in certain instances.

The Federal Deposit Insurance Reform Act of 2005 gives the FDIC increased flexibility in assessing premiums on banks and savings associations, including the Bank, to pay for deposit
insurance and in managing its deposit insurance reserves. The reform legislation provides a credit to all insured institutions, based on the amount of their insured deposits at year-end 1996, to offset the premiums that they may be assessed;
establishes a single Deposit Insurance Fund covering all banks and thrifts; increases deposit insurance to $250,000 for Individual Retirement Accounts; and authorizes inflation-based increases in deposit insurance on other accounts every 5 years,
beginning in 2011. The FDIC also is directed to conduct studies regarding further deposit insurance reform.

In December 2009,
the FDIC enacted a proposal that required most FDIC-insured banks to prepay their projected insurance assessments for the years 2010 through 2012. In December 2009, the Company advanced approximately $5.7 million of such prepaid assessments. This
advance assumes average insured deposit growth for the Company of 5% through 2012 and increases in assessment rates of approximately 22% from current rates. The prepaid assessments were capitalized as an asset and will be amortized based on the
expected period in which the assessment would have been incurred. The Companys average quarterly FDIC insurance expense is projected to be $395,000, $504,000, and $530,000 in 2010, 2011 and 2012, respectively. The actual FDIC insurance expense
could be higher if the balance in the deposit insurance fund reaches levels that cause the FDIC to implement additional special assessments or take other actions that result in an increase to the amounts paid by banks under the FDIC insurance
program.

The earnings of the Company are significantly affected by the monetary and fiscal policies of governmental
authorities, including the Federal Reserve Board. Among the instruments of monetary policy used by the Federal Reserve Board to implement these objectives are open-market operations in U.S. Government securities and federal funds, changes in the
discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These instruments of monetary policy are used in varying combinations to influence the overall level of bank loans, investments and deposits,
and the interest rates charged on loans and paid for deposits. The Federal Reserve Board frequently uses these instruments of monetary policy, especially its open-market operations and the discount rate, to influence the level of interest rates and
to affect the strength of the economy, the level of inflation or the price of the dollar in foreign exchange markets. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banking institutions
in the past and are expected to continue to do so in the future. It is not possible to predict the nature of future changes in monetary and fiscal policies, or the effect that they may have on the Companys business and earnings.

The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) also imposes numerous requirements designed to address corporate and accounting
fraud. Sarbanes-Oxley requires chief executive officers and chief financial officers, or their equivalent, to certify the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate
this certification requirement. In addition, under Sarbanes-Oxley, legal counsel is required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to the chief executive officer or chief
financial officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the Board of Directors or the Board itself. Executives are also prohibited from insider trading
during retirement plan blackout periods, and loans to company executives are restricted.

Over the past two years,
a number of additional laws have been enacted directed at stabilizing the economy and infusing capital into financial institutions and markets. These laws affect banks and their holding companies. For example, on October 3, 2008, the Emergency
Economic Stabilization Act of 2008 (EESA) was signed into law as part of a broad initiative to stabilize U.S. financial markets and provide liquidity. EESA enabled the federal government, under terms and conditions developed by the Secretary of the
Treasury, to insure troubled assets, including mortgage-backed securities, and collect premiums from participating financial institutions. EESA included, among other provisions, the $700 billion Troubled Assets Relief Program (TARP), under which the
Secretary of the Treasury is authorized to purchase, insure, hold, and sell a wide variety of financial instruments, particularly those that are based on or related to residential or commercial mortgages originated or issued on or before
March 14, 2008, and an increase in the amount of deposit insurance provided by the FDIC.



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Under the TARP, the Department of Treasury also authorized a voluntary Capital Purchase
Program (CPP) to purchase up to $250 billion of senior preferred shares of qualifying financial institutions that elected to participate by November 14, 2008. Participating companies must adopt certain standards for executive compensation,
including (a) prohibiting golden parachute payments, as defined in EESA, to senior Executive Officers; (b) requiring recovery of any compensation paid to senior executive officers based on criteria that is later proven to be
materially inaccurate; and (c) prohibiting incentive compensation that encourages unnecessary and excessive risks that threaten the value of the financial institution. The terms of the CPP also limit certain uses of capital by the issuer,
including repurchases of company stock, and increases in dividends.

EESA temporarily raised the limit on federal deposit
insurance coverage from $100,000 to $250,000 per depositor per institution, and this increase has been extended until December 31, 2013. Separate from EESA, in October 2008, the FDIC also announced the Temporary Liquidity Guarantee Program.
Under one component of this program, the FDIC temporarily provides unlimited coverage for transaction deposit accounts through June 30, 2010.

On February 10, 2009, the Financial Stability Plan (FSP) was announced by the U.S. Treasury Department. The FSP is a comprehensive set of measures intended to shore up the financial system. The core
elements of the plan include making bank capital injections, creating a public-private investment fund to buy troubled assets, establishing guidelines for loan modification programs and expanding the Federal Reserve lending program.

On February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) was enacted to provide a stimulus to the U.S. economy
in the wake of the economic downturn brought about by the subprime mortgage crisis and the resulting credit crunch. The bill includes federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending in
education, healthcare, and infrastructure. Under ARRA, an institution will be subject to certain restrictions and standards throughout the period in which any obligation arising from financial assistance provided under TARP remains outstanding.
These include limits on compensation incentives for risk-taking by senior executive officers, a prohibition on golden parachute payments, and allowance of shareholder votes on executive compensation.

On February 18, 2009, the Homeowner Affordability and Stability Plan (HASP) was announced by the President of the United States. HASP
is intended to support a recovery in the housing market and ensure that consumers can continue to pay off their mortgages through access to low-cost refinancing and certain initiatives to promote lower mortgage interest rates and prevent
foreclosure.

Additional legislative proposals that could affect banks and their holding companies continue to be discussed in
Congress.

Available Information

The Company files annual reports, quarterly reports, proxy statements and other documents with the Securities and Exchange Commission (SEC) under the Securities Exchange Act of 1934 (Exchange Act). The
public may read and copy any materials that the Company files with the SEC at the SECs Public Reference Room at 100 F. Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference
Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including the Company, that file electronically with the SEC. The public
can obtain any documents that the Company files with the SEC at www.sec.gov.

The Company also makes available free of charge
through its website (www.alliancebankna.com) the Companys Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to the Exchange Act
as soon as reasonably practicable after the Company electronically files such material with, or furnishes it to, the SEC.

Item 1A  Risk Factors

There are risks inherent to the Companys business. The material risks
and uncertainties that management believes affect the Company are described below. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on
or that management currently deems immaterial may also impair the Companys business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, the Companys financial
condition and results of operations could be materially and adversely affected.

The Company is Subject to Interest Rate Risk

The Companys earnings and cash flows are largely dependent upon its net interest income. Net interest income is the
difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that
are beyond the Companys control, including general economic and credit market conditions and policies of various governmental and regulatory agencies and, in particular, the Board of Governors of the Federal Reserve System. Changes in monetary
policy, including changes in interest rates, could influence not only the interest the Company receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) the
Companys ability to originate loans and obtain deposits, (ii) the fair value of the Companys financial assets and liabilities, and (iii) the average duration of the Companys mortgage-backed securities portfolio. If the
interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Companys net interest income, and therefore earnings, could be adversely affected. Earnings
could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.



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Although management believes it has implemented effective asset and liability management
strategies to reduce the potential effects of changes in interest rates on the Companys results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on the Companys
financial condition and results of operations. See the section captioned Net Interest Income in Item 7, Managements Discussion and Analysis of Financial Condition and Results of Operations and Item 7A, Quantitative and
Qualitative Disclosure About Market Risk located elsewhere in this report for further discussion related to the Companys management of interest rate risk.

The Company is Subject to Lending Risk

There are inherent risks
associated with the Companys lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic or credit market conditions in the markets where the Company operates as well as the
State of New York and the entire United States. Increases in interest rates and/or weakening economic or credit market conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing
these loans. The Company is also subject to various laws and regulations that affect its lending activities. Failure to comply with applicable laws and regulations could subject the Company to regulatory enforcement action that could result in the
assessment of significant civil money penalties against the Company.

As of December 31, 2009, approximately 35% of the
Companys loan and lease portfolio consisted of commercial loans and leases net of unearned income. These types of loans are generally viewed as having more risk of default than conventional residential real estate loans or most consumer loans.
Commercial loans are also typically larger than residential real estate loans and consumer loans. Because the Companys loan portfolio contains a significant number of commercial loans with relatively large balances, the deterioration of one or
a few of these loans could cause a significant increase in non-performing loans. An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for credit losses and an increase in loan
charge-offs, all of which could have a material adverse effect on the Companys financial condition and results of operations. See the section captioned Loans and Leases in Item 7. Managements Discussion and Analysis of
Financial Condition and Results of Operations located elsewhere in this report for further discussion related to commercial loans and leases.

The Companys Allowance for Credit Losses May Be Insufficient

The Company maintains an allowance for
credit losses, which is a reserve established through a provision for credit losses charged to expense, that represents managements best estimate of probable losses incurred within the existing portfolio of loans and leases. The allowance is
necessary to provide for estimated credit losses and risks inherent in the loan and lease portfolio. The level of the allowance reflects managements continuing evaluation of industry concentrations; specific credit risks; loan loss experience;
current loan and lease portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. The determination of the appropriate level of the allowance for credit losses inherently
involves a significant degree of subjectivity and requires the Company to make estimates of current credit risks, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing
loans, identification of additional problem loans and other factors, both within and outside of the Companys control, may require an increase in the allowance for credit losses. In addition, bank regulatory agencies periodically review the
Companys allowance for credit losses and may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future
periods exceed the allowance for credit losses, the Company will need additional provisions to increase the allowance for credit losses. These increases in the allowance for credit losses will result in a decrease in net income and, possibly,
capital, and may have a material adverse affect on the Companys financial condition and results of operations. See the section captioned Asset Quality and the Allowance for Credit Losses in Item 7. Managements Discussion
and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to the Companys process for determining the appropriate level of the allowance for credit losses.

The Companys Profitability Depends Significantly on Economic Conditions in Central New York

The Companys success depends significantly on the general economic conditions of Central New York and the specific local markets in
which the Company operates. Unlike larger national or other regional banks that are more geographically diversified, the Company provides banking and financial services to customers primarily in the Central New York counties of Cortland, Erie,
Madison, Oneida, Onondaga and Oswego. The local economic conditions in these areas have a significant impact on the demand for the Companys products and services as well as the ability of the Companys customers to repay loans, the value
of the collateral securing loans and the stability of the Companys deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international
or domestic occurrences, unemployment, changes in securities or credit markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on the Companys financial condition and results of
operations.

The Company Operates In a Highly Competitive Industry and Market Area

The Company faces substantial competition in all areas of its operations from a variety of different competitors, many of which are larger
and may have more financial resources. Such competitors primarily include national, regional, and community banks within the various markets where the Company operates. The Company also faces competition from many other types of financial
institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries. The financial services industry could become even more
competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type
of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks



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to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of the Companys competitors have fewer regulatory constraints
and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and
services than the Company can. The Companys ability to compete successfully depends on a number of factors, including, among other things:



| |  | The ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe,
sound assets.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------

| |  | The ability to expand the Companys market position.
|- |  | ----------------------------------------------------

| |  | The scope, relevance and pricing of products and services offered to meet customer needs and demands.
|- |  | -----------------------------------------------------------------------------------------------------

| |  | The rate at which the Company introduces new products and services relative to its competitors.
|- |  | -----------------------------------------------------------------------------------------------

| |  | Customer satisfaction with the Companys level of service.
|- |  | ----------------------------------------------------------

| |  | Industry and general economic trends.
|- |  | -------------------------------------

| |  | The ability of the Company to upgrade and acquire technology and information systems to support the sales and service of deposit and loan products.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------

Failure to perform in any of these areas could significantly weaken the Companys competitive
position, which could adversely affect the Companys growth and profitability, which, in turn, could have a material adverse effect on the Companys financial condition and results of operations.

The Company Is Subject To Extensive Government Regulation and Supervision

The Company, primarily through its subsidiary bank, is subject to extensive federal regulation and supervision. Banking regulations are primarily intended to protect depositors
funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect the Companys lending practices, capital structure, investment practices, dividend policy and growth, among other things.
Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes,
regulations or policies, could affect the Company in substantial and unpredictable ways. Such changes could subject the Company to additional costs, limit the types of financial services and products the Company may offer and/or increase the ability
of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could
have a material adverse effect on the Companys business, financial condition and results of operations. While the Company has policies and procedures designed to prevent any such violations, there can be no assurance that such violations will
not occur. See the section captioned Supervision and Regulation in Item 1. Business, which is located elsewhere in this report.

We Cannot Predict The Effect On Our Operations of Recent Legislative and Regulatory Initiatives That Were Enacted In Response To The Ongoing Financial Crisis

The U.S. federal, state and foreign governments have taken or are considering extraordinary actions in an attempt to deal with the worldwide
financial crisis and the severe decline in the global economy. To the extent adopted, many of these actions have been in effect for only a limited time, and have produced limited or no relief to the capital, credit and real estate markets. There is
no assurance that these actions or other actions under consideration will ultimately be successful.

In the United States, the
federal government has adopted the Emergency Economic Stabilization Act of 2008 (enacted on October 3, 2008), or the EESA, the American Recovery and Reinvestment Act of 2009 (enacted on February 17, 2009), or the ARRA. With authority
granted under these laws, the U.S. Treasury Department has proposed a financial stability plan that is intended to provide for the federal government to invest additional capital in banks and otherwise facilitate bank capital formation; temporarily
increase the limits on federal deposit insurance; and to offer various forms of economic stimulus, including assistance for homeowners to restructure and lower mortgage payments on qualifying loans.

In addition to the EESA and ARRA, there is the potential for new federal or state laws and regulations regarding lending and funding
practices and liquidity standards, and financial institution regulatory agencies are expected to be very aggressive in responding to concerns and trends identified in examinations, including the institution of formal enforcement actions. Negative
developments in the financial services industry and the impact of recently enacted or new legislation in response to those developments could negatively impact our operations by restricting our business operations, including our ability to originate
or sell loans, and adversely impact our financial performance. In addition, industry, legislative or regulatory developments may cause us to materially change our existing strategic direction, capital strategies, compensation or operating plans.

President Obama has announced a plan to reform the U.S. financial system. Among other things, the plan would create a new
consumer protection agency and authorize greater powers for the Federal Reserve Board. Legislation is pending in Congress that would among other things, create the U.S. Consumer Financial Protection Agency. The proposed legislation currently exempts
lenders with as much as $10 billion in assets and credit unions with up to $1.5 billion in assets from agency examination and enforcement. While the agency will set consumer-protection rules for the smaller banks, their primary regulator will
examine them for compliance and enforce violations.

There can be no assurance that the financial stability plan proposed by
the Treasury Department and the Presidents proposals, or any other legislative or regulatory initiatives enacted or adopted in response to the ongoing economic crisis, will be effective at dealing with the ongoing economic crisis and improving
economic conditions globally, nationally or in our markets or that the measures adopted will not have adverse consequences to us.



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The Soundness of Other Financial Services Institutions May Adversely Affect Our Credit Risk

We rely on other financial services institutions through trading, clearing, counterparty, and other relationships. We
maintain limits and monitor concentration levels of our counterparties as specified in our internal policies. Our reliance on other financial services institutions exposes us to credit risk in the event of default by these institutions or
counterparties. These losses could adversely affect our results of operations and financial condition.

Increases in FDIC Deposit Insurance
Premiums and Assessments Could Adversely Affect Our Financial Condition

FDIC insurance premiums have increased
substantially in 2009 and we expect to pay significantly higher FDIC premiums in the future. Market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. The FDIC adopted a
revised risk-based deposit insurance assessment schedule on February 27, 2009, which raised deposit insurance premiums. On May 22, 2009, the FDIC also implemented a five basis point special assessment of each insured depository
institutions assets minus Tier 1 capital as of June 30, 2009, but no more than 10 basis points times the institutions assessment base for the second quarter of 2009, which was collected on September 30, 2009. Additional special
assessments may be imposed by the FDIC for future periods.

In December 2009, the FDIC enacted a proposal that required most
FDIC-insured banks to prepay their projected insurance assessments for the years 2010 through 2012. In December 2009 the Company advanced approximately $5.7 million of such prepaid assessments. This advance assumes average insured deposit growth for
the Company of 5% through 2012 and increases in assessment rates of approximately 22% from current rates. The prepaid assessments were capitalized as an asset and will be amortized based on the expected period in which the assessment would have been
incurred. The actual FDIC insurance expense could be higher if the balance in the deposit insurance fund reaches levels that cause the FDIC to implement additional special assessments or take other actions that result in an increase to the amounts
paid by banks under the FDIC insurance program.

We participate in the FDICs Temporary Liquidity Guarantee Program, or
TLG, for non-interest bearing transaction deposit accounts. Banks that participate in the TLGs non-interest bearing transaction account guarantee will pay the FDIC an annual assessment of 10 basis points on the amounts in such accounts above
the amounts covered by FDIC deposit insurance. To the extent that these TLG assessments are insufficient to cover any loss or expenses arising from the TLG program, the FDIC is authorized to impose an emergency special assessment on all FDIC-insured
depository institutions. The FDIC has authority to impose charges for the TLG program upon depository institution holding companies, as well. These changes, along with the full utilization of our FDIC insurance assessment credit in early 2009, will
cause the premiums and TLG assessments charged by the FDIC to increase. These actions could significantly increase our non-interest expense in 2009 and for the foreseeable future. We have elected to voluntarily withdraw from the TLGP as of
January 1, 2010.

Certain of Our Intangible Assets May Become Impaired in the Future

Intangible assets are tested for impairment on a periodic basis. Impairment testing incorporates the current market price of the
Companys common stock, the estimated fair value of our assets and liabilities, and certain information of similar companies. It is possible that future impairment testing could result in a decline in value of our intangibles which may be less
than the carrying value, which may adversely affect our financial condition. If we determine that an impairment exists at a given point in time, our earnings and the book value of the related intangibles will be reduced by the amount of the
impairment. Notwithstanding the foregoing, the results of impairment testing on our intangible assets have no impact on our tangible book value or regulatory capital levels.

The Companys Controls and Procedures May Fail or Be Circumvented

Management regularly reviews and updates the Companys internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in
part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Companys controls and procedures or failure to comply with regulations related
to controls and procedures could have a material adverse effect on the Companys business, results of operations and financial condition.

New Lines of Business or New Products and Services May Subject the Company to Additional Risks

From time to
time, the Company may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are
not fully developed. In developing and marketing new lines of business and/or new products and services the Company may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or
new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful
implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of the Companys system of internal controls. Failure
to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on the Companys business, results of operations and financial condition.

The Company Relies on Dividends from Its Subsidiary for Most of Its Revenue

The Company is a separate and distinct legal entity from its subsidiaries. It receives substantially all of its revenue from dividends from the Bank. These dividends are the
principal source of funds to pay dividends on the Companys common stock and interest and principal on the Companys debt. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to the



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Company. Also, the Companys right to participate in a distribution of assets upon a subsidiarys liquidation or reorganization is subject to the prior claims of the subsidiarys
creditors. In the event the Bank is unable to pay dividends to the Company, the Company may not be able to service debt, pay obligations or pay dividends on the Companys common and preferred stock.

The inability to receive dividends from the Bank could have a material adverse affect on the Companys business, financial condition
and results of operations. See the section captioned Supervision and Regulation in Item 1. Business and Note 16  Dividends and Restrictions in the notes to consolidated financial statements included in Item 8. Financial
Statements and Supplementary Data, which are located elsewhere in this report.

The Company May Not Be Able To Attract and Retain Skilled
People

The Companys success depends, in large part, on its ability to attract and retain key human resource talent.
Competition for the best people in most activities engaged in by the Company can be intense and the Company may not be able to hire people or to retain them. The unexpected loss of services of one or more of the Companys key personnel could
have a material adverse impact on the Companys business because of their skills, knowledge of the Companys market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

The Companys Information Systems May Experience an Interruption Or Breach In Security

The Company relies heavily on communications and information systems to conduct its business. Any failure, interruption or breach in security of these systems could result in
failures or disruptions in the Companys customer relationship management, general ledger, deposit, loan and other systems. While the Company has policies and procedures designed to prevent or limit the effect of the failure, interruption or
security breach of its information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures,
interruptions or security breaches of the Companys information systems could damage the Companys reputation, result in a loss of customer business, subject the Company to additional regulatory scrutiny, or expose the Company to civil
litigation and possible financial liability, any of which could have a material adverse effect on the Companys financial condition and results of operations.

The Company Continually Encounters Technological Change

The financial
services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better
serve customers and to reduce costs. The Companys future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to
create additional efficiencies in the Companys operations. Many of the Companys competitors have substantially greater resources to invest in technological enhancements. The Company may not be able to effectively implement new
technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse
impact on the Companys business and, in turn, the Companys financial condition and results of operations.

The
Companys Articles of Incorporation, By-Laws and Shareholder Rights Plan As Well As Certain Banking Laws May Have an Anti-Takeover Effect

Provisions of the Companys articles of incorporation and by-laws, federal banking laws, including regulatory approval requirements, and the Companys stock purchase rights plan could make it
more difficult for a third party to acquire the Company, even if doing so would be perceived to be beneficial to the Companys stockholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business
combination, which, in turn, could adversely affect the market price of the Companys common stock.

Item 1B.  Unresolved Staff Comments

Not applicable.

Item 2  Properties

The Company conducts business in Central New York State through 29 banking offices and two administrative centers. The Company leases its corporate administrative center, located in Syracuse, NY. Eleven
banking offices and one of the administrative centers are subject to leases and/or long-term land leases. The other banking offices and administrative center are owned.

Item 3  Legal Proceedings

In December 1998, the Oneida Indian Nation (The Nation) and the U.S. Justice Department filed a motion to amend a long-standing land claim against the State of New York to include a class of 20,000 unnamed defendants who own
real property in Madison County and Oneida County. An additional motion sought to include the Company as a representative of a class of landowners. On September 25, 2000, the United States District Court of the Northern District of New York
rendered a decision denying the motion to include the landowners as a group, and thus, excluding the Company and many of its borrowers from the litigation. The State of New York, the County of Madison and the County of Oneida remain as defendants in
the litigation. This ruling may be appealed by The Nation, and does not prevent The Nation from suing landowners individually, in which case the litigation could involve assets of the Company. On May 21, 2007, the U.S. District Court issued a
decision dismissing the possessory land claims. The Courts decision has been appealed by the



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Nation. Although management cannot predict the timing of the resolution of this matter, it continues to believe that this matter will be resolved without adversely affecting the Company.

The Company and its subsidiaries are subject to various claims, legal proceedings and matters that arise in the ordinary
course of business. In managements opinion, no pending action, if adversely decided, would materially affect the Companys financial condition.

Item 4  Reserved

PART II

Item 5  Market for the Registrants Common Equity, Related Stockholder Matters and Issuer
Purchases of Equity Securities

Common Stock Data

The common stock of the Company is listed on the NASDAQ Global Market under the symbol ALNC. Market makers for the stock include Keefe, Bruyette & Woods, Inc.
and Sandler ONeill & Partners, L.P. There were 973 shareholders of record as of December 31, 2009. The following table presents stock prices for the Company for 2009 and 2008. Stock prices below are based on daily high and low
closing prices for the quarter, as reported on the NASDAQ Global Market.



|            |  |        |  |      |  |  |  |  |  |        |  |                   |  |  |  |  |  |  |  |        |  |  |  |  |  |  |  |        |  |  |  |  |  |                  
|----------- |  | ------ |  | ---- |  |  |  |  |  | ------ |  | ----------------- |  |  |  |  |  |  |  | ------ |  |  |  |  |  |  |  | ------ |  |  |  |  |  | -----------------
|            |  | 2009   |  | 2008
|            |  | High   |  |      |  |  |  |  |  | Low    |  | Dividend Declared |  |  |  |  |  |  |  | High   |  |  |  |  |  |  |  | Low    |  |  |  |  |  | Dividend Declared
|1st Quarter |  | $23.70 |  |      |  |  |  |  |  | $15.16 |  | $0.26             |  |  |  |  |  |  |  | $26.70 |  |  |  |  |  |  |  | $23.25 |  |  |  |  |  | $0.24            
|2nd Quarter |  | $29.00 |  |      |  |  |  |  |  | $19.00 |  | $0.26             |  |  |  |  |  |  |  | $27.27 |  |  |  |  |  |  |  | $21.03 |  |  |  |  |  | $0.24            
|3rd Quarter |  | $30.20 |  |      |  |  |  |  |  | $24.85 |  | $0.28             |  |  |  |  |  |  |  | $25.00 |  |  |  |  |  |  |  | $19.56 |  |  |  |  |  | $0.26            
|4th Quarter |  | $30.05 |  |      |  |  |  |  |  | $21.41 |  | $0.28             |  |  |  |  |  |  |  | $24.54 |  |  |  |  |  |  |  | $20.00 |  |  |  |  |  | $0.26            

Registrar and Transfer Agent

American Stock Transfer & Trust Company

59 Maiden Lane

New York, NY 10038

Automatic Dividend Reinvestment Plan

The Company has an automatic
dividend reinvestment plan. This plan is administered by American Stock Transfer and Trust Company, as agent. It offers a convenient way for shareholders to increase their investment in the Company. The plan enables certain shareholders to reinvest
cash dividends on all or part of their common stock in additional shares of the Companys common stock without paying brokerage commissions or service charges. Shareholders who are interested in this program may receive a Plan Prospectus and
enrollment card by calling ASTC Dividend Reinvestment at 1-800-278-4353, or writing to the following address:

Dividend Reinvestment

American Stock Transfer & Trust Company

59 Maiden Lane

New York, NY 10038

Dividends

The Company has historically paid regular quarterly cash
dividends on its common stock, and the Board of Directors presently intends to continue the payment of regular quarterly cash dividends, subject to the need for those funds for debt service and other purposes. However, because substantially all of
the funds available for the payment of dividends are derived from the Bank, future dividends will depend upon the earnings of the Bank, its financial condition and its need for funds. Furthermore, there are a number of federal banking policies and
regulations that restrict the Companys ability to pay dividends. In particular, because the Bank is a depository institution whose deposits are insured by the FDIC, it may not pay dividends or distribute capital assets if it is in default on
any assessment due the FDIC. Also, as a national bank, the Bank is subject to OCC regulations which impose certain minimum capital requirements that would affect the amount of cash available for distribution to the Company. In addition, under
Federal Reserve policy, the Company is required to maintain adequate regulatory capital, is expected to serve as a source of financial strength to the Bank and to commit resources to support the Bank. These policies and regulations may have the
effect of reducing the amount of dividends that the Company can declare to its shareholders.



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Stock Performance Graph

The graph below matches Alliance Financial Corporations cumulative 5-year total shareholder return on common stock with the cumulative total returns of the Russell 3000 index
and the SNL Bank NASDAQ index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from 12/31/2004 to 12/31/2009.

LOGO



|                               |  |               |  |          |  |          |  |          |  |          |  |         
|------------------------------ |  | ------------- |  | -------- |  | -------- |  | -------- |  | -------- |  | --------
|                               |  | Period Ending
|Index                          |  | 12/31/04      |  | 12/31/05 |  | 12/31/06 |  | 12/31/07 |  | 12/31/08 |  | 12/31/09
|Alliance Financial Corporation |  | 100.00        |  | 108.14   |  | 110.52   |  | 93.30    |  | 88.92    |  | 106.19  
|SNL Bank NASDAQ                |  | 100.00        |  | 96.95    |  | 108.85   |  | 85.45    |  | 62.06    |  | 50.34   
|Russell 3000                   |  | 100.00        |  | 106.12   |  | 122.80   |  | 129.11   |  | 80.94    |  | 103.88  



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Item 6  Selected Financial Data

Five-Year Comparative Summary



|                                                                                |  |                                                 |  |             |  |             |  |             |  |            
|------------------------------------------------------------------------------- |  | ----------------------------------------------- |  | ----------- |  | ----------- |  | ----------- |  | -----------
|                                                                                |  | Year ended December 31,                        
|                                                                                |  | 2009                                            |  | 2008        |  | 2007        |  | 2006        |  | 2005       
|Selected Financial Condition Data                                               |  | (In thousands)                                 
|Total assets                                                                    |  | $1,417,244                                      |  | $1,367,358  |  | $1,307,014  |  | $1,272,967  |  | $  983,256 
|Loans & leases, net of unearned income                                          |  | 914,162                                         |  | 910,755     |  | 895,533     |  | 881,411     |  | 654,086    
|Allowance for credit losses                                                     |  | 9,414                                           |  | 9,161       |  | 8,426       |  | 7,029       |  | 4,960      
|Securities available-for-sale                                                   |  | 362,158                                         |  | 310,993     |  | 282,220     |  | 261,987     |  | 265,494    
|Goodwill                                                                        |  | 32,073                                          |  | 32,073      |  | 32,187      |  | 33,456      |  |           
|Intangible assets, net                                                          |  | 10,075                                          |  | 11,528      |  | 13,183      |  | 14,912      |  | 9,671      
|Deposits                                                                        |  | 1,075,671                                       |  | 937,882     |  | 945,230     |  | 936,671     |  | 739,118    
|Borrowings                                                                      |  | 172,707                                         |  | 238,972     |  | 200,757     |  | 178,575     |  | 150,429    
|Junior subordinated obligations                                                 |  | 25,774                                          |  | 25,774      |  | 25,774      |  | 25,774      |  | 10,310     
|Shareholders equity                                                            |  | 123,935                                         |  | 144,481     |  | 115,560     |  | 109,506     |  | 69,571     
|Common shareholders equity                                                     |  | 123,935                                         |  | 117,563     |  | 115,560     |  | 109,506     |  | 69,571     
|Investment assets under management (Market value, not included in total assets) |  | $786,302                                        |  | $  726,019  |  | $  971,078  |  | $  927,674  |  | $  862,504 
|                                                                                | 
|                                                                                |  | Year ended December 31,                        
|                                                                                |  | 2009                                            |  | 2008        |  | 2007        |  | 2006        |  | 2005       
|                                                                                |  | (In thousands, except share and per share data)
|Selected Operating Data                                                         |  |                                                 |  |             |  |             |  |             |  |            
|Interest income                                                                 |  | $  63,962                                       |  | $  67,964   |  | $  71,032   |  | $  57,673   |  | $  46,255  
|Interest expense                                                                |  | 20,581                                          |  | 30,267      |  | 38,550      |  | 29,951      |  | 19,336     
|                                                                                |  |                                                 |  |             |  |             |  |             |  |            
|Net interest income                                                             |  | 43,381                                          |  | 37,697      |  | 32,482      |  | 27,722      |  | 26,919     
|Provision for credit losses                                                     |  | 6,100                                           |  | 5,502       |  | 3,790       |  | 2,477       |  | 144        
|                                                                                |  |                                                 |  |             |  |             |  |             |  |            
|Net interest income after provision for credit losses                           |  | 37,281                                          |  | 32,195      |  | 28,692      |  | 25,245      |  | 26,775     
|Non-interest income                                                             |  | 20,811                                          |  | 20,360      |  | 21,292      |  | 17,714      |  | 14,238     
|                                                                                |  |                                                 |  |             |  |             |  |             |  |            
|Total Operating income                                                          |  | 58,092                                          |  | 52,555      |  | 49,984      |  | 42,959      |  | 41,013     
|                                                                                |  |                                                 |  |             | 
|Non-interest expense                                                            |  | 43,208                                          |  | 39,378      |  | 37,638      |  | 33,886      |  | 31,352     
|                                                                                |  |                                                 |  |             |  |             |  |             |  |            
|Income before taxes                                                             |  | 14,884                                          |  | 13,177      |  | 12,346      |  | 9,073       |  | 9,661      
|Income tax expense                                                              |  | 3,436                                           |  | 2,820       |  | 2,869       |  | 1,762       |  | 2,154      
|                                                                                |  |                                                 |  |             |  |             |  |             |  |            
|Net Income                                                                      |  | $  11,448                                       |  | $  10,357   |  | $    9,477  |  | $    7,311  |  | $    7,507 
|                                                                                |  |                                                 |  |             |  |             |  |             |  |            
|Net income available to common shareholders                                     |  | $  10,364                                       |  | $  10,310   |  | $    9,477  |  | $    7,311  |  | $    7,507 
|                                                                                |  |                                                 |  |             | 
|Stock and Per Share Data                                                        |  |                                                 |  |             |  |             |  |             |  |            
|Basic earnings per common share                                                 |  | $      2.25                                     |  | $      2.23 |  | $      1.98 |  | $      1.89 |  | $      2.09
|Diluted earnings per common share                                               |  | $      2.24                                     |  | $      2.21 |  | $      1.96 |  | $      1.87 |  | $      2.04
|Basic weighted average common shares outstanding                                |  | 4,514,268                                       |  | 4,542,957   |  | 4,710,530   |  | 3,799,626   |  | 3,532,144  
|Diluted weighted average common shares outstanding                              |  | 4,543,069                                       |  | 4,565,709   |  | 4,754,045   |  | 3,855,386   |  | 3,602,964  
|Cash dividends declared                                                         |  | $      1.08                                     |  | $      1.00 |  | $      0.90 |  | $      0.88 |  | $      0.84
|Dividend payout ratio (1)                                                       |  | 48.2%                                           |  | 44.6%       |  | 45.5%       |  | 46.8%       |  | 41.0%      
|Common book value                                                               |  | $    26.86                                      |  | $    25.67  |  | $    24.53  |  | $    22.81  |  | $    19.52 
|Tangible common book value                                                      |  | $    17.72                                      |  | $    16.15  |  | $    14.90  |  | $    12.74  |  | $    16.80 



12



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##### Table of Contents

|                                                               |  |                                       |  |        |  |        |  |        |  |       
|-------------------------------------------------------------- |  | ------------------------------------- |  | ------ |  | ------ |  | ------ |  | ------
|                                                               |  | Year ended December 31,              
|Selected Financial and Other Data (2)                          |  | 2009                                  |  | 2008   |  | 2007   |  | 2006   |  | 2005  
|                                                               |  |                                       |  |        | 
|Performance Ratios:                                            |  |                                       |  |        |  |        |  |        |  |       
|Return on average assets                                       |  | 0.81%                                 |  | 0.78%  |  | 0.74%  |  | 0.69%  |  | 0.80% 
|Return on average equity                                       |  | 8.68%                                 |  | 8.77%  |  | 8.48%  |  | 9.40%  |  | 10.75%
|Return on average common equity                                |  | 8.46%                                 |  | 8.80%  |  | 8.48%  |  | 9.40%  |  | 10.75%
|Non-interest income to total income(3)                         |  | 30.06%                                |  | 34.86% |  | 39.29% |  | 38.99% |  | 34.62%
|Efficiency Ratio(4)                                            |  | 69.66%                                |  | 68.04% |  | 70.35% |  | 74.58% |  | 76.14%
|                                                               |  |                                       |  |        | 
|Rate/Yield Information:                                        |  |                                       |  |        |  |        |  |        |  |       
|Yield on earning assets                                        |  | 5.15%                                 |  | 5.88%  |  | 6.36%  |  | 6.06%  |  | 5.47% 
|Cost of funds                                                  |  | 1.85%                                 |  | 2.87%  |  | 3.78%  |  | 3.46%  |  | 2.48% 
|Net interest rate spread                                       |  | 3.30%                                 |  | 3.01%  |  | 2.58%  |  | 2.60%  |  | 2.99% 
|Net interest margin (tax equivalent)(5)                        |  | 3.55%                                 |  | 3.35%  |  | 3.02%  |  | 3.02%  |  | 3.28% 
|                                                               | 
|                                                               |  | At or for the Year ended December 31,
|                                                               |  | 2009                                  |  | 2008   |  | 2007   |  | 2006   |  | 2005  
|Asset Quality Ratios                                           |  |                                       |  |        |  |        |  |        |  |       
|Non-performing loans and leases to total loans and leases      |  | 0.94%                                 |  | 0.49%  |  | 0.75%  |  | 0.30%  |  | 0.25% 
|Non-performing assets to total assets                          |  | 0.64%                                 |  | 0.38%  |  | 0.53%  |  | 0.21%  |  | 0.17% 
|Allowance for credit losses to non-performing loans and leases |  | 109.7%                                |  | 204.6% |  | 125.7% |  | 266.4% |  | 304.7%
|Allowance for credit losses to total loans and leases          |  | 1.03%                                 |  | 1.01%  |  | 0.94%  |  | 0.80%  |  | 0.76% 
|Net charge-offs to average loans and leases                    |  | 0.63%                                 |  | 0.53%  |  | 0.27%  |  | 0.23%  |  | 0.08% 
|                                                               |  |                                       |  |        | 
|Equity Ratios                                                  |  |                                       |  |        |  |        |  |        |  |       
|Total common shareholders equity to total assets              |  | 8.74%                                 |  | 8.60%  |  | 8.84%  |  | 8.60%  |  | 7.08% 
|Tangible common equity to tangible assets(6)                   |  | 5.95%                                 |  | 5.59%  |  | 5.56%  |  | 4.99%  |  | 6.15% 
|                                                               |  |                                       |  |        | 
|Regulatory Ratios                                              |  |                                       |  |        |  |        |  |        |  |       
|Consolidated:                                                  |  |                                       |  |        |  |        |  |        |  |       
|Tier 1 (core) capital                                          |  | 7.55%                                 |  | 9.59%  |  | 7.53%  |  | 7.53%  |  | 7.42% 
|Tier 1 risk-based capital                                      |  | 12.06%                                |  | 14.05% |  | 10.64% |  | 10.42% |  | 10.93%
|Total risk-based capital                                       |  | 13.13%                                |  | 15.08% |  | 11.59% |  | 11.26% |  | 11.72%
|Bank:                                                          |  |                                       |  |        |  |        |  |        |  |       
|Tier 1 (core) capital                                          |  | 7.14%                                 |  | 8.97%  |  | 7.26%  |  | 7.00%  |  | 6.75% 
|Tier 1 risk-based capital                                      |  | 11.47%                                |  | 13.15% |  | 10.34% |  | 9.65%  |  | 9.96% 
|Total risk-based capital                                       |  | 12.55%                                |  | 14.19% |  | 11.30% |  | 10.48% |  | 10.78%



|(1) | Cash dividends declared per share divided by diluted earnings per share
|--- | -----------------------------------------------------------------------

|(2) | Averages presented are daily averages
|--- | -------------------------------------

(3) Non-interest income (net of realized gains and losses on securities and non-recurring items) divided by the sum of net interest income and non-interest income (net of realized gains and losses on
securities and non-recurring items)

(4) Non-interest expense divided by the sum of net interest income and non-interest income (net of
realized gains and losses on securities and non-recurring items)

|(5) | Tax equivalent net interest income divided by average earning assets
|--- | --------------------------------------------------------------------

(6) The Company uses certain non-GAAP financial measures, such as the Tangible Common Equity to Tangible Assets ratio (TCE), to provide information for investors to effectively analyze financial trends of
ongoing business activities, and to enhance comparability with peers across the financial sector. The Company believes TCE is useful because it is a measure utilized by regulators, market analysts and investors in evaluating a companys
financial condition and capital strength. TCE, as defined by the Company, represents common equity less goodwill and intangible assets. A reconciliation from the Companys GAAP Total Equity to Total Assets ratio to the Non-GAAP Tangible Common
Equity to Tangible Assets ratio is presented below:



|                                                  |  |                         |           |      |   |           |  |      |           |      |   |           |  |   |        
|------------------------------------------------- |  | ----------------------- | --------- | ---- | - | --------- |  | ---- | --------- | ---- | - | --------- |  | - | -------
|                                                  |  | Year ended December 31,
|                                                  |  | 2009                    |           | 2008 |   | 2007      |  | 2006 |           | 2005
|                                                  |  |                         |           |      |  
|Total assets                                      |  | $                       | 1,417,244 |      | $ | 1,367,358 |  | $    | 1,307,014 |      | $ | 1,272,967 |  | $ | 983,256
|Less: Goodwill and intangible assets, net         |  |                         | 42,148    |      |   | 43,601    |  |      | 45,370    |      |   | 48,368    |  |   | 9,671  
|                                                  |  |                         |           |      |   |           |  |      |           |      |   |           |  |   |        
|Tangible assets (non-GAAP)                        |  |                         | 1,375,096 |      |   | 1,323,757 |  |      | 1,261,644 |      |   | 1,224,599 |  |   | 973,585
|                                                  |  |                         |           |      |  
|Total Common Equity                               |  |                         | 123,935   |      |   | 117,563   |  |      | 115,560   |      |   | 109,506   |  |   | 69,571 
|Less: Goodwill and intangible assets, net         |  |                         | 42,148    |      |   | 43,601    |  |      | 45,370    |      |   | 48,368    |  |   | 9,671  
|                                                  |  |                         |           |      |   |           |  |      |           |      |   |           |  |   |        
|Tangible Common Equity (non-GAAP)                 |  |                         | 81,787    |      |   | 73,962    |  |      | 70,190    |      |   | 61,138    |  |   | 59,900 
|                                                  |  |                         |           |      |  
|Total Equity/Total Assets                         |  |                         | 8.74%     |      |   | 8.60%     |  |      | 8.84%     |      |   | 8.60%     |  |   | 7.08%  
|Tangible Common Equity/Tangible Assets (non-GAAP) |  |                         | 5.95%     |      |   | 5.59%     |  |      | 5.56%     |      |   | 4.99%     |  |   | 6.15%  



13



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##### Table of Contents

Summarized quarterly financial information for the years ended December 31, 2009 and
2008 is as follows:



|                                            |  |            |  |                                                         |  |           |  |           |  |           |  | 
|------------------------------------------- |  | ---------- |  | ------------------------------------------------------- |  | --------- |  | --------- |  | --------- |  | 
|                                            |  | Year ended |  | Three months ended                                     
|                                            |  | 12/31/09   |  | 12/31/09                                                |  | 9/30/09   |  | 6/30/09   |  | 3/31/09  
|                                            |  |            |  | (Dollars in thousands, except share and per share data)
|Total interest income                       |  | $63,962    |  | $16,069                                                 |  | $16,129   |  | $15,875   |  | $15,889   |  | 
|Total interest expense                      |  | 20,581     |  | 4,585                                                   |  | 4,899     |  | 5,253     |  | 5,844     |  | 
|                                            |  |            |  |                                                         |  |           |  |           |  |           |  | 
|Net interest income                         |  | 43,381     |  | 11,484                                                  |  | 11,230    |  | 10,622    |  | 10,045    |  | 
|Provision for credit losses                 |  | 6,100      |  | 1,425                                                   |  | 1,125     |  | 1,800     |  | 1,750     |  | 
|Non-interest income                         |  | 20,811     |  | 5,923                                                   |  | 4,762     |  | 4,766     |  | 5,360     |  | 
|Non-interest expense                        |  | 43,208     |  | 11,342                                                  |  | 10,900    |  | 10,899    |  | 10,067    |  | 
|                                            |  |            |  |                                                         |  |           |  |           |  |           |  | 
|Income before income taxes                  |  | 14,884     |  | 4,640                                                   |  | 3,967     |  | 2,689     |  | 3,588     |  | 
|Provision for income taxes                  |  | 3,436      |  | 1,143                                                   |  | 1,009     |  | 653       |  | 631       |  | 
|                                            |  |            |  |                                                         |  |           |  |           |  |           |  | 
|Net Income                                  |  | $11,448    |  | $  3,497                                                |  | $  2,958  |  | $  2,036  |  | $  2,957  |  | 
|                                            |  |            |  |                                                         |  |           |  |           |  |           |  | 
|Net Income available to common shareholders |  | $10,364    |  | $  3,497                                                |  | $  2,958  |  | $  1,310  |  | $  2,599  |  | 
|                                            |  |            |  |                                                         |  |           |  |           |  |           |  | 
|                                            |  |            |  |                                                         |  |          
|Basic earnings per share                    |  | $    2.25  |  | $    0.76                                               |  | $    0.64 |  | $    0.29 |  | $    0.57 |  | 
|Diluted earnings per share                  |  | $    2.24  |  | $    0.75                                               |  | $    0.64 |  | $    0.28 |  | $    0.57 |  | 
|Basic weighted average shares outstanding   |  | 4,514,268  |  | 4,546,819                                               |  | 4,521,331 |  | 4,495,439 |  | 4,492,810 |  | 
|Diluted weighted average shares outstanding |  | 4,543,069  |  | 4,585,800                                               |  | 4,563,168 |  | 4,518,827 |  | 4,495,787 |  | 
|Cash dividends declared per share           |  | $    1.08  |  | $    0.28                                               |  | $    0.28 |  | $    0.26 |  | $    0.26 |  | 
|Net interest margin (tax equivalent)        |  | 3.55%      |  | 3.68%                                                   |  | 3.62%     |  | 3.50%     |  | 3.42%     |  | 
|Return on average assets                    |  | 0.81%      |  | 0.97%                                                   |  | 0.82%     |  | 0.58%     |  | 0.86%     |  | 
|Return on average equity                    |  | 8.68%      |  | 11.13%                                                  |  | 9.68%     |  | 5.82%     |  | 8.07%     |  | 
|Return on average common equity             |  | 8.46%      |  | 11.13%                                                  |  | 9.68%     |  | 4.33%     |  | 8.69%     |  | 
|Non-interest income to total income         |  | 30.06%     |  | 29.35%                                                  |  | 29.78%    |  | 30.97%    |  | 30.19%    |  | 
|Efficiency ratio                            |  | 69.66%     |  | 69.77%                                                  |  | 68.17%    |  | 70.83%    |  | 69.96%    |  | 



|                                            |  |               |  |                                                         |  |           |  |           |  |          
|------------------------------------------- |  | ------------- |  | ------------------------------------------------------- |  | --------- |  | --------- |  | ---------
|                                            |  | Year ended    |  | Three months ended                                     
|                                            |  | 12/31/08      |  | 12/31/08                                                |  | 9/30/08   |  | 6/30/08   |  | 3/31/08  
|                                            |  |               |  | (Dollars in thousands, except share and per share data)
|Total interest income                       |  | $    67,964   |  | $  16,699                                               |  | $  16,734 |  | $  16,980 |  | $  17,551
|Total interest expense                      |  | 30,267        |  | 6,855                                                   |  | 7,155     |  | 7,473     |  | 8,784    
|                                            |  |               |  |                                                         |  |           |  |           |  |          
|Net interest income                         |  | 37,697        |  | 9,844                                                   |  | 9,579     |  | 9,507     |  | 8,767    
|Provision for credit losses                 |  | 5,502         |  | 1,976                                                   |  | 849       |  | 1,311     |  | 1,366    
|Non-interest income                         |  | 20,360        |  | 4,754                                                   |  | 5,134     |  | 5,287     |  | 5,185    
|Non-interest expense                        |  | 39,378        |  | 10,055                                                  |  | 9,899     |  | 9,630     |  | 9,794    
|                                            |  |               |  |                                                         |  |           |  |           |  |          
|Income before income taxes                  |  | 13,177        |  | 2,567                                                   |  | 3,965     |  | 3,853     |  | 2,792    
|Provision for income taxes                  |  | 2,820         |  | 183                                                     |  | 955       |  | 966       |  | 716      
|                                            |  |               |  |                                                         |  |           |  |           |  |          
|Net Income                                  |  | $    10,357   |  | $  2,384                                                |  | $  3,010  |  | $  2,887  |  | $  2,076 
|                                            |  |               |  |                                                         |  |           |  |           |  |          
|Net Income available to common shareholders |  | $    10,310   |  | $  2,337                                                |  | $  3,010  |  | $  2,887  |  | $  2,076 
|                                            |  |               |  |                                                         |  |           |  |           |  |          
|                                            |  |               |  |                                                         | 
|Basic earnings per share                    |  | $        2.23 |  | $    0.51                                               |  | $    0.65 |  | $    0.62 |  | $    0.44
|Diluted earnings per share                  |  | $        2.21 |  | $    0.51                                               |  | $    0.65 |  | $    0.62 |  | $    0.44
|Basic weighted average shares outstanding   |  | 4,542,957     |  | 4,492,810                                               |  | 4,545,357 |  | 4,556,157 |  | 4,578,087
|Diluted weighted average shares outstanding |  | 4,597,624     |  | 4,510,483                                               |  | 4,564,904 |  | 4,583,309 |  | 4,606,753
|Cash dividends declared per share           |  | $        1.00 |  | $    0.26                                               |  | $    0.26 |  | $    0.24 |  | $    0.24
|Net interest margin (tax equivalent)        |  | 3.35%         |  | 3.43%                                                   |  | 3.43%     |  | 3.39%     |  | 3.15%    
|Return on average assets                    |  | 0.78%         |  | 0.71%                                                   |  | 0.92%     |  | 0.87%     |  | 0.63%    
|Return on average equity                    |  | 8.77%         |  | 7.67%                                                   |  | 10.42%    |  | 9.93%     |  | 7.15%    
|Return on average common equity             |  | 8.80%         |  | 7.74%                                                   |  | 10.42%    |  | 9.93%     |  | 7.15%    
|Non-interest income to total income         |  | 34.86%        |  | 32.55%                                                  |  | 34.89%    |  | 35.74%    |  | 36.32%   
|Efficiency ratio                            |  | 68.04%        |  | 68.87%                                                  |  | 67.28%    |  | 65.09%    |  | 71.14%   



14



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##### Table of Contents

Item 7  Managements Discussion and Analysis of Financial
Condition and Results of Operations

The following section highlights information to assist with understanding the
consolidated financial condition and results of operations of Alliance Financial Corporation and its subsidiaries (combined, the Company), during the year ended December 31, 2009 and the preceding two years. The consolidated
financial statements and related notes, included elsewhere in this annual report on Form 10-K should be read in conjunction with the discussions in this section. The matters discussed in this section contain certain forward-looking statements within
the meaning of the Private Securities Litigation Reform Act of 1995. Statements made that are not historical facts are forward-looking and are based on estimates, forecasts and assumptions involving risks and uncertainties that could cause actual
results or outcomes to differ materially from those expressed in the forward-looking statements. The risks and uncertainties referred to above include, but are not limited to those described under Cautionary Note Regarding Forward-Looking
Statements and Risk Factors in Items 1 and 1A, respectively of this Form 10-K.

2009 Highlights and Overview

Our results of operations are dependent primarily on net interest income, which is the difference between the income
earned on our loans and leases and securities and our cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the provision for credit losses, securities and loan sale activities, loan
servicing activities, service charges and fees collected on our deposit accounts, income collected from trust and investment advisory services and the income earned on our investment in bank-owned life insurance. Our expenses primarily consist of
salaries and employee benefits, occupancy and equipment expense, marketing expense, professional services, technology expense, amortization of intangible assets, other expense and income tax expense. Results of operations are also significantly
affected by general economic and competitive conditions, particularly changes in interest rates, inflation, government policies and the actions of regulatory authorities.



15



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##### Table of Contents

Average Balance Sheet

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Interest income and yield information is adjusted
for items exempt from federal income taxes and assumes a 34% tax rate. Non-accrual loans have been included in the average balances. Securities are shown at average amortized cost.



|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|------------------------------------------------------------------------------------------------------- |  | ------------------------ |  | ---------------- |  | ---------------- |  | -------------- |  | ---------------- |  | ---------------- |  | ------------- |  | ---------------- |  | ----------------
|                                                                                                        |  | Years ended December 31,
|                                                                                                        |  | 2009                     |  | 2008             |  | 2007            
|                                                                                                        |  |                          |  |                  |  |                  |  |                | 
|                                                                                                        |  | Avg. Balance             |  | Amt. of Interest |  | Avg. Yield/ Rate |  | Avg. Balance   |  | Amt. of Interest |  | Avg. Yield/ Rate |  | Avg. Balance  |  | Amt. of Interest |  | Avg. Yield/ Rate
|                                                                                                        |  | (Dollars in thousands)  
|Assets:                                                                                                 |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|Interest-earning assets:                                                                                |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|Federal funds sold                                                                                      |  | $    13,084              |  | $        15      |  | 0.11%            |  | $        4,856 |  | $      100       |  | 2.06%            |  | $        362  |  | $      18        |  | 4.97%           
|Taxable investment securities                                                                           |  | 256,494                  |  | 10,143           |  | 3.95%            |  | 189,164        |  | 8,796            |  | 4.65%            |  | 174,719       |  | 7,929            |  | 4.54%           
|Nontaxable investment securities                                                                        |  | 85,173                   |  | 5,172            |  | 6.07%            |  | 88,667         |  | 5,420            |  | 6.11%            |  | 84,987        |  | 5,252            |  | 6.18%           
|FHLB and FRB stock                                                                                      |  | 10,875                   |  | 558              |  | 5.13%            |  | 11,063         |  | 634              |  | 5.73%            |  | 8,741         |  | 628              |  | 7.18%           
|Residential real estate loans                                                                           |  | 344,707                  |  | 19,087           |  | 5.54%            |  | 294,829        |  | 17,442           |  | 5.92%            |  | 263,180       |  | 15,914           |  | 6.05%           
|Commercial loans                                                                                        |  | 202,020                  |  | 11,221           |  | 5.55%            |  | 207,931        |  | 14,068           |  | 6.77%            |  | 211,964       |  | 17,058           |  | 8.05%           
|Non-taxable commercial loans                                                                            |  | 9,449                    |  | 570              |  | 6.03%            |  | 8,618          |  | 565              |  | 6.56%            |  | 8,527         |  | 606              |  | 7.11%           
|Taxable leases (net of unearned income)                                                                 |  | 68,334                   |  | 4,068            |  | 5.95%            |  | 103,726        |  | 6,436            |  | 6.20%            |  | 111,182       |  | 7,559            |  | 6.80%           
|Nontaxable leases (net of unearned income)                                                              |  | 16,472                   |  | 1,069            |  | 6.49%            |  | 16,284         |  | 1,020            |  | 6.26%            |  | 19,259        |  | 1,152            |  | 5.98%           
|Indirect auto loans                                                                                     |  | 187,919                  |  | 10,339           |  | 5.50%            |  | 179,762        |  | 10,180           |  | 5.66%            |  | 180,688       |  | 9,983            |  | 5.52%           
|Consumer loans                                                                                          |  | 91,387                   |  | 4,036            |  | 4.42%            |  | 90,675         |  | 5,685            |  | 6.27%            |  | 91,502        |  | 7,317            |  | 8.00%           
|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                 
|Total interest-earning assets                                                                           |  | 1,285,914                |  | 66,278           |  | 5.15%            |  | 1,195,575      |  | 70,346           |  | 5.88%            |  | $1,155,111    |  | $73,416          |  | 6.36%           
|Non-interest-earning assets:                                                                            |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|Other assets                                                                                            |  | 136,512                  |  |                  |  |                  |  | 133,780        |  |                  |  |                  |  | 132,431       |  |                  |  |                 
|Allowance for credit losses                                                                             |  | (9,990)                  |  |                  |  |                  |  | (8,686)        |  |                  |  |                  |  | (7,656)       |  |                  |  |                 
|Net unrealized gains (losses) on available-for-sale securities                                          |  | 6,912                    |  |                  |  |                  |  | 1,867          |  |                  |  |                  |  | (1,712)       |  |                  |  |                 
|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|Total                                                                                                   |  | $1,419,348               |  |                  |  |                  |  | $1,322,536     |  |                  |  |                  |  | $1,278,174    |  |                  |  |                 
|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|                                                                                                        |  |                          |  |                  |  |                  |  |                | 
|Demand deposits                                                                                         |  | $    117,113             |  | $        531     |  | 0.45%            |  | $    107,204   |  | $      733       |  | 0.68%            |  | $      97,740 |  | $    911         |  | 0.93%           
|Savings deposits                                                                                        |  | 92,114                   |  | 454              |  | 0.49%            |  | 86,239         |  | 492              |  | 0.57%            |  | 84,764        |  | 474              |  | 0.56%           
|MMDA deposits                                                                                           |  | 303,344                  |  | 3,347            |  | 1.10%            |  | 225,590        |  | 4,732            |  | 2.10%            |  | 197,079       |  | 6,322            |  | 3.21%           
|Time deposits                                                                                           |  | 382,420                  |  | 9,622            |  | 2.52%            |  | 385,275        |  | 15,277           |  | 3.97%            |  | 432,652       |  | 20,547           |  | 4.75%           
|Borrowings                                                                                              |  | 193,648                  |  | 5,819            |  | 3.01%            |  | 223,230        |  | 7,634            |  | 3.42%            |  | 182,051       |  | 8,336            |  | 4.58%           
|Junior subordinated obligations issued to unconsolidated subsidiary trusts                              |  | 25,774                   |  | 808              |  | 3.13%            |  | 25,774         |  | 1,399            |  | 5.43%            |  | 25,774        |  | 1,960            |  | 7.60%           
|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                 
|Total interest-bearing liabilities                                                                      |  | 1,114,413                |  | 20,581           |  | 1.85%            |  | $1,053,312     |  | 30,267           |  | 2.87%            |  | $1,020,060    |  | $38,550          |  | 3.78%           
|Non-interest-bearing liabilities:                                                                       |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|Demand deposits                                                                                         |  | 156,396                  |  |                  |  |                  |  | 133,997        |  |                  |  |                  |  | 126,698       |  |                  |  |                 
|Other liabilities                                                                                       |  | 16,685                   |  |                  |  |                  |  | 17,138         |  |                  |  |                  |  | 19,688        |  |                  |  |                 
|Shareholders equity                                                                                    |  | 131,854                  |  |                  |  |                  |  | 118,089        |  |                  |  |                  |  | 111,728       |  |                  |  |                 
|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|Total                                                                                                   |  | $1,419,348               |  |                  |  |                  |  | $1,322,536     |  |                  |  |                  |  | $1,278,174    |  |                  |  |                 
|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|Net interest income (tax equivalent)                                                                    |  |                          |  | $  45,697        |  |                  |  |                |  | $40,079          |  |                  |  |               |  | $34,866          |  |                 
|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|Net interest rate spread                                                                                |  |                          |  |                  |  | 3.30%            |  |                |  |                  |  | 3.01%            |  |               |  |                  |  | 2.58%           
|Net interest margin (tax equivalent)                                                                    |  |                          |  |                  |  | 3.55%            |  |                |  |                  |  | 3.35%            |  |               |  |                  |  | 3.02%           
|Federal tax exemption on nontaxable investment securities, loans and leases included in interest income |  |                          |  | 2,316            |  |                  |  |                |  | 2,382            |  |                  |  |               |  | 2,384            |  |                 
|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 
|Net interest income                                                                                     |  |                          |  | $  43,381        |  |                  |  |                |  | $37,697          |  |                  |  |               |  | $32,482          |  |                 
|                                                                                                        |  |                          |  |                  |  |                  |  |                |  |                  |  |                  |  |               |  |                  |  |                 



16



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##### Table of Contents

Rate/Volume Analysis

The following table sets forth the dollar volume of increase (decrease) in interest income and interest expense resulting from changes in the volume of earning assets and interest-bearing liabilities, and
from changes in rates. Volume changes are computed by multiplying the volume difference by the prior years rate. Rate changes are computed by multiplying the rate difference by the prior years balance. The change in interest due to both
rate and volume has been allocated proportionally between the volume and rate variances.



|                                                                           |  |                            |  |              |  |                            |  |  |  |           |  |           |  |            
|-------------------------------------------------------------------------- |  | -------------------------- |  | ------------ |  | -------------------------- |  |  |  | --------- |  | --------- |  | -----------
|                                                                           |  | 2009 Compared to 2008      |  |              |  | 2008 Compared to 2007     
|                                                                           |  | Increase (decrease) due to |  |              |  | Increase (decrease) due to
|                                                                           |  | Volume                     |  | Rate         |  | NetChange                  |  |  |  | Volume    |  | Rate      |  | Net Change 
|                                                                           |  | (In thousands)            
|Federal funds sold                                                         |  | $        67                |  | $      (152) |  | $    (85)                  |  |  |  | $      98 |  | $    (16) |  | $        82
|Taxable investment securities                                              |  | 2,808                      |  | (1,461)      |  | 1,347                      |  |  |  | 668       |  | 199       |  | 867        
|Non-taxable investment securities                                          |  | (213)                      |  | (35)         |  | (248)                      |  |  |  | 226       |  | (58)      |  | 168        
|FHLB and FRB stock                                                         |  | (11)                       |  | (65)         |  | (76)                       |  |  |  | 148       |  | (142)     |  | 6          
|Residential real estate loans                                              |  | 2,817                      |  | (1,172)      |  | 1,645                      |  |  |  | 1,869     |  | (341)     |  | 1,528      
|Commercial loans                                                           |  | (388)                      |  | (2,459)      |  | (2,847)                    |  |  |  | (319)     |  | (2,671)   |  | (2,990)    
|Non-taxable commercial loans                                               |  | 52                         |  | (47)         |  | 5                          |  |  |  | 6         |  | (47)      |  | (41)       
|Taxable leases, net of unearned income                                     |  | (2,114)                    |  | (254)        |  | (2,368)                    |  |  |  | (488)     |  | (635)     |  | (1,123)    
|Non-taxable leases, net of unearned income                                 |  | 12                         |  | 37           |  | 49                         |  |  |  | (184)     |  | 52        |  | (132)      
|Indirect loans                                                             |  | 456                        |  | (297)        |  | 159                        |  |  |  | (51)      |  | 248       |  | 197        
|Consumer loans                                                             |  | 44                         |  | (1,693)      |  | (1,649)                    |  |  |  | (66)      |  | (1,566)   |  | (1,632)    
|                                                                           |  |                            |  |              |  |                           
|Total interest-earning assets                                              |  | $  3,530                   |  | $  (7,598)   |  | $ (4,068)                  |  |  |  | $ 1,907   |  | $ (4,977) |  | $  (3,070) 
|                                                                           |  |                            |  |              |  |                            | 
|Interest-bearing demand deposits                                           |  | 64                         |  | (266)        |  | (202)                      |  |  |  | 82        |  | (260)     |  | (178)      
|Savings deposits                                                           |  | 33                         |  | (71)         |  | (38)                       |  |  |  | 9         |  | 9         |  | 18         
|MMDA deposits                                                              |  | 1,309                      |  | (2,694)      |  | (1,385)                    |  |  |  | 821       |  | (2,411)   |  | (1,590)    
|Time deposits                                                              |  | (113)                      |  | (5,542)      |  | (5,655)                    |  |  |  | (2,102)   |  | (3,168)   |  | (5,270)    
|Borrowings                                                                 |  | (953)                      |  | (862)        |  | (1,815)                    |  |  |  | 1,662     |  | (2,364)   |  | (702)      
|Junior subordinated obligations issued to unconsolidated subsidiary trusts |  |                           |  | (591)        |  | (591)                      |  |  |  |          |  | (561)     |  | (561)      
|                                                                           |  |                            |  |              |  |                           
|Total interest-bearing liabilities                                         |  | $     340                  |  | $(10,026)    |  | $ (9,686)                  |  |  |  | $    472  |  | $ (8,755) |  | $  (8,283) 
|                                                                           |  |                            |  |              |  |                           
|                                                                           |  |                            |  |              |  |                            | 
|Net interest income (tax equivalent)                                       |  | $  3,190                   |  | $    2,428   |  | $   5,618                  |  |  |  | $ 1,435   |  | $   3,778 |  | $    5,213 
|                                                                           |  |                            |  |              |  |                           

Comparison of Operating Results for the Years Ended
December 31, 2009 and 2008

General

Net income was $11.4 million for the year ended December 31, 2009, compared with $10.4 million in 2008. Net income available to common shareholders was $10.4 million or $2.24
per diluted share in 2009, compared with $10.3 million or $2.21 per diluted share in 2008. Net income for 2009 included gains on sales of securities totaling $1.3 million after taxes or $0.29 per diluted share which offset non-recurring expenses of
approximately $482,000 after taxes or $0.11 per diluted share. Preferred stock dividends and the accretion of the preferred stock discount were $1.1 million or $0.24 per diluted share in 2009.

Net Interest Income

Net interest income for the year ended December 31, 2009 totaled $43.4 million, an increase of $5.7 million or 15.1% compared with $37.7 million in 2008. The increase in net interest income resulted
from a combination of earning asset growth and a higher net interest margin. Average earning assets increased $90.3 million in 2009 compared with 2008, due primarily to growth in the residential loan and securities portfolios. The tax-equivalent net
interest margin was 3.55% in 2009, compared with 3.35% in 2008. The net interest margin growth in 2009 is primarily the result of the Companys ongoing balance sheet management and deposit pricing strategies and the effects of those strategies
in the low interest rate environment of the past year. The net interest margin increased 26 basis points during 2009, from 3.42% in the first quarter to 3.68% in the fourth quarter. The rate of growth in the Companys net interest margin slowed
in the last quarter of 2009 as interest rates on a substantial component of the Companys interest-bearing liabilities have adjusted to the lower rates in effect during the period. As a result, the Company expects its ability to continue to
reduce its cost of funds from current levels will be limited, which ultimately will cause a leveling off or reversal of the growth in its net interest margin.

The Companys tax-equivalent earning assets yield decreased 73 basis points in 2009 compared with 2008, which was more than offset by a 102 basis point decrease in its cost of funds over the same
period. The yield on the Companys interest-earning assets was 5.15% in 2009, compared with 5.88% in 2008. The Companys cost of funds was 1.85% in 2009, compared with 2.87% in 2008.

Since September 2007, the Federal Reserve has reduced its target fed funds rate from 5.25% to between zero and 0.25%. Over this same time period, a sharp drop in equity markets,
economic recession and federal government monetary and economic stimulus efforts have contributed to a sharp decline in the yields on U.S. Treasury securities. As a result of these factors, the yields on two-year, five-year and ten-year treasury
securities dropped 339 basis points, 272 basis points and 230 basis points, respectively from August 31, 2007 to December 31, 2008. Treasury yields rebounded somewhat in 2009, with yields increasing 38 basis points, 113 basis points and
159 basis



17



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##### Table of Contents

points on the two-year, five-year and ten-year treasury securities, respectively from the end of 2008. The low interest rate environment of the past two years has resulted in lower yields for all
of the Companys earning assets. Yields on commercial loans and consumer loans were most affected by these conditions, with yields on these assets down 122 basis points and 185 basis points, respectively, in 2009 compared with 2008. These asset
types are more sensitive than the Companys other interest-bearing assets to changes in market interest rates due to the variable rate characteristics of a portion of these portfolios and to the high levels of annual amortization in the
portfolios as a result of their relatively shorter duration.

Changes in the Companys asset mix also contributed to the
decline in the earning assets yield in 2009, as securities and residential mortgages comprised a larger portion of the Companys earning assets in 2009 compared with 2008. The yields on these assets are typically lower than yields on commercial
loans and leases. Growth in the securities and residential portfolios combined with low demand for commercial loans and the planned runoff of the equipment lease portfolio resulted in the securities and residential mortgage portfolios increasing to
53.4% of earning assets in 2009, compared with 47.9% in 2008.

The Companys cost of funds declined markedly in 2009 in
all interest-bearing liability categories except savings accounts. The average yield of money market and time deposits dropped 100 basis points and 145 basis points, respectively in 2009 as a result of the lower rate environment and the
Companys deposit pricing strategies. Our wholesale funding costs also dropped significantly in 2009, with the average cost of our borrowings down 41 basis points. At the same time the Company was lowering its borrowing costs due to the lower
rates in 2009, it continued to extend the maturity on new or renewed borrowings in order to lessen the potential impact of higher interest rates on its borrowing costs. The weighted average maturity of the Companys borrowings was 2.4 years at
December 31, 2009.

The average cost on the Companys junior subordinated obligations decreased 230 basis points in
2009 due to the sharp decline in the three-month Libor index to which these variable rate obligations are tied.

The
Companys liability mix changed favorably during 2009 as the Company continued to focus on growing lower cost savings, demand and money market accounts (transaction accounts) and relied less on higher promotional rates to attract or retain
retail time accounts. The aggregate average balance of transaction accounts was $669.0 million in 2009, which was an increase of $115.9 million or 21.0% from the aggregate average balances of $553.0 million in 2008. Average transaction account
balances comprised 63.6% of total average deposits in 2009, compared with 58.9% in 2008. Average time account balances in 2009 were $382.4 million or 36.4% of total average deposits in 2009, compared with $385.3 million or 41.1% in 2008. The
Companys ability to gather core transaction deposits over the past year has been greatly enhanced by its strong financial position and earnings performance, enhanced product offerings including upgraded treasury management and internet banking
platforms, and a high positive awareness of Alliances brand. These factors, combined with negative operating performance or other challenges being experienced by certain larger financial institutions operating in our market, have been
important contributors to the Companys core deposit gains in 2009.

Non-Interest Income

The Companys non-interest income is comprised of service charges on deposits, fees from investment management and brokerage services,
mortgage banking operations that include gains from sales and income from servicing, and other recurring operating income fees from normal banking operations, along with non-core components that primarily consist of net gains or losses from sales of
investment securities.

The following table sets forth certain information on non-interest income for the years indicated:



|                                                        |  |                          |        |      |   |        |  |   |         |  |        
|------------------------------------------------------- |  | ------------------------ | ------ | ---- | - | ------ |  | - | ------- |  | -------
|                                                        |  | Years ended December 31,
|                                                        |  | 2009                     |        | 2008 |   | Change
|                                                        |  | (In thousands)           |        |     
|Investment management income                            |  | $                        | 7,134  |      | $ | 8,670  |  | $ | (1,536) |  | (17.7)%
|Service charges on deposit accounts                     |  |                          | 5,037  |      |   | 5,164  |  |   | (127)   |  | (2.5)% 
|Card-related fees                                       |  |                          | 2,248  |      |   | 2,106  |  |   | 142     |  | 6.7%   
|Insurance agency income                                 |  |                          | 1,387  |      |   | 1,583  |  |   | (196)   |  | (12.4)%
|Income from bank-owned life insurance                   |  |                          | 1,014  |      |   | 856    |  |   | 158     |  | 18.5%  
|Gain on sale of loans                                   |  |                          | 748    |      |   | 252    |  |   | 496     |  | 196.8% 
|Gains (losses) on sale of securities available-for-sale |  |                          | 2,168  |      |   | 137    |  |   | 2,031   |  | 1482.5%
|Other operating income                                  |  |                          | 1,075  |      |   | 1,592  |  |   | (517)   |  | (32.5)%
|                                                        |  |                          |        |      |   |        |  |   |         |  |        
|Total non-interest income                               |  | $                        | 20,811 |      | $ | 20,360 |  | $ | 451     |  | 2.2 %  
|                                                        |  |                          |        |      |   |        |  |   |         |  |        

Total non-interest income increased $451,000 or 2.2%
in 2009. A $2.0 million increase in gains on sales of securities in 2009 offset a $1.5 million decrease in investment management income and a $517,000 decrease in other non-interest income. The decrease in investment management income resulted from
the decline in the performance of the public equity markets in 2008 and the first quarter of 2009. Investment management income increased 4.8% in the fourth quarter of 2009 from the first quarter low due largely to the recovery in the equity
markets. Other non-interest income is down largely as the result of fewer, individually immaterial, non-recurring items in 2009.

Non-interest
income (excluding securities gains) comprised 30.1% of total revenue in 2009 compared with 34.9% for 2008.



18



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##### Table of Contents

Non-Interest Expenses

The following table sets forth certain information on operating expenses for the years indicated:



|                                    |  |                         |        |      |   |        |  |   |       |  |        
|----------------------------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ----- |  | -------
|                                    |  | Years ended December 31
|                                    |  | 2009                    |        | 2008 |   | Change
|                                    |  | (In thousands)          |        |     
|Salaries and employee benefits      |  | $                       | 20,428 |      | $ | 19,823 |  | $ | 605   |  | 3.0%   
|Occupancy and equipment expenses    |  |                         | 7,047  |      |   | 7,032  |  |   | 15    |  | 0.2%   
|Communication expense               |  |                         | 756    |      |   | 791    |  |   | (35)  |  | (4.4)% 
|Office supplies and postage expense |  |                         | 1,337  |      |   | 1,137  |  |   | 200   |  | 17.6%  
|Marketing expense                   |  |                         | 932    |      |   | 1,090  |  |   | (158) |  | (14.5)%
|Amortization of intangible assets   |  |                         | 1,453  |      |   | 1,622  |  |   | (169) |  | (10.4)%
|Professional fees                   |  |                         | 2,893  |      |   | 2,661  |  |   | 232   |  | 8.7%   
|FDIC insurance premium              |  |                         | 2,284  |      |   | 557    |  |   | 1,727 |  | 310.1% 
|Other non-interest expense          |  |                         | 6,078  |      |   | 4,665  |  |   | 1,413 |  | 30.3%  
|                                    |  |                         |        |      |   |        |  |   |       |  |        
|Total non-interest expenses         |  | $                       | 43,208 |      | $ | 39,378 |  | $ | 3,830 |  | 9.7%   
|                                    |  |                         |        |      |   |        |  |   |       |  |        

Total non-interest expense increased $3.8 million or
9.7% in 2009. FDIC insurance expense increased $1.7 million in 2009 compared with 2008, due in large part to a special charge assessed by the Federal Deposit Insurance Corporation to all FDIC-insured banks, and to overall higher rates charged in
2009. The special assessment charged to Alliance in the second quarter totaled $676,000.

In December 2009, the FDIC enacted a
proposal that required most FDIC-insured banks to prepay their projected insurance assessments for the years 2010 through 2012. In December 2009, the Company prepaid approximately $5.7 million of such assessments. This advance assumes average
insured deposit growth for the Company of 5% through 2012 and increases in assessment rates of approximately 22% from current rates. The prepaid assessments were capitalized as an asset and will be amortized based on the expected period in which the
assessment would have been incurred. The actual FDIC insurance expense could be higher if the balance in the deposit insurance fund reaches levels that cause the FDIC to implement additional special assessments or take other actions that result in
an increase to the amounts paid by banks under the FDIC insurance program.

Other non-interest expense increased $1.4 million
or 30.3% due to a combination of growth related expenses, increased loan collection costs and approximately $786,000 of miscellaneous individually non-material non-recurring items in 2009.

The Companys efficiency ratio was 69.7% in 2009, compared with 68.0% in 2008. Excluding the $676,000 special FDIC insurance assessment, the efficiency ratio was 68.6% in 2009.

Income Tax Expense

The Companys effective tax rate was 23.1% in 2009 and 21.4% in 2008. The increase in the effective tax rate in 2009 primarily reflects a decrease in the percentage of non-taxable income to pre-tax income.

Comparison of Operating Results for the Years Ended December 31, 2008 and 2007

General

Net income was $10.4 million for the year ended December 31,
2008, compared with $9.5 million in 2008. Net income available to common shareholders was $10.3 million or $2.21 per diluted share in 2008, compared with $9.5 million or $1.96 per diluted share in 2007.

Net Interest Income

Net
interest income for the year ended December 31, 2008 totaled $37.7 million, an increase of $5.2 million or 16.1% compared with $32.5 million in 2007. The increase in net interest income resulted from a combination of earning asset growth and a
higher net interest margin. Average earning assets increased $40.5 million in 2008 compared with 2007, due primarily to growth in the residential loan and securities portfolios. The tax-equivalent net interest margin was 3.35% in 2008, compared with
3.02% in 2007. The net interest margin growth in 2008 is primarily the result of the Companys ongoing balance sheet management and deposit pricing strategies and the effects of those strategies in the low interest rate environment of the past
year.

The Company experienced a decrease of 48 basis points in its tax-equivalent earning assets yield in 2008 compared with
2007, which was more than offset by a 91 basis point decrease in its cost of funds over the same period. The yield on the Companys interest-earning assets was 5.88% in 2008, compared with 6.36% in 2007. The Companys cost of funds was
2.87% in 2008, compared with 3.78% in 2007.

As discussed previously in this Form 10-K, the significant easing of monetary
policy by the Federal Reserve since September 2007, along with a sharp drop in equity markets, economic recession and federal government monetary and economic stimulus efforts have contributed to a sharp decline in the yields on U.S. Treasury
securities. Yields on commercial loans and consumer loans were most affected by these conditions in 2008, with yields on these assets down 128 basis points and 173 basis points, respectively, in 2008 compared with 2007. These asset types are more
sensitive than the Companys other interest-bearing assets to changes in market interest rates due to the variable



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##### Table of Contents

rate characteristics of a portion of these portfolios and to the high levels of annual amortization in the portfolios as a result of their relatively shorter duration.

Loans and leases comprised 75.4% of average earning assets in 2008, compared with 76.7% in 2007. The slightly lower proportion of earning
assets in loan and leases resulted largely from the Companys previously announced planned wind-down of the Companys lease portfolio in the third quarter of 2008, which was also a contributing factor to the lower earning-assets yield in
2008.

The Companys cost of funds declined markedly in 2008 in all interest-bearing liability categories except savings
accounts. The average yield of money market and time deposits dropped 111 basis points and 78 basis points, respectively in 2008 as a result of the lower rate environment and the Companys deposit pricing strategies. Our wholesale funding costs
also dropped significantly in 2008, with the average cost of our borrowings down 115 basis points. At the same time the Company was lowering its borrowing costs due to the lower rates in 2008, it took the opportunity to lower its overall
liability-sensitive position by extending the maturity on new or renewed borrowings. The weighted average maturity of the Companys borrowings was 2.7 years at December 31, 2008.

The average cost on the Companys junior subordinated obligations decreased 217 basis points in 2008 due to the decline in the three-month Libor index to which these variable
rate obligations are tied.

The Companys liability mix changed favorably during 2008 as the Company continued to focus
on growing lower cost savings, demand and money market accounts (transaction accounts) and relied less on higher promotional rates to attract or retain retail time accounts. The aggregate average balance of transaction accounts was $553.0 million in
2008, which was an increase of $47.6 million or 9.4% from the aggregate average balances of $505.5 million in 2007. Average transaction account balances comprised 58.9% of total average deposits in 2008, compared with 53.9% in 2007. Average time
account balances in 2008 were $385.3 million or 41.1% of total average deposits in 2008, compared with $432.7 million or 46.1% in 2007. The decrease in average time account balances occurred largely in the first half of 2008 as the Companys
de-emphasis on higher promotional rates allowed the Company to reduce its reliance on highly rate sensitive, short-term retail time accounts.

Non-Interest Income

The following table sets forth certain information on non-interest income for the years indicated:



|                                                        |  |                          |        |      |   |        |  |   |       |  |         
|------------------------------------------------------- |  | ------------------------ | ------ | ---- | - | ------ |  | - | ----- |  | --------
|                                                        |  | Years ended December 31,
|                                                        |  | 2008                     |        | 2007 |   | Change
|                                                        |  | (In thousands)           |        |     
|Investment management income                            |  | $                        | 8,670  |      | $ | 9,180  |  | $ | (510) |  | (5.6)%  
|Service charges on deposit accounts                     |  |                          | 5,164  |      |   | 5,296  |  |   | (132) |  | (2.5)%  
|Card-related fees                                       |  |                          | 2,106  |      |   | 1,942  |  |   | 164   |  | 8.4%    
|Insurance agency income                                 |  |                          | 1,583  |      |   | 1,855  |  |   | (272) |  | (17.2)% 
|Income from bank-owned life insurance                   |  |                          | 856    |      |   | 635    |  |   | 221   |  | 34.8%   
|Gain on sale of loans                                   |  |                          | 252    |      |   | 192    |  |   | 60    |  | 31.3%   
|Gains (losses) on sale of securities available-for-sale |  |                          | 137    |      |   | (12)   |  |   | 149   |  | 1,241.7%
|Other operating income                                  |  |                          | 1,592  |      |   | 2,204  |  |   | (612) |  | (27.8)% 
|                                                        |  |                          |        |      |   |        |  |   |       |  |         
|Total non-interest income                               |  | $                        | 20,360 |      | $ | 21,292 |  | $ | (932) |  | (4.4)%  
|                                                        |  |                          |        |      |   |        |  |   |       |  |         

Total non-interest income decreased $932,000 or 4.4%
in 2008, with lower investment management fees and fewer non-recurring income items in 2008 as compared to 2007 contributing to the decrease. The largest single non-recurring item in 2007 was a $283,000 gain on the prepayment of certain equipment
leases which is included in other non-interest income in 2007.

Investment management income decreased by $510,000 or 5.6% in
2008 as a result of the impact of declines in equity markets on the investment management portfolio under management. The S&P 500 Index and the Dow Jones Industrial Average were down 39% and 34%, respectively in 2008. These market declines were
the primary factors in a 25% decline in the levels and values of assets managed by the Company, and on the fees generated from these managed assets.

Non-interest income comprised 34.9% of total revenue (non-interest income, net of realized gains and losses on securities and non-recurring items, and net interest income) in 2008 compared with 39.3% in
2007.



20



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##### Table of Contents

Non-Interest Expenses

The following table sets forth certain information on operating expenses for the years indicated:



|                                    |  |                         |  |                 |  |            |  |        
|----------------------------------- |  | ----------------------- |  | --------------- |  | ---------- |  | -------
|                                    |  | Years ended December 31
|                                    |  | 2008                    |  | 2007            |  | Change    
|                                    |  | (In thousands)          |  |                
|Salaries and employee benefits      |  | $    19,823             |  | $        18,281 |  | $    1,542 |  | 8.4%   
|Occupancy and equipment expenses    |  | 7,032                   |  | 6,765           |  | 267        |  | 3.9%   
|Communication expense               |  | 791                     |  | 827             |  | (36)       |  | (4.4)% 
|Office supplies and postage expense |  | 1,137                   |  | 1,236           |  | (99)       |  | (8.0)% 
|Marketing expense                   |  | 1,090                   |  | 1,237           |  | (147)      |  | (11.9)%
|Amortization of intangible assets   |  | 1,622                   |  | 1,729           |  | (107)      |  | (6.2)% 
|Professional fees                   |  | 2,661                   |  | 2,845           |  | (184)      |  | (6.5)% 
|FDIC insurance premium              |  | 557                     |  | 113             |  | 444        |  | 392.9% 
|Other non-interest expense          |  | 4,665                   |  | 4,605           |  | 60         |  | 1.3%   
|                                    |  |                         |  |                 |  |            |  |        
|Total non-interest expenses         |  | $  39,378               |  | $      37,638   |  | $  1,740   |  | 4.6%   
|                                    |  |                         |  |                 |  |            |  |        

Total non-interest expense increased $1.7 million or
4.6% in 2008. Salaries and benefits increased $1.5 million or 8.4% due primarily to the absence of incentive compensation accruals in 2007, and increased participation in the Companys 401(k) plan, higher medical insurance costs and normal
salary increases in 2008.

The Companys efficiency ratio was 68.0% in 2008, compared with 70.4% in 2007.

Income Tax Expense

The
Companys effective tax rate was 21.4% in 2008 and 23.2% in 2007. The decrease in the effective tax rate in 2008 primarily reflects an increase in the percentage of non-taxable income to pre-tax income.



21



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##### Table of Contents

Comparison of Financial Condition at December 31, 2009 and December 31, 2008

General

Total assets were
$1.4 billion at December 31, 2009, an increase of $49.9 million or 3.6% from December 31, 2008. Securities available-for-sale increased $63.0 million in 2009 to $362.2 million at the end of 2009. Total loans and leases (net of unearned
income) increased $3.4 million to $914.2 million at December 31, 2009, compared with $910.8 million at December 31, 2008. The Companys overall loan and lease portfolio growth was restrained by the planned and actively managed runoff
of the lease portfolio, which decreased $36.4 million in 2009.

Securities

The securities portfolio is designed to provide a favorable total return utilizing low-risk, high-quality securities while at the same time assisting in meeting the liquidity needs
of the Banks loan and deposit operations, and supporting the Companys interest risk objectives. Our securities portfolio is predominately comprised of investment grade mortgage-backed securities, securities issued by U.S. government
sponsored corporations and municipal securities. The Company classifies the majority of its securities as available-for-sale. The Company does not engage in securities trading or derivatives activities in carrying out its investment strategies.

The following table sets forth the amortized cost and market value for the Companys available-for-sale securities
portfolio:



|                                                      |  |                   |  |               |  |                   |  |               |  |                   |  |              
|----------------------------------------------------- |  | ----------------- |  | ------------- |  | ----------------- |  | ------------- |  | ----------------- |  | -------------
|                                                      |  | At December 31,  
|                                                      |  | 2009              |  | 2008          |  | 2007             
|                                                      |  | Amortized    Cost |  | Fair    Value |  | Amortized    Cost |  | Fair    Value |  | Amortized    Cost |  | Fair    Value
|Securities available for sale:                        |  | (In thousands)   
|Debt securities:                                      |  |                   |  |               |  |                   |  |               |  |                   |  |              
|U.S. Treasury obligations                             |  | $        100      |  | $    101      |  | $       101       |  | $       102   |  | $       100       |  | $       101  
|Obligations of U.S. government-sponsored corporations |  | 5,864             |  | 6,129         |  | 34,489            |  | 35,143        |  | 60,902            |  | 60,942       
|Obligations of states and political subdivisions      |  | 75,104            |  | 77,147        |  | 89,154            |  | 91,033        |  | 87,028            |  | 88,580       
|Mortgage-backed securities - residential              |  | 273,499           |  | 275,680       |  | 167,753           |  | 169,960       |  | 120,258           |  | 120,155      
|                                                      |  |                   |  |               |  |                   |  |               |  |                   |  |              
|Total debt securities                                 |  | 354,567           |  | 359,057       |  | $291,497          |  | $296,238      |  | $268,288          |  | $269,778     
|                                                      |  |                   |  |               |  |                  
|Stock investments:                                    |  |                   |  |               |  |                   |  |               |  |                   |  |              
|Equity securities                                     |  | 1,958             |  | 2,104         |  | 1,958             |  | 1,923         |  | 1,934             |  | 1,946        
|Mutual funds                                          |  | 1,000             |  | 997           |  | 1,000             |  | 988           |  | 1,000             |  | 989          
|                                                      |  |                   |  |               |  |                   |  |               |  |                   |  |              
|Total stock investments                               |  | 2,958             |  | 3,101         |  | 2,958             |  | 2,911         |  | 2,934             |  | 2,935        
|                                                      |  |                   |  |               |  |                  
|Total available for sale                              |  | 357,525           |  | 362,158       |  | 294,455           |  | 299,149       |  | 271,222           |  | 272,713      
|Net unrealized gains on available-for-sale securities |  | 4,633             |  |               |  | 4,694             |  |               |  | 1,491             |  |              
|                                                      |  |                   |  |               |  |                   |  |               |  |                   |  |              
|Total carrying value                                  |  | $362,158          |  |               |  | $299,149          |  |               |  | $272,713          |  |              
|                                                      |  |                   |  |               |  |                   |  |               |  |                   |  |              

The Companys investment securities portfolio totaled $362.2 million at December 31,
2009, compared with $299.1 million at December 31, 2008. The Companys portfolio is comprised entirely of investment grade securities, the majority of which are rated AAA by one or more of the nationally recognized rating
agencies. The breakdown of our securities portfolio at December 31, 2009 is 76% guaranteed mortgage-backed securities, 21% municipal securities and 2% obligations of U.S. Government sponsored corporations. Mortgage-backed securities, which
totaled $275.7 million at December 31, 2009, are comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie-Mae, Freddie-Mac or Ginnie Mae, which in turn are backed by the federal
government. The Companys municipal bond portfolio is comprised 99.6% of general obligation bonds issued by local municipalities and school districts in New York State. The Company does not invest in any securities backed by sub-prime, Alt-A or
other high-risk mortgages. The Company also does not hold any preferred stock, corporate debt or trust preferred securities in its investment portfolio.

The Company had net unrealized gains of approximately $4.6 million in its securities portfolio at December 31, 2009, compared with net unrealized gains of $4.7 million at December 31, 2008.



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##### Table of Contents

The following table sets forth as of December 31, 2009, the maturities and the
weighted-average yields of the Companys debt securities, which have been calculated on the basis of the amortized cost, weighted for scheduled maturity of each security, and adjusted to a fully tax-equivalent basis:



|                                                      |  |                                             |  |                                                          |  |                                                        |  |                                       |  |             
|----------------------------------------------------- |  | ------------------------------------------- |  | -------------------------------------------------------- |  | ------------------------------------------------------ |  | ------------------------------------- |  | ------------
|                                                      |  | At December 31, 2009                       
|                                                      |  | AmountMaturingWithin    One Year    or Less |  | Amount    Maturing After    One Year butWithin FiveYears |  | AmountMaturing AfterFive Years but    Within Ten Years |  | Amount    Maturing After    Ten Years |  | TotalCost   
|                                                      |  | (In thousands)                             
|U.S. Treasury obligations                             |  | $      100                                  |  | $                                                       |  | $                                                     |  | $                                    |  | $        100
|Obligations of U.S. government-sponsored corporations |  | 386                                         |  | 5,478                                                    |  |                                                       |  |                                      |  | 5,864       
|Obligations of states and political subdivisions      |  | 14,305                                      |  | 32,588                                                   |  | 22,249                                                 |  | 5,962                                 |  | 75,104      
|Mortgage-backed securities                            |  | 70,781                                      |  | 139,133                                                  |  | 49,681                                                 |  | 13,904                                |  | 273,499     
|                                                      |  |                                             |  |                                                          |  |                                                        |  |                                       |  |             
|Total debt securities available-for-sale              |  | $  85,572                                   |  | $  177,199                                               |  | $  71,930                                              |  | $  19,866                             |  | $  354,567  
|                                                      |  |                                             |  |                                                          |  |                                                        |  |                                       |  |             
|Weighted average yield at year end(1)                 |  | 4.07%                                       |  | 4.01%                                                    |  | 4.17%                                                  |  | 4.39%                                 |  | 4.08%       



|(1) | Weighted average yields on the tax-exempt obligations have been computed on a fully tax-equivalent basis assuming a marginal federal tax rate of
34%. These yields are an arithmetic computation of interest income divided by average balance and may differ from the yield to maturity, which considers the time value of money.
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

Loans and Leases

The loan
and lease portfolio is the largest component of the Banks earning assets and accounts for the greatest portion of total interest income. The Bank provides a full range of credit products through its branch network and its commercial
department. Consistent with the focus on providing community banking services, the Bank generally does not attempt to diversify geographically by making a significant amount of loans to borrowers outside of the primary service area. Loans are
primarily internally generated and the majority of the lending activity takes place in the New York State counties of Cortland, Madison, Onondaga, Oneida, and Oswego. In addition, the Bank originates indirect auto loans in the western counties of
New York State. In connection with the Companys ongoing strategic review and balance sheet management processes, Alliance Leasing, Inc. ceased origination of new transactions in the third quarter of 2008. The operations of Alliance Leasing are
currently limited to servicing the existing lease portfolio. As a result, the lease portfolio is projected to amortize at the rate of approximately $6 million per quarter over the next year.

Total loans and leases, net of unearned income and deferred costs, were $914.2 million at December 31, 2009, compared with $910.8 million at December 31, 2008.

Residential mortgages increased $42.9 million or 13.7% in 2009 as the Company increased its share of the relatively stable local
residential mortgage market. The Company originated a record $159.1 million in residential mortgages in 2009, which was a 54% increase from 2008s originations of $103.2 million. The Company has achieved strong residential mortgage growth over
the last two years, capturing a larger share of the local conventional residential mortgage market, through a planned expansion of loan origination and servicing functions. This growth was accomplished while maintaining our commitment to traditional
underwriting standards. Substantially all of the Companys residential mortgage originations are conventional mortgages originated in its local markets. The Company does not originate sub-prime, Alt-A, negative amortizing or other higher risk
residential mortgages.

Commercial loans and mortgages decreased $6.3 million or 2.9% in 2009, due primarily to weak loan
demand in our market and lower utilization of existing commercial line of credit facilities. Despite the weak demand, originations of commercial loans (excluding lines of credit) increased $6.1 million or 11.8% in 2009, to $57.8 million. The recent
credit market turmoil and difficulties experienced by some of the larger lenders with whom we compete is anticipated to present opportunities for Alliance to compete more effectively for sound commercial credits without compromising our
long-standing underwriting standards. As one of the largest community banks headquartered in Central New York, Alliance expects to play a more prominent role in meeting the financing needs of credit worthy commercial customers with terms that are
sound and within our standards. The Company has recently invested in the growth of the commercial business through the hiring of experienced bankers with the expectation of increasing its originations and related deposit gathering in 2010. The
Company believes that the dislocation caused by the financial crisis at the nations large banks will create opportunity for it to increase its market share in Central New York and grow its commercial portfolio.

Leases (net of unearned income) continued to decrease in 2009 as a result of the Companys previously announced decision to cease new
lease originations. The Companys lease portfolio decreased $36.4 million or 34.8% in 2009 to $68.2 million at the end of the year. Leases are expected to continue to run-off at the rate of approximately $6 million per quarter over the next
twelve months.

Indirect auto loan balances increased $2.1 million or 1.2% in 2009. The Company originated $90.9 million of
indirect auto loans in 2009, compared with $95.0 million in 2008. Alliance originates auto loans through a network of reputable, well established automobile dealers located in Central and Western New York. Applications received through the
Companys indirect lending program are subject to the same comprehensive underwriting criteria and procedures as are employed in its direct lending programs. Credit quality metrics within this portfolio remain stable and compare favorably to
the industry.



23



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##### Table of Contents

The following table sets forth the composition of the Banks loan and lease portfolio at the dates
indicated:



|                                             |  |                        |  |         |  |           |  |         |  |          |  |         |  |          |  |         |  |          |  |        
|-------------------------------------------- |  | ---------------------- |  | ------- |  | --------- |  | ------- |  | -------- |  | ------- |  | -------- |  | ------- |  | -------- |  | -------
|                                             |  | At December 31,       
|                                             |  | 2009                   |  | 2008    |  | 2007      |  | 2006    |  | 2005    
|                                             |  | Amount                 |  | Percent |  | Amount    |  | Percent |  | Amount   |  | Percent |  | Amount   |  | Percent |  | Amount   |  | Percent
|                                             |  | (Dollars in thousands)
|Residential real estate                      |  | $356,906               |  | 39.2%   |  | $314,039  |  | 34.6%   |  | $273,465 |  | 30.6%   |  | $252,134 |  | 28.7%   |  | $185,760 |  | 28.5%  
|Commercial loans                             |  | 111,243                |  | 12.2%   |  | 118,756   |  | 13.1%   |  | 121,204  |  | 13.6%   |  | 122,006  |  | 13.9%   |  | 104,797  |  | 16.0%  
|Commercial real estate                       |  | 96,753                 |  | 10.7%   |  | 95,559    |  | 10.5%   |  | 95,932   |  | 10.8%   |  | 101,594  |  | 11.5%   |  | 57,611   |  | 8.8%   
|Leases, net of unearned income               |  | 68,224                 |  | 7.5%    |  | 104,655   |  | 11.6%   |  | 131,300  |  | 14.7%   |  | 131,048  |  | 14.9%   |  | 65,172   |  | 10.0%  
|Indirect auto loans                          |  | 184,947                |  | 20.3%   |  | 182,807   |  | 20.2%   |  | 176,115  |  | 19.7%   |  | 181,929  |  | 20.7%   |  | 172,113  |  | 26.4%  
|Other consumer loans                         |  | 92,022                 |  | 10.1%   |  | 90,906    |  | 10.0%   |  | 94,246   |  | 10.6%   |  | 90,438   |  | 10.3%   |  | 66,981   |  | 10.3%  
|                                             |  |                       
|                                             |  | 910,095                |  | 100.0%  |  | 906,722   |  | 100.0%  |  | 892,262  |  | 100.0%  |  | 879,149  |  | 100.0%  |  | 652,434  |  | 100.0% 
|                                             |  |                        |  |         |  |           |  |         |  |          |  |         |  |          |  |         |  |          |  |        
|Net deferred loan costs                      |  | 4,067                  |  |         |  | 4,033     |  |         |  | 3,271    |  |         |  | 2,262    |  |         |  | 1,652    |  |        
|                                             |  |                        |  |         |  |           |  |         |  |          |  |         |  |          |  |         |  |          |  |        
|Total loans and leases                       |  | 914,162                |  |         |  | 910,755   |  |         |  | 895,533  |  |         |  | 881,411  |  |         |  | 654,086  |  |        
|Allowance for credit losses and lease losses |  | (9,414)                |  |         |  | (9,161)   |  |         |  | (8,426)  |  |         |  | (7,029)  |  |         |  | (4,960)  |  |        
|                                             |  |                        |  |         |  |           |  |         |  |          |  |         |  |          |  |         |  |          |  |        
|Net Loans and Leases                         |  | $904,748               |  |         |  | $901, 594 |  |         |  | $887,107 |  |         |  | $874,382 |  |         |  | $649,126 |  |        
|                                             |  |                        |  |         |  |           |  |         |  |          |  |         |  |          |  |         |  |          |  |        

The following table shows the amount of loans and leases outstanding as of December 31, 2009,
which, based on remaining scheduled payments of principal, are due in the periods indicated:



|                                             |  |                                 |  |                                        |  |                                        |  |                        |  |           
|-------------------------------------------- |  | ------------------------------- |  | -------------------------------------- |  | -------------------------------------- |  | ---------------------- |  | ----------
|                                             |  | Maturing withinone year or less |  | Maturingafter one butwithin five years |  | Maturing afterfive butwithin ten years |  | Maturingafterten years |  | Total     
|                                             |  | (In thousands)                 
|Residential real estate                      |  | $    15,358                     |  | $    63,984                            |  | $    89,836                            |  | $  187,728             |  | $  356,906
|Commercial loans and commercial real estate  |  | 57,014                          |  | 71,851                                 |  | 40,198                                 |  | 38,933                 |  | 207,996   
|Leases, net of unearned income               |  | 21,582                          |  | 36,163                                 |  | 8,279                                  |  | 2,200                  |  | 68,224    
|Indirect auto loans                          |  | 56,927                          |  | 125,964                                |  | 2,056                                  |  |                       |  | 184,947   
|Other consumer loans                         |  | 20,489                          |  | 42,890                                 |  | 23,047                                 |  | 5,596                  |  | 92,022    
|                                             |  |                                 |  |                                        |  |                                        |  |                        |  |           
|Total loans & leases, net of unearned income |  | $  171,370                      |  | $  340,852                             |  | $  163,416                             |  | $  234,457             |  | $  910,095
|                                             |  |                                 |  |                                        |  |                                        |  |                        |  |           

The following table sets forth the sensitivity to changes in interest
rates as of December 31, 2009:



|                                          |  |                |  |               |  |           
|----------------------------------------- |  | -------------- |  | ------------- |  | ----------
|                                          |  | Fixed Rate     |  | Variable Rate |  | Total     
|                                          |  | (In thousands)
|Due after one year, but within five years |  | $  266,805     |  | $    74,047   |  | $  340,852
|Due after five years                      |  | 278,600        |  | 119,273       |  | 397,873   

Asset Quality and
the Allowance for Credit Losses

The following table represents a summary of delinquent loans and leases grouped by the
number of days delinquent at the dates indicated:



|                                    |  |                        |  |                   |  |          |  |      
|----------------------------------- |  | ---------------------- |  | ----------------- |  | -------- |  | -----
|Delinquent loans and leases         |  | December 31, 2009      |  | December 31, 2008
|                                    |  | $                      |  | %(1)              |  | $        |  | %(1) 
|                                    |  | (Dollars in thousands)
|30 days past due                    |  | $  7,883               |  | 0.87%             |  | $ 11,124 |  | 1.22%
|60 days past due                    |  | 2,271                  |  | 0.25%             |  | 4,736    |  | 0.52%
|90 days past due and still accruing |  |                       |  |                  |  | 126      |  | 0.01%
|Non-accrual                         |  | 8,582                  |  | 0.94%             |  | 4,352    |  | 0.48%
|                                    |  |                        |  |                  
|Total                               |  | $18,736                |  | 2.06%             |  | $ 20,338 |  | 2.23%
|                                    |  |                        |  |                  

(1)  As a percentage of total loans and leases,
excluding deferred costs

Delinquent loans and leases (including non-performing) decreased modestly in 2009 through a
combination of charge-offs, collections and customer payments. The equipment lease portfolio exhibited the largest decline in past-due levels in 2009, largely through charge-offs, as the Company continued to reduce its exposure to leases which have
experienced disproportionately higher levels of delinquencies than the Companys other loan categories. Leases past due 30 days or more decreased $3.3 million or 49.6% in 2009. Delinquencies in the Companys residential mortgage,
commercial and consumer loan portfolios were relatively stable in 2009, with total delinquencies up only $1.7 million for the combined portfolios, on aggregate year-end balances in these portfolios of $841.9 million.



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Loans and leases past due 30 days or more totaled $18.7 million or 2.06% of total loans and
leases at December 31, 2009, compared with $20.3 million or 2.23% of total loans and leases at December 31, 2008. Approximately 42% of all delinquent loans and leases at the end of 2009 were past due less than sixty days, compared with 55%
at the end of 2008. Residential mortgages past due 30 days or more totaled $7.3 million at December 31, 2009, compared with $6.7 million at December 31, 2008. Commercial loans past due 30 days or more totaled $6.2 million at
December 31, 2009, compared with $5.5 million at December 31, 2008.

The following table represents information concerning the
aggregate amount of non-performing assets:



|                                                                |  |                |  |            |  |            |  |            |  |            
|--------------------------------------------------------------- |  | -------------- |  | ---------- |  | ---------- |  | ---------- |  | -----------
|                                                                |  | December 31,  
|                                                                |  | 2009           |  | 2008       |  | 2007       |  | 2006       |  | 2005       
|                                                                |  | (In thousands)
|Non-accrual loans and leases:                                   |  |                |  |            |  |            |  |            |  |            
|Residential real estate                                         |  | $    2,843     |  | $    1,506 |  | $    1,118 |  | $      298 |  | $        12
|Commercial loans and commercial real estate                     |  | 4,013          |  | 1,997      |  | 4,988      |  | 1,248      |  | 1,103      
|Leases                                                          |  | 1,418          |  | 595        |  | 320        |  | 99         |  |           
|Indirect auto                                                   |  | 109            |  | 101        |  | 83         |  | 63         |  | 74         
|Consumer                                                        |  | 199            |  | 153        |  | 158        |  | 141        |  | 169        
|                                                                |  |                |  |            |  |            |  |            |  |            
|Total non-accrual loans and leases                              |  | 8,582          |  | 4,352      |  | 6,667      |  | 1,849      |  | 1,358      
|                                                                |  |                |  |            |  |            |  |            |  |            
|Accruing loans and leases past due 90 days or more              |  |               |  | 126        |  | 39         |  | 790        |  | 270        
|                                                                |  |                |  |            |  |            |  |            |  |            
|Total non-performing loans                                      |  | 8,582          |  | 4,478      |  | 6,706      |  | 2,639      |  | 1,628      
|Other real estate owned and other repossessed assets            |  | 445            |  | 657        |  | 229        |  |           |  | 6          
|                                                                |  |                |  |            |  |            |  |            |  |            
|Total non-performing assets                                     |  | $    9,027     |  | $    5,135 |  | $    6,935 |  | $    2,639 |  | $    1,634 
|                                                                |  |                |  |            |  |            |  |            |  |            
|Total non-performing loans and leases to total loans and leases |  | 0.94%          |  | 0.49%      |  | 0.75%      |  | 0.30%      |  | 0.25%      
|Total non-performing assets to total assets                     |  | 0.64%          |  | 0.38%      |  | 0.53%      |  | 0.21%      |  | 0.17%      
|Allowance for credit losses to non-performing loans and leases  |  | 109.7%         |  | 204.6%     |  | 125.7%     |  | 266.4%     |  | 304.7%     
|Allowance for credit losses to total loans and leases           |  | 1.03%          |  | 1.01%      |  | 0.94%      |  | 0.80%      |  | 0.76%      

Non-performing assets, defined as non-accruing loans and leases plus loans and leases 90 days or more past due, along with other real estate owned and other repossessed assets were $9.0 million or 0.64% of total assets at December 31,
2009, compared with $5.1 million or 0.38% of total assets at December 31, 2008. Included in nonperforming assets at the end of 2009 are nonperforming loans and leases totaling $8.6 million, compared with $4.5 million at December 31, 2008.
The Companys exposure to any individual nonperforming credit is low with an average balance of approximately $67,000 for each individual nonperforming loan and lease. Conventional residential mortgages comprised $2.8 million (35 loans) or 33%
of nonperforming loans and leases at December 31, 2009. Nonperforming commercial loans totaled $4.0 million (39 loans) or 47% of nonperforming loans and leases at the end of the fourth quarter. Leases on nonperforming status totaled $1.4
million (26 leases) or 17% of nonperforming loans and leases at the end of the fourth quarter.

Non-performing assets
increased in each of the first three quarters in 2009, due largely to weaknesses in the local, state and national economies, and totaled $10.6 million at the end of the third quarter of 2009. Nonperforming assets decreased $1.5 million or 14.4%
during the fourth quarter of 2009 largely through charge-offs, collections and customer payments in the commercial loan and lease portfolios. Total nonperforming residential mortgages, consumer and indirect auto loans were virtually unchanged during
the fourth quarter.

As a recurring part of its portfolio management program, the Company has identified approximately $9.1
million in potential problem loans at December 31, 2009, as compared to $13.3 million at December 31, 2008. The average balance of identified potential problem loans was $252,000 and $333,000 at December 31, 2009 and December 31,
2008, respectively. Potential problem loans are loans that are currently performing, but where the borrowers operating performance or other relevant factors could result in potential credit problems, and are typically classified by our loan
rating system as substandard. At December 31, 2009, potential problem loans primarily consisted of commercial loans and commercial real estate. There can be no assurance that additional loans will not become nonperforming, require
restructuring, or require increased provision for loan losses.

The Bank has a loan and lease monitoring program that it
believes appropriately evaluates non-performing loans and leases and the loan and lease portfolio in general. The loan and lease review program continually audits the loan and lease portfolio to confirm managements loan and lease risk rating
system, and systematically tracks such problem loans and leases to ensure compliance with loan and lease policy underwriting guidelines, and to evaluate the adequacy of the allowance for credit losses.

The Banks policy is to place a loan or lease on non-accrual status and recognize income on a cash basis when a loan or lease is more
than 90 days past due, unless in the opinion of management, the loan or lease is well secured and in the process of collection. The impact of interest not recognized on non-accrual loans and leases was $255,000 in 2009, $264,000 in 2008, and
$202,000 in 2007. The Bank considers a loan or lease impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the
contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally based upon the present value of future cash flows discounted at the historical effective interest rate, except that all collateral-dependent
loans and leases are measured for impairment based on fair value of the collateral. As of December 31, 2009, there was $3.6 million in impaired loans for which $332,000 in related allowance for credit losses was allocated. There was $1.1
million in impaired loans for which $193,000 in related allowance for credit losses was allocated as of December 31, 2008.

The allowance for credit losses represents managements best estimate of probable incurred credit losses in the Banks loan and lease portfolio. Managements quarterly evaluation of the allowance for credit losses is a
comprehensive analysis that builds a total allowance by evaluating the probable incurred credit losses within each product class. The Bank uses a general allocation methodology for all residential and consumer loan pools. This methodology estimates
an allowance for each pool based on the average loss rate for the time



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##### Table of Contents

period that includes the current year and two full prior years. The average loss rate is adjusted to reflect the expected impact that current trends regarding loan growth, delinquency, losses,
economic conditions, loan concentrations, policy changes, experience and ability of lending personnel, and current interest rates have. For commercial loan and lease pools, the Bank establishes a specific allocation for all loans and leases in
excess of $250,000 which are considered to be impaired and which have been risk rated under the Banks risk rating system as substandard, doubtful or loss. The specific allocation is based on the most recent valuation of the loan or lease
collateral. For all other commercial loans and leases, the Bank uses the general allocation methodology that estimates the probable incurred loss for each risk rating category. The general allocation methodology for commercial loans and leases
considers the same qualitative factors that are considered when evaluating residential mortgage and consumer loan pools. The combination of using both the general and specific allocation methodologies reflects managements best estimate of the
probable incurred credit losses in the Banks loan and lease portfolio. Loans and leases are charged against the allowance for credit losses, in accordance with the Banks loan and lease policy, when they are determined by management to be
uncollectible. Recoveries on loans and leases previously charged off are credited to the allowance for credit losses when they are received. When management determines that the allowance for credit losses is less than adequate to provide for
probable incurred losses, a direct charge to operating income is recorded.

The following table summarizes changes in the
allowance for credit losses arising from loans and leases charged off, recoveries on loans and leases previously charged off and additions to the allowance, which have been charged to expense.



|                                                       |  |                          |  |            |  |            |  |            |  |           
|------------------------------------------------------ |  | ------------------------ |  | ---------- |  | ---------- |  | ---------- |  | ----------
|                                                       |  | Years ended December 31,
|                                                       |  | 2009                     |  | 2008       |  | 2007       |  | 2006       |  | 2005      
|                                                       |  | (In thousands)          
|Balance at beginning of year                           |  | $    9,161               |  | $    8,426 |  | $    7,029 |  | $    4,960 |  | $    5,267
|Loans and leases charged-off:                          |  |                          |  |            |  |            |  |            |  |           
|Residential real estate                                |  | 76                       |  | 276        |  | 103        |  | 33         |  | 39        
|Commercial loans and commercial real estate            |  | 1,622                    |  | 1,940      |  | 545        |  | 689        |  | 393       
|Leases                                                 |  | 4,122                    |  | 1,844      |  | 881        |  | 560        |  |          
|Indirect auto                                          |  | 317                      |  | 295        |  | 211        |  | 195        |  | 296       
|Consumer                                               |  | 1,135                    |  | 1,284      |  | 1,487      |  | 913        |  | 360       
|                                                       |  |                          |  |            |  |            |  |            |  |           
|Total loans and leases charged off                     |  | 7,272                    |  | 5,639      |  | 3,227      |  | 2,390      |  | 1,088     
|Recoveries of loans and leases previously charged off: |  |                          |  |            |  |            |  |            |  |           
|Residential real estate                                |  | 59                       |  | 32         |  | 1          |  | 1          |  | 45        
|Commercial loans and commercial real estate            |  | 514                      |  | 113        |  | 48         |  | 59         |  | 209       
|Leases                                                 |  | 165                      |  | 40         |  | 13         |  |           |  |          
|Indirect auto                                          |  | 133                      |  | 91         |  | 119        |  | 213        |  | 191       
|Consumer                                               |  | 554                      |  | 596        |  | 653        |  | 412        |  | 192       
|                                                       |  |                          |  |            |  |            |  |            |  |           
|Total recoveries                                       |  | 1,425                    |  | 872        |  | 834        |  | 685        |  | 637       
|                                                       |  |                          |  |            |  |            |  |            |  |           
|Net loans and leases charged off                       |  | 5,847                    |  | 4,767      |  | 2,393      |  | 1,705      |  | 451       
|Provision for credit losses                            |  | 6,100                    |  | 5,502      |  | 3,790      |  | 2,477      |  | 144       
|Allowance acquired from Bridge Street Financial Inc.   |  |                         |  |           |  |           |  | 1,297      |  |          
|                                                       |  |                          |  |            |  |            |  |            |  |           
|Balance at end of year                                 |  | $  9,414                 |  | $   9,161  |  | $    8,426 |  | $    7,029 |  | $    4,960
|                                                       |  |                          |  |            |  |            |  |            |  |           

The provision for credit losses was $6.1 million in
2009, compared with $5.5 million in 2008. Net charge-offs were $5.8 million in 2009, compared with $4.8 million in 2008. Net charge-offs equaled 0.63% of average loans and leases outstanding during 2009, compared with 0.53% in 2008. Net charge-offs
in the Companys lease portfolio comprised 68% of total net charge-offs in 2009, compared with 38% in 2008. The charge-offs in the Companys lease portfolio in 2009 have been concentrated in four distinct segments of the portfolio, in
which the aggregate balances (net of charge-downs) have been reduced to $6.4 million at the end of the year. Net charge-offs in these four segments totaled $3.1 million or 78% of all lease net charge-offs in 2009. Approximately $1.8 million or 28.7%
of the leases in these segments was past due at the end of 2009, including $1.3 million (net of charge-downs to estimated collectible amounts) which are on nonaccrual status. The allowance for credit losses allocated to these four segments totaled
$1.2 million or 19.0% of the net remaining balances. The remaining balance of the lease portfolio totaling approximately $61.8 million is performing well, with a delinquency and non-accrual rate of only 2.6% at December 31, 2009.

The provision for credit losses as a percentage of net charge-offs was 104% in 2009, compared with 115% in 2008. The provision as a
percentage of net charge-offs was lower in 2009 due in large part to the Companys declining exposure to leases as a result of its decision in the third quarter of 2008 to exit this line of business, along with the relatively better performance
and higher credit quality of the remaining leases in the portfolio at the end of 2009. Generally stable credit quality metrics during 2009 in the Companys mortgage, consumer and indirect and commercial loan portfolios have also contributed to
the lower provision to charge-off ratio.

The allowance for credit losses was $9.4 million at December 31, 2009, compared
with $9.2 million at December 31, 2008. The ratio of the allowance for credit losses to total loans and leases was 1.03% at December 31, 2009, compared with 1.01% at December 31, 2008. The ratio of the allowance for credit losses to
nonperforming loans and leases was 110% at December 31, 2009, compared with 205% at December 31, 2008. The decrease in the nonperforming coverage ratio resulted from the higher level of nonperforming loans and leases in 2009. The Company
believes that its process of identifying and quantifying the potential loss exposure on nonperforming loans and leases, which gives consideration to the amount and quality of information about the borrowers financial condition, their potential
sources of funds for repayment and underlying collateral values, among other things, adequately quantified the Companys loss exposure on nonperforming loans and leases as part of its overall process of determining the adequacy of the allowance
for credit losses at December 31, 2009.



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##### Table of Contents

The allowance for credit losses has been allocated within the following categories of loans
and leases at the dates indicated with the corresponding percent of loans to total loans for each category (dollars in thousands):



|                        |  |                   |  |                              |  |                   |  |                              |  |                   |  |                              |  |                   |  |                              |  |                   |  |                             
|----------------------- |  | ----------------- |  | ---------------------------- |  | ----------------- |  | ---------------------------- |  | ----------------- |  | ---------------------------- |  | ----------------- |  | ---------------------------- |  | ----------------- |  | ----------------------------
|                        |  | At December 31,  
|                        |  | 2009              |  | 2008                         |  | 2007              |  | 2006                         |  | 2005             
|                        |  | AmountofAllowance |  | Percentof Loansto TotalLoans |  | AmountofAllowance |  | Percentof Loansto TotalLoans |  | AmountofAllowance |  | Percentof Loansto TotalLoans |  | AmountofAllowance |  | Percentof Loansto TotalLoans |  | AmountofAllowance |  | Percentof Loansto TotalLoans
|                        |  |                   |  |                              |  |                   |  |                              |  |                  
|Residential real estate |  | $     906         |  | 39.2%                        |  | $     850         |  | 34.6%                        |  | $     978         |  | 30.6%                        |  | $     969         |  | 28.7%                        |  | $     653         |  | 28.5%                       
|Commercial(1)           |  | 3,959             |  | 22.9%                        |  | 3,988             |  | 23.6%                        |  | 4,097             |  | 24.4%                        |  | 3,143             |  | 25.4%                        |  | 2,521             |  | 24.8%                       
|Leases                  |  | 2,624             |  | 7.5%                         |  | 2,673             |  | 11.6%                        |  | 1,951             |  | 14.7%                        |  | 1,468             |  | 14.9%                        |  | 385               |  | 10.0%                       
|Indirect auto           |  | 995               |  | 20.3%                        |  | 879               |  | 20.2%                        |  | 685               |  | 19.7%                        |  | 785               |  | 20.7%                        |  | 1,099             |  | 26.4%                       
|Consumer                |  | 930               |  | 10.1%                        |  | 771               |  | 10.0%                        |  | 715               |  | 10.6%                        |  | 664               |  | 10.3%                        |  | 302               |  | 10.3%                       
|                        |  |                   |  |                              |  |                   |  |                              |  |                  
|Total                   |  | $  9,414          |  | 100.0%                       |  | $  9,161          |  | 100.0%                       |  | $  8,426          |  | 100.0%                       |  | $  7,029          |  | 100.0%                       |  | $  4,960          |  | 100.00%                     
|                        |  |                   |  |                              |  |                   |  |                              |  |                  



|(1) | includes commercial real estate loans
|--- | -------------------------------------

The allowance for credit losses is allocated according to the amount deemed to be reasonably necessary to provide for the probable incurred losses within each category of loans and leases. Increases in
the amount allocated to the commercial and lease portfolios reflect the higher outstanding balances of these portfolios coupled with the higher inherent risk of these portfolios compared with residential and consumer lending.

Deposits

The Banks
deposits are the Companys primary source of funds. The deposit base is comprised of demand deposit, savings and money market accounts, and time deposits that are primarily provided by individuals, businesses, and local governments within the
communities served. The Bank continuously monitors market pricing, competitors rates, and internal interest rate spreads to maintain and promote growth and profitability.

The following table sets forth the composition of the Companys deposits by business line at year-end (dollars in thousands):



|                      |  |                   |  |                   |  |           |  |            |  |         |  |          |  |            |  |           |  |          |  |         |  | 
|--------------------- |  | ----------------- |  | ----------------- |  | --------- |  | ---------- |  | ------- |  | -------- |  | ---------- |  | --------- |  | -------- |  | ------- |  | 
|                      |  | December 31, 2009 |  | December 31, 2008
|                      |  | Retail            |  | Commercial        |  | Municipal |  | Total      |  | Percent |  | Retail   |  | Commercial |  | Municipal |  | Total    |  | Percent |  | 
|                      |  |                   |  |                   |  |           |  |            |  |         | 
|Non-interest checking |  | $40,320           |  | $115,304          |  | $3,525    |  | $159,149   |  | 14.8%   |  | $35,685  |  | $101,423   |  | $3,737    |  | $140,845 |  | 15.0%   |  | 
|Interest checking     |  | 97,580            |  | 15,559            |  | 17,229    |  | 130,368    |  | 12.1%   |  | 82,096   |  | 11,134     |  | 13,062    |  | 106,292  |  | 11.3%   |  | 
|Total checking        |  | 137,900           |  | 130,863           |  | 20,754    |  | 289,517    |  | 26.9%   |  | 117,781  |  | 112,557    |  | 16,799    |  | 247,137  |  | 26.3%   |  | 
|                      |  |                   |  |                   |  |           |  |            |  |         | 
|Savings               |  | 82,328            |  | 9,714             |  | 2,482     |  | 94,524     |  | 8.8%    |  | 76,811   |  | 8,049      |  | 3,382     |  | 88,242   |  | 9.4%    |  | 
|Money market          |  | 82,103            |  | 96,760            |  | 138,188   |  | 317,051    |  | 29.5%   |  | 74,597   |  | 45,471     |  | 127,324   |  | 247,392  |  | 26.4%   |  | 
|Time deposits         |  | 311,626           |  | 20,568            |  | 42,385    |  | 374,579    |  | 34.8%   |  | 296,381  |  | 20,189     |  | 38,541    |  | 355,111  |  | 37.9%   |  | 
|                      |  |                   |  |                   |  |           |  |            |  |         | 
|Total deposits        |  | $613,957          |  | $257,905          |  | $203,809  |  | $1,075,671 |  | 100.0%  |  | $565,570 |  | $186,266   |  | $186,046  |  | $937,882 |  | 100.0%  |  | 
|                      |  |                   |  |                   |  |           |  |            |  |         |  |          |  |            |  |           |  |          |  |         |  | 

Total deposits were $1.1 billion at December 31, 2009, which was an increase of $137.8
million or 14.7% compared with December 31, 2008. Approximately 78% of the deposit increase, or $108.0 million, resulted from growth across all of our retail, commercial and municipal business lines. The Companys deposit mix continued to
be weighted heavily in lower cost demand, savings and money market accounts (transaction accounts), which comprised 65.2% of total deposits at the end of 2009, compared with 62.1% at the end of 2008. The Companys ability to gather core
transaction deposits over the past year has been greatly enhanced by its strong financial position and earnings performance, enhanced product offerings including upgraded treasury management and internet banking platforms, and a high positive
awareness of Alliances brand. These factors, combined with negative operating performance or other challenges being experienced by certain larger financial institutions operating in our market, have been important contributors to the
Companys core deposit gains in 2009. The balance of the increase in deposits in 2009 resulted from the acquisition of wholesale time deposits to fund investment portfolio growth.

Time deposits in excess of $100,000, which tend to be more volatile and sensitive to interest rates, totaled $108.3 million at December 31, 2009, representing 28.9% of total
time deposits and 10.1% of total deposits. These deposits totaled $102.0 million, representing 28.7% of total time deposits and 10.9% of total deposits at year-end 2008.

The following table schedules the amount of the Companys time deposits of $100,000 or more by time remaining until maturity as of December 31, 2009 (in thousands):



|                           |  |            
|-------------------------- |  | -----------
|Less than three months     |  | $    24,193
|Three months to six months |  | 30,618     
|Six months to one year     |  | 39,923     
|Over one year              |  | 13,562     
|                           |  |            
|Total                      |  | $  108,296 
|                           |  |            



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##### Table of Contents

Borrowings

The Bank offers retail repurchase agreements primarily to its larger business customers. Under the terms of the agreements, the Bank sells investment portfolio securities to the customer and agrees to
repurchase the securities on the next business day. The Bank uses this arrangement as a deposit alternative for its business customers. As of December 31, 2009, retail repurchase agreement balances amounted to $17.2 million compared to balances
of $40.5 million at December 31, 2008.

During 2009, the Bank utilized collateralized repurchase agreements with various
brokers and advances from the Federal Home Loan Bank of New York (FHLB) as alternative sources of funding and as a liability management tool. At December 31, 2009, the combination of repurchase agreements and FHLB advances were $155.5 million,
compared to $198.5 million at December 31, 2008. Detailed information regarding the Companys borrowings is included in Note 7 in the consolidated financial statements section of this report.

Capital

On May 13,
2009, the Company redeemed all 26,918 shares of its Fixed Rate Cumulative Perpetual Preferred Stock (Preferred Stock) it sold to the U.S. Department of the Treasury (Treasury Department) on December 19, 2008 in
connection with the Treasury Departments Capital Purchase Program (CPP) under the Troubled Asset Relief Program. The Company paid $27.2 million to the Treasury Department to redeem the Preferred Stock, which included the original
investment amount of $26.9 million plus accrued dividends of approximately $329,000. The Company and Bank received unconditional approvals from their respective regulators and from the Treasury Department to redeem the Preferred Stock. As a result
of the redemption, the Company recorded a reduction in undivided profits of approximately $551,000 in the second quarter of 2009 associated with accelerated discount accretion related to the difference between the amount at which the Preferred Stock
sale was initially recorded and the redemption price. The Preferred Stock dividend and the acceleration of the accretion reduced the second quarters net income available to common shareholders and earnings per common share by $726,000 and
$0.16, respectively. On June 17, 2009, the Company repurchased the warrant (Warrant) to purchase 173,069 shares of its common stock issued to the Treasury Department as part of the CPP for $900,000. The repurchase of the Warrant was
recorded as a reduction to shareholders equity, and had no affect on the Companys net income and earnings per share.

Shareholders equity decreased $20.5 million in 2009, and was $123.9 million at December 31, 2009. The redemption of the preferred stock and repurchase of the warrant in connection with the Companys exit from the Treasury
Departments Capital Purchase Program, along with the dividends paid on the preferred stock, reduced shareholders equity by $28.3 million in 2009. Net income for the year increased shareholders equity by $11.4 million and was
partially offset by common stock dividends declared of $5.0 million or $1.08 per common share.

The Companys Tier 1
leverage ratio was 7.55% and its total risk-based capital ratio was 13.14% at the end of the fourth quarter, both of which exceeded the regulatory thresholds required to be classified as a well-capitalized institution, which are 5.0% and 10.0%,
respectively.

The Companys goal is to maintain a strong capital position, consistent with the risk profile of the Bank,
that supports growth and expansion activities while at the same time exceeding regulatory standards. Capital adequacy in the banking industry is evaluated primarily by the use of ratios which measure capital against total assets, as well as against
total assets that are weighted based on defined risk characteristics. At December 31, 2009, the Company exceeded all regulatory required minimum capital ratios and met the regulatory definition of a well-capitalized institution. A
more comprehensive analysis of regulatory capital requirements, including ratios for the Company, is included in Note 18 of the consolidated financial statements.

Liquidity and Capital Resources

The Companys liquidity is primarily
measured by the Banks ability to provide funds to meet loan requests, to accommodate possible outflows of deposits, and to take advantage of market interest rate opportunities. Funding of loan and lease commitments, providing for liability
outflows, and management of interest rate fluctuations require continuous analysis in order to match the maturities of specific categories of short-term loans and leases, and investments with specific types of deposits and borrowings. Liquidity is
normally considered in terms of the nature and mix of the Banks sources and uses of funds. The Asset Liability Management Committee (ALCO) of the Bank is responsible for implementing the policies and guidelines for the maintenance of prudent
levels of liquidity. Management believes, as of December 31, 2009, that liquidity as measured by the Bank is in compliance with its policy guidelines.

The Banks principal sources of funds for operations are cash flows generated from earnings, deposits, securities, loan and lease repayments, borrowings from the FHLB, and securities sold under
repurchase agreements. During the year ended December 31, 2009, cash and cash equivalents decreased by $21.4 million, as net cash provided by operating and financing activities of $51.5 million was more than offset by net cash used in investing
activities of $72.9 million. Net cash used in investing activities primarily resulted from a net increase loans of $9.7 million and securities purchases exceeding maturities, sales and principal repayments by $62.4 million. The net cash provided by
financing activities principally reflects a $137.8 million net increase in deposits, partly reduced by a net decrease in borrowings of $66.3 million, redemption of Preferred Stock of $26.9 million and cash dividends of $5.4 million in the year ended
December 31, 2009. Net cash from operating activities was primarily provided by net income in the amount of $11.4 million.

As a member of the FHLB, the Bank is eligible to borrow up to an established credit limit against certain residential mortgage loans and investment securities that have been pledged as collateral. As of December 31, 2009, the
Banks credit limit with the FHLB was $152.0 million with outstanding borrowings in the amount of $135.5 million.



28



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The Company had a $127.7 million line of credit at December 31, 2009 with the Federal
Reserve Bank of New York through its Discount Window. The Company has pledged indirect auto loans and securities totaling $186.7 million and $4.5 million, respectively, at December 31, 2009. The Company did not draw any funds on this line of
credit in 2009. At December 31, 2009 and 2008, the Company also had available $76.5 million of federal funds lines of credit with other financial institutions, none of which was in use at December 31, 2009 and 2008, respectively.

In December 2003, the Company formed Alliance Financial Capital Trust I, a wholly-owned subsidiary of the Company. The trust
was formed for the purpose of issuing $10.0 million of Company-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and investing the proceeds from the sale of such capital securities solely in junior
subordinated debt securities of the Company. The debentures held by the trust are the sole assets of that trust. Distributions on the capital securities issued by the trust are payable quarterly at a rate per annum equal to the interest rate being
earned by the trust on the debentures held by the trust. The capital securities have a variable annual coupon rate that resets quarterly based upon three-month LIBOR plus 285 basis points (3.13% at December 31, 2009). The capital securities
have a 30-year maturity and are redeemable at par beginning in January 2009.

In September 2006, the Company formed Alliance
Financial Capital Trust II, a wholly-owned subsidiary of the Company. The trust was formed for the purpose of issuing $15.0 million of Company-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and
investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of the Company. The debentures held by the trust are the sole assets of that trust. Distributions on the capital securities issued by the
trust are payable quarterly at a rate per annum equal to the interest rate being earned by the trust on the debentures held by the trust. The capital securities have a variable annual coupon rate that resets quarterly based upon three-month LIBOR
plus 165 basis points (1.90% at December 31, 2009). The capital securities have a 30-year maturity and are redeemable at par in September 2011 and any time thereafter.

Contractual Obligations, Commitments, and Off-Balance Sheet Arrangements

Contractual
Obligations

The Company has various financial obligations, including contractual obligations and commitments that may
require future cash payments. The following table presents as of December 31, 2009, 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.



|                                                                       |  |  |  |                   |  |                        |  |                       |  |                        |  |                    |  |           
|---------------------------------------------------------------------- |  |  |  | ----------------- |  | ---------------------- |  | --------------------- |  | ---------------------- |  | ------------------ |  | ----------
|                                                                       |  |  |  |                   |  | Payments Due In       
|                                                                       |  |  |  | Note    Reference |  | One Year    or Less    |  | One to    Three Years |  | Three to    Five Years |  | Over Five    Years |  | Total     
|                                                                       |  |  |  |                   |  | (Dollars in thousands)
|Time deposits*                                                         |  |  |  | 6                 |  | $  286,611             |  | $  71,215             |  | $  16,753              |  | $                 |  | $  374,579
|Borrowings*                                                            |  |  |  | 7                 |  | 57,707                 |  | 25,000                |  | 50,000                 |  | 40,000             |  | 172,707   
|Junior subordinated obligations issued to unconsolidated subsidiaries* |  |  |  | 8                 |  |                       |  |                      |  |                       |  | 25,774             |  | 25,774    
|Operating leases                                                       |  |  |  | 15                |  | 1,003                  |  | 1,548                 |  | 874                    |  | 2,657              |  | 6,082     
|Purchase obligations                                                   |  |  |  | 15                |  | 172                    |  | 344                   |  | 344                    |  | 1,536              |  | 2,396     
|                                                                       |  |  |  |                   |  |                        |  |                       |  |                        |  |                    |  |           
|Total                                                                  |  |  |  |                   |  | $  345,493             |  | $  98,107             |  | $  67,971              |  | $  69,967          |  | $  581,538
|                                                                       |  |  |  |                   |  |                        |  |                       |  |                        |  |                    |  |           

*Excludes interest

The Company has obligations under its pension, post-retirement plan, directors retirement and supplemental executive retirement plans
as described in Note 12 to the consolidated financial statements. The supplemental executive retirement, pension and postretirement benefit and directors retirement payments represent actuarially determined future benefit payments to eligible
plan participants.

As of December 31, 2009, the liability for uncertain tax positions, excluding associated interest and
penalties, was $115,000. This liability represents an estimate of tax positions that the Company has taken in its tax returns which may ultimately not be sustained upon examination by the tax authorities. Since the ultimate amount and timing of any
future cash settlements cannot be predicted with reasonable certainty, this estimated liability has been excluded from the contractual obligations table.

Commitments and Off-Balance Sheet Arrangements

In the normal course of
business, to meet the financing needs of its customers and to reduce its exposure to fluctuations in interest rates, the Bank is party to financial instruments with off-balance sheet risk, held for purposes other than trading. The financial
instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Banks exposure to credit loss in the event of nonperformance by the other party to
the financial instrument, for loan commitments and standby letters of credit, is represented by the contractual amount of those instruments, assuming that the amounts are fully advanced and that collateral or other security is of no value. The Bank
uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet loans. The amount of collateral obtained, if deemed necessary by the Bank upon extension of credit, is based on managements credit
evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. Commitments to originate loans, unused lines of credit, and un-advanced
portions of construction loans are agreements to lend to a customer provided 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. Many of the commitments are expected to expire without being drawn upon. Therefore, the amounts presented below do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Bank
to guarantee the performance by a customer to a third party. These guarantees are issued primarily to support public and private borrowing arrangements, bond financing, and similar



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##### Table of Contents

transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

The following table details the amounts and expected maturities of significant commitments and off-balance sheet arrangements as of
December 31, 2009. Further discussion of these commitments and off-balance sheet arrangements is included in Note 15 to the consolidated financial statements.



|                              |  |                        |  |                                   |  |                                    |  |                                |  |             
|----------------------------- |  | ---------------------- |  | --------------------------------- |  | ---------------------------------- |  | ------------------------------ |  | ------------
|Commitments to extend credit: |  | One Year or Less       |  | One
to                Three Years |  | Three to                Five Years |  | Over                Five Years |  | Total       
|                              |  | (Dollars in thousands)
|Residential real estate       |  | $      8,984           |  | $                                |  | $                                 |  | $                             |  | $      8,984
|Commercial loans and leases   |  | 38,776                 |  | 7,207                             |  | 2,037                              |  | 23,968                         |  | 71,988      
|Revolving home equity lines   |  | 1,345                  |  | 8,548                             |  | 12,323                             |  | 28,831                         |  | 51,047      
|Consumer revolving credit     |  | 30,697                 |  |                                  |  |                                   |  |                               |  | 30,697      
|Standby letters of credit     |  | 4,371                  |  |                                  |  |                                   |  |                               |  | 4,371       
|                              |  |                        |  |                                   |  |                                    |  |                                |  |             
|Total                         |  | $    84,173            |  | $    15,755                       |  | $    14,360                        |  | $    52,799                    |  | $  167,087  
|                              |  |                        |  |                                   |  |                                    |  |                                |  |             

Application of Critical Accounting Policies

The Companys consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United
States. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on
information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance
on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and
liabilities are required to be recorded at fair value or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The
fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available,
valuation adjustments are estimated in good faith by management.

The most significant accounting policies followed by the
Company are presented in Note 1 to the consolidated financial statements included elsewhere in this Annual Report on Form 10-K. These policies, along with the disclosures presented in the other financial statement notes and in this discussion,
provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods,
assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for credit losses, accrued income taxes, pensions and post-retirement obligations and the fair value analysis of goodwill and
intangible assets to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new information becomes available. Actual results could differ from those estimates.

The allowance for credit losses represents managements estimate of probable incurred loan and lease losses inherent in
the loan and lease portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected
future cash flows on impaired loans and leases, estimated losses on pools of homogeneous loans and leases based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to
significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for credit losses,
and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in this report.

The Company estimates its tax expense based on the amount it expects to owe the respective tax authorities. Taxes are discussed in more detail in Note 10 to the consolidated financial statements section of this report. Accrued taxes
represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account statutory,
judicial and regulatory guidance in the context of the Corporations tax position. If the final resolution of taxes payable differs from our estimates due to regulatory determination or legislative or judicial actions, adjustments to tax
expense may be required.

The Company utilizes significant estimates and assumptions in determining the fair value of its
goodwill and intangible assets for purposes of impairment testing. The valuation requires the use of assumptions, including, among others, discount rates, rates of return on assets, account attrition rates and costs of servicing. Impairment testing
for goodwill requires that the fair value of each of our reporting units be compared to the carrying amount of its net assets, including goodwill. Determining the fair value of a reporting unit requires us to use a high degree of subjective
judgment. The Company utilizes both market-based valuation multiples and discounted cash flow valuation models that incorporate such variables as revenue growth rates, expense trends, interest rates and terminal values. Based upon an evaluation of
key data and market factors, we select the specific variables to be incorporated into the valuation model. Future changes in the economic environment or operations of our reporting units could cause changes to these variables, which could result in
impairment being identified.

The valuation of the Companys obligations associated with pension, post-retirement,
directors retirement and supplemental executive retirement plans utilize various actuarial assumptions. These assumptions include discount rate, rate of future compensation increases and expected return on plan assets. Specific discussion of
the assumptions used by management is discussed in Note 12 to the consolidated financial statements section of this report.



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Item 7A  Quantitative and Qualitative Disclosures about Market
Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or
prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. The Companys market risk arises principally from interest rate risk in its lending, deposit and borrowing activities. Other types of market
risks do not arise in the normal course of the Companys business activities.

The Banks Asset Liability Management
Committee (ALCO) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The policies and guidelines established by the ALCO are reviewed and approved by the
Companys Board of Directors.

Interest rate risk is monitored primarily through the use of two complementary measures:
earnings simulation modeling and net portfolio value estimation. Both measures are highly assumption dependent and change regularly as the balance sheet and business mix evolve; however, taken together, they represent a reasonably comprehensive view
of the magnitude of interest rate risk, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. The key assumptions employed by these measures are
analyzed regularly and reviewed by the ALCO.

The table that follows is provided pursuant to the market risk disclosure rules
set forth in Item 305 of Regulation S-K of the Securities and Exchange Commission. The information provided in the following table is based on significant estimates and assumptions and constitutes, like certain other statements included herein,
a forward-looking statement. The base case information in the table shows (1) an estimate of the Corporations net portfolio value at December 31, 2009 arrived at by discounting estimated future cash flows at current market rates
and (2) an estimate of net interest income for the year ending December 31, 2010 assuming that maturing assets or liabilities are replaced with new balances of the same type, in the same amount, and at current rate levels and repricing
balances are adjusted to current rate levels. The rate change information in the table shows estimates of net portfolio value at December 31, 2009 and net interest income for the year ending December 31, 2010 assuming rate changes of
plus 100, 200, and 300 basis points and minus 100 basis points. In addition, cash flows for non-maturity deposits are based on a decay or runoff rate based on average account age. Also, rate changes are assumed to be shock or immediate
changes and occur uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. In projecting future net interest income under the indicated rate change scenarios, activity is simulated
by replacing maturing balances with new balances of the same type, in the same amount, but at the assumed rate level and adjusting repricing balances to the assumed rate level.

Based on the foregoing assumptions and as depicted in the table that follows, an immediate increase in interest rates of 100, 200, or 300 basis points would have a negative effect on
net interest income over a one-year time period. This is principally because the Banks interest-bearing deposit accounts are assumed to reprice faster than its loans and investment securities. However, if the Bank does not increase
the rates paid on its deposit accounts as quickly or in the same amount as increases in market interest rates, the magnitude of the negative impact will decline, and the impact may even become positive. Over a longer period of time, and
assuming that interest rates remain stable after the initial rate increase and the Bank purchases securities and originates loans at yields higher than those maturing and reprices loans at higher yields, the impact of an increase in interest rates
should be positive. This occurs primarily because with the passage of time more loans and investment securities will reprice at the higher rates and there will be no offsetting increase in interest expense for those loans and investment
securities funded by noninterest-bearing checking deposits and capital. Generally, the reverse should be true of an immediate decrease in interest rates of 100 basis points. However, the positive impact on net interest income of a decline
in interest rates of 100 basis points is currently constrained by the low level of deposit rates.



|                            |  |                                         |  |                                                 |  |         |  |                             
|--------------------------- |  | --------------------------------------- |  | ----------------------------------------------- |  | ------- |  | ----------------------------
|                            |  | Net Portfolio Value atDecember 31,
2009 |  | Net Interest IncomeYear EndingDecember 31, 2010
|Rate Change Scenario        |  | Amount                                  |  | Percent Change        From Base Case            |  | Amount  |  | Percent ChangeFrom Base Case
|                            |  | (Dollars in thousands)                 
|+300 basis point rate shock |  | $211,394                                |  | (18.9)%                                         |  | $34,320 |  | (25.2)%                     
|+200 basis point rate shock |  | 223,366                                 |  | (14.3)%                                         |  | 40,221  |  | (12.3)%                     
|+100 basis point rate shock |  | 238,285                                 |  | (8.5)%                                          |  | 42,203  |  | (8.0)%                      
|Base case (no rate change)  |  | 260,511                                 |  | %                                              |  | 45,881  |  | %                          
|-100 basis point rate shock |  | 249,122                                 |  | (4.4)%                                          |  | 46,794  |  | 2.0%                        



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Item 8  Financial Statements and Supplementary Data

MANAGEMENTS REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

The Companys management is responsible for establishing and maintaining adequate internal control over financial reporting, as such
term is defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. 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 policies or procedures may deteriorate. The Companys internal
control over financial reporting is a process designed under the supervision of the Companys principal executive officer and principal financial officer to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of the Companys financial statements for external reporting purposes in accordance with Unites States generally accepted accounting principles.

Under the supervision and with the participation of management, including the Companys principal executive officer and principal financial officer, the Company conducted an evaluation of the
effectiveness of its internal control over financial reporting based on the framework in Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its evaluation under that
framework, management concluded that the Companys internal control over financial reporting was effective as of December 31, 2009. In addition, based on our assessment, management has determined that there were no material weaknesses in
the Companys internal controls over financial reporting.

The Companys independent registered public accounting
firm, Crowe Horwath LLP, has issued an attestation report on the Companys internal control over financial reporting, which is set forth below under the heading Report of Independent Registered Public Accounting Firm on Internal
Control.



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING

FIRM ON INTERNAL CONTROL

We have audited Alliance Financial Corporations internal control over financial reporting as of December 31, 2009, based on criteria established in Internal Control  Integrated Framework issued by the Committee of
Sponsoring Organizations of the Treadway Commission (COSO). Alliance Financial Corporations management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal
control over financial reporting, included in the accompanying Managements Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based
on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board
(United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an
understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other
procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

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, Alliance Financial Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2009, based on criteria established in
Internal Control  Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Alliance Financial Corporation as of December 31, 2009 and 2008 and the related
consolidated statements of income, changes in shareholders equity, comprehensive income and cash flows for each of the three years in the period ended December 31, 2009 and our report dated March 12, 2010 expressed an unqualified opinion
on those consolidated financial statements.



/s/Crowe Horwath LLPCrowe Horwath LLP


Livingston, New Jersey

March 12, 2010



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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING

FIRM ON FINANCIAL STATEMENTS

Board of Directors and Shareholders

Alliance Financial Corporation

Syracuse, New York

We have audited the accompanying consolidated balance sheets of Alliance Financial Corporation as of December 31, 2009 and 2008 and the related consolidated statements of income, changes in shareholders equity, comprehensive
income and cash flows for each of the three years in the period ended December 31, 2009. 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 audits in accordance with the standards of the Public Company Accounting
Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. 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 consolidated
financial statements referred to above present fairly, in all material respects, the financial position of Alliance Financial Corporation as of December 31, 2009 and 2008 and the results of its operations and its cash flows for each of the
three years in the period ended December 31, 2009 in conformity with accounting principles generally accepted in the United States of America.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Alliance Financial Corporations internal control over financial reporting as
of December 31, 2009, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 12, 2010 expressed an unqualified opinion
thereon.



/s/Crowe Horwath LLPCrowe Horwath LLP


Livingston, New Jersey

March 12, 2010



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Alliance Financial Corporation and Subsidiaries

Consolidated Balance Sheets

December 31, 2009 and 2008





|                                                                                                                                                                                            |  |               |  |              
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------- |  | -------------
|(Dollars in thousands, except per share data)                                                                                                                                               |  | 2009          |  | 2008         
|                                                                                                                                                                                            |  |              
|Cash and due from banks                                                                                                                                                                     |  | $      26,696 |  | $      21,172
|Federal funds sold                                                                                                                                                                          |  |              |  | 26,918       
|                                                                                                                                                                                            |  |               |  |              
|Cash and cash equivalents                                                                                                                                                                   |  | 26,696        |  | 48,090       
|                                                                                                                                                                                            |  |              
|Securities available-for-sale                                                                                                                                                               |  | 362,158       |  | 299,149      
|Federal Home Loan Bank of NY(FHLB) and Federal Reserve Bank (FRB) Stock                                                                                                                 |  | 10,074        |  | 11,844       
|Loans held for sale                                                                                                                                                                         |  | 1,023         |  | 875          
|Loans and leases, net of unearned income                                                                                                                                                    |  | 914,162       |  | 910,755      
|Less allowance for credit losses                                                                                                                                                            |  | 9,414         |  | 9,161        
|                                                                                                                                                                                            |  |               |  |              
|Net loans and leases                                                                                                                                                                        |  | 904,748       |  | 901,594      
|                                                                                                                                                                                            |  |              
|Premises and equipment, net                                                                                                                                                                 |  | 20,086        |  | 21,202       
|Accrued interest receivable                                                                                                                                                                 |  | 4,167         |  | 4,218        
|Bank-owned life insurance                                                                                                                                                                   |  | 27,354        |  | 24,940       
|Goodwill                                                                                                                                                                                    |  | 32,073        |  | 32,073       
|Intangible assets, net                                                                                                                                                                      |  | 10,075        |  | 11,528       
|Other assets                                                                                                                                                                                |  | 18,790        |  | 11,845       
|                                                                                                                                                                                            |  |               |  |              
|Total assets                                                                                                                                                                                |  | $1,417,244    |  | $1,367,358   
|                                                                                                                                                                                            |  |               |  |              
|                                                                                                                                                                                            |  |              
|Liabilities and shareholders equity                                                                                                                                                        |  |               |  |              
|Liabilities:                                                                                                                                                                                |  |               |  |              
|Deposits                                                                                                                                                                                    |  |               |  |              
|Non-interest bearing                                                                                                                                                                        |  | $    159,149  |  | $    140,845 
|Interest bearing                                                                                                                                                                            |  | 916,522       |  | 797,037      
|                                                                                                                                                                                            |  |               |  |              
|Total deposits                                                                                                                                                                              |  | 1,075,671     |  | 937,882      
|                                                                                                                                                                                            |  |              
|Borrowings                                                                                                                                                                                  |  | 172,707       |  | 238,972      
|Accrued interest payable                                                                                                                                                                    |  | 1,745         |  | 3,037        
|Other liabilities                                                                                                                                                                           |  | 17,412        |  | 17,212       
|Junior subordinated obligations issued to unconsolidated subsidiary trusts                                                                                                                  |  | 25,774        |  | 25,774       
|                                                                                                                                                                                            |  |               |  |              
|Total liabilities                                                                                                                                                                           |  | 1,293,309     |  | 1,222,877    
|                                                                                                                                                                                            |  |              
|Commitments and contingent liabilities (Note 15)                                                                                                                                            |  |              |  |             
|                                                                                                                                                                                            |  |              
|Shareholders equity:                                                                                                                                                                       |  |               |  |              
|Preferred stock  par value $1.00 a share; 900,000 shares authorized, $26,918 liquidation value, none issued and outstanding
in 2009; 26,918 shares issued and outstanding in 2008          |  |              |  | 26,331       
|Preferred stock  par value $1.00 a share; 100,000 shares authorized, Series A, junior preferred stock, none issued and
outstanding                                                         |  |              |  |             
|Common stock  par value $1.00 a share; 10,000,000 shares authorized, 4,937,233 and 4,901,222 shares issued, and 4,614,921
and 4,578,910 shares outstanding for 2009 and 2008, respectively |  | 4,937         |  | 4,901        
|Surplus                                                                                                                                                                                     |  | 43,013        |  | 41,922       
|Undivided profits                                                                                                                                                                           |  | 86,194        |  | 81,110       
|Accumulated other comprehensive income                                                                                                                                                      |  | 946           |  | 971          
|Directors stock-based deferred compensation plan: 103,512 and 85,510 shares, respectively                                                                                                  |  | (2,499)       |  | (2,098)      
|Treasury stock, at cost: 322,312 shares                                                                                                                                                     |  | (8,656)       |  | (8,656)      
|                                                                                                                                                                                            |  |               |  |              
|Total Shareholders Equity                                                                                                                                                                  |  | 123,935       |  | 144,481      
|                                                                                                                                                                                            |  |               |  |              
|Total Liabilities and Shareholders Equity                                                                                                                                                  |  | $1,417,244    |  | $1,367,358   
|                                                                                                                                                                                            |  |               |  |              

The accompanying notes are an integral part of the consolidated
financial statements.



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Income

Years
Ended December 31, 2009, 2008 and 2007





|                                                       |  |                                       |        |      |   |        |  |   |       
|------------------------------------------------------ |  | ------------------------------------- | ------ | ---- | - | ------ |  | - | ------
|                                                       |  | 2009                                  |        | 2008 |   | 2007  
|                                                       |  | (In thousands, except per share data)
|Interest and fees on loans and leases                  |  | $                                     | 49,832 |      | $ | 54,857 |  | $ | 58,992
|Federal funds sold and interest bearing deposits       |  |                                       | 15     |      |   | 100    |  |   | 28    
|Interest and dividends on taxable securities           |  |                                       | 10,701 |      |   | 9,430  |  |   | 8,546 
|Interest and dividends on nontaxable securities        |  |                                       | 3,414  |      |   | 3,577  |  |   | 3,466 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total Interest Income                                  |  |                                       | 63,962 |      |   | 67,964 |  |   | 71,032
|Interest Expense                                       |  |                                       |        |      |   |        |  |   |       
|Deposits:                                              |  |                                       |        |      |   |        |  |   |       
|Savings accounts                                       |  |                                       | 454    |      |   | 492    |  |   | 474   
|Money market accounts                                  |  |                                       | 3,347  |      |   | 4,732  |  |   | 6,322 
|Time accounts                                          |  |                                       | 9,622  |      |   | 15,277 |  |   | 20,547
|NOW accounts                                           |  |                                       | 531    |      |   | 733    |  |   | 911   
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total                                                  |  |                                       | 13,954 |      |   | 21,234 |  |   | 28,254
|Borrowings:                                            |  |                                       |        |      |   |        |  |   |       
|Repurchase agreements                                  |  |                                       | 955    |      |   | 1,584  |  |   | 2,790 
|FHLB advances                                          |  |                                       | 4,864  |      |   | 6,050  |  |   | 5,546 
|Junior subordinated obligations                        |  |                                       | 808    |      |   | 1,399  |  |   | 1,960 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total interest expense                                 |  |                                       | 20,581 |      |   | 30,267 |  |   | 38,550
|                                                       |  |                                       |        |      |   |        |  |   |       
|Net interest income                                    |  |                                       | 43,381 |      |   | 37,697 |  |   | 32,482
|Provision for credit losses                            |  |                                       | 6,100  |      |   | 5,502  |  |   | 3,790 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Net interest income after provision for credit losses  |  |                                       | 37,281 |      |   | 32,195 |  |   | 28,692
|Non-interest income:                                   |  |                                       |        |      |   |        |  |   |       
|Investment management income                           |  |                                       | 7,134  |      |   | 8,670  |  |   | 9,180 
|Service charges on deposit accounts                    |  |                                       | 5,037  |      |   | 5,164  |  |   | 5,296 
|Card-related fees                                      |  |                                       | 2,248  |      |   | 2,106  |  |   | 1,942 
|Insurance agency income                                |  |                                       | 1,387  |      |   | 1,583  |  |   | 1,855 
|Income from bank-owned life insurance                  |  |                                       | 1,014  |      |   | 856    |  |   | 635   
|Gain on the sale of loans                              |  |                                       | 748    |      |   | 252    |  |   | 192   
|Gain (loss) on sale of securities available-for-sale   |  |                                       | 2,168  |      |   | 137    |  |   | (12)  
|Other non-interest income                              |  |                                       | 1,075  |      |   | 1,592  |  |   | 2,204 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total non-interest income                              |  |                                       | 20,811 |      |   | 20,360 |  |   | 21,292
|Non-interest expense:                                  |  |                                       |        |      |   |        |  |   |       
|Salaries and employee benefits                         |  |                                       | 20,428 |      |   | 19,823 |  |   | 18,281
|Occupancy and equipment expense                        |  |                                       | 7,047  |      |   | 7,032  |  |   | 6,765 
|Communication expense                                  |  |                                       | 756    |      |   | 791    |  |   | 827   
|Office supplies and postage expense                    |  |                                       | 1,337  |      |   | 1,137  |  |   | 1,236 
|Marketing expense                                      |  |                                       | 932    |      |   | 1,090  |  |   | 1,237 
|Amortization of intangible assets                      |  |                                       | 1,453  |      |   | 1,622  |  |   | 1,729 
|Professional fees                                      |  |                                       | 2,893  |      |   | 2,661  |  |   | 2,845 
|FDIC insurance premium                                 |  |                                       | 2,284  |      |   | 557    |  |   | 113   
|Other non-interest expense                             |  |                                       | 6,078  |      |   | 4,665  |  |   | 4,605 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total non-interest expenses                            |  |                                       | 43,208 |      |   | 39,378 |  |   | 37,638
|                                                       |  |                                       |       
|Income before income tax expense                       |  |                                       | 14,884 |      |   | 13,177 |  |   | 12,346
|Income tax expense                                     |  |                                       | 3,436  |      |   | 2,820  |  |   | 2,869 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Net income                                             |  | $                                     | 11,448 |      | $ | 10,357 |  | $ | 9,477 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Dividends and accretion of discount on preferred stock |  |                                       | 1,084  |      |   | 47     |  |   |      
|                                                       |  |                                       |        |      |   |        |  |   |       
|Net income available to common shareholders            |  | $                                     | 10,364 |      | $ | 10,310 |  | $ | 9,477 
|Earnings Per Common Share                              |  |                                       |        |      |   |        |  |   |       
|Basic                                                  |  | $                                     | 2.25   |      | $ | 2.23   |  | $ | 1.98  
|Diluted                                                |  | $                                     | 2.24   |      | $ | 2.21   |  | $ | 1.95  

The
accompanying notes are an integral part of the consolidated financial statements.



36



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders Equity

Years Ended December 31, 2009, 2008 and 2007





|                                                                   |  |                                      |  |                                       |  |              |  |           |  |                   |  |                                               |  |                |  |                           |  |           
|------------------------------------------------------------------ |  | ------------------------------------ |  | ------------------------------------- |  | ------------ |  | --------- |  | ----------------- |  | --------------------------------------------- |  | -------------- |  | ------------------------- |  | ----------
|                                                                   |  | Issued and Outstanding Common Shares |  | Preferred Stock                       |  | Common Stock |  | Surplus   |  | Undivided Profits |  | Accumulated Other Comprehensive Income (Loss) |  | Treasury Stock |  | Directors Deferred Stock |  | Total     
|                                                                   |  |                                      |  | (In thousands, except per share data) |  |              |  |           |  |                  
|Balance at January 1, 2007                                         |  | 4,800,512                            |  |                                      |  | 4,895        |  | 38,986    |  | 70,658            |  | (2,122)                                       |  | (2,911)        |  |                          |  | 109,506   
|Comprehensive income:                                              |  |                                      |  |                                       |  |              |  |           |  |                   |  |                                               |  |                |  |                           |  |           
|Net income                                                         |  |                                     |  |                                      |  |             |  |          |  | 9,477             |  |                                              |  |               |  |                          |  | 9,477     
|Other comprehensive income, net of taxes                           |  |                                     |  |                                      |  |             |  |          |  |                  |  | 3,327                                         |  |               |  |                          |  | 3,327     
|Total comprehensive income                                         |  |                                     |  |                                      |  |             |  |          |  |                  |  |                                              |  |               |  |                          |  | 12,804    
|Issuance of restricted stock                                       |  | 16,950                               |  |                                      |  | 17           |  | (17)      |  |                  |  |                                              |  |               |  |                          |  |          
|Forfeiture of restricted stock                                     |  | (10,150)                             |  |                                      |  | (10)         |  | (80)      |  |                  |  |                                              |  |               |  |                          |  | (90)      
|Amortization of restricted stock                                   |  |                                     |  |                                      |  |             |  | 330       |  |                  |  |                                              |  |               |  |                          |  | 330       
|Stock options exercised                                            |  | 8,027                                |  |                                      |  | 8            |  | 170       |  |                  |  |                                              |  |               |  |                          |  | 178       
|Tax benefit of stock-based compensation                            |  |                                     |  |                                      |  |             |  | 97        |  |                  |  |                                              |  |               |  |                          |  | 97        
|Retirement of common stock                                         |  | (20,524)                             |  |                                      |  | (21)         |  | (639)     |  |                  |  |                                              |  |               |  |                          |  | (660)     
|Cash dividend $0.90 per share                                      |  |                                     |  |                                      |  |             |  |          |  | (4,291)           |  |                                              |  |               |  |                          |  | (4,291)   
|Treasury stock purchased                                           |  | (83,930)                             |  |                                      |  |             |  |          |  |                  |  |                                              |  | (2,314)        |  |                          |  | (2,314)   
|Balance at December 31,
2007                                       |  | 4,710,885                            |  |                                      |  | 4,889        |  | 38,847    |  | 75,844            |  | 1,205                                         |  | (5,225)        |  |                          |  | 115,560   
|Comprehensive income:                                              |  |                                      |  |                                       |  |              |  |           |  |                   |  |                                               |  |                |  |                           |  |           
|Net income                                                         |  |                                     |  |                                      |  |             |  |          |  | 10,357            |  |                                              |  |               |  |                          |  | 10,357    
|Other comprehensive loss, net of taxes                             |  |                                     |  |                                      |  |             |  |          |  |                  |  | (195)                                         |  |               |  |                          |  | (195)     
|Total comprehensive income                                         |  |                                      |  |                                       |  |              |  |           |  |                   |  |                                               |  |                |  |                           |  | 10,162    
|Cumulative effect of change in pension measurement date            |  |                                     |  |                                      |  |             |  |          |  | 44                |  | (39)                                          |  |               |  |                          |  | 5         
|Cumulative effect of change in accounting for adoption of EITF06-4 |  |                                     |  |                                      |  |             |  |          |  | (462)             |  |                                              |  |               |  |                          |  | (462)     
|Issuance of preferred stock and warrants                           |  |                                     |  | 26,325                                |  |             |  | 593       |  |                  |  |                                              |  |               |  |                          |  | 26,918    
|Accretion of preferred stock discount                              |  |                                     |  | 6                                     |  |             |  |          |  | (6)               |  |                                              |  |               |  |                          |  |          
|Issuance of restricted stock                                       |  | 15,500                               |  |                                      |  | 16           |  | (16)      |  |                  |  |                                              |  |               |  |                          |  |          
|Forfeiture of restricted stock                                     |  | (3,575)                              |  |                                      |  | (4)          |  | (11)      |  |                  |  |                                              |  |               |  |                          |  | (15)      
|Amortization of restricted stock                                   |  |                                     |  |                                      |  |             |  | 374       |  |                  |  |                                              |  |               |  |                          |  | 374       
|Tax benefit of stock-based compensation                            |  |                                     |  |                                      |  |             |  | 37        |  |                  |  |                                              |  |               |  |                          |  | 37        
|Cash dividend $1.00 per common share                               |  |                                     |  |                                      |  |             |  |          |  | (4,626)           |  |                                              |  |               |  |                          |  | (4,626)   
|Preferred stock dividend                                           |  |                                     |  |                                      |  |             |  |          |  | (41)              |  |                                              |  |               |  |                          |  | (41)      
|Treasury stock purchased                                           |  | (143,900)                            |  |                                      |  |             |  |          |  |                  |  |                                              |  | (3,431)        |  |                          |  | (3,431)   
|Directors deferred stock plan purchase                            |  |                                     |  |                                      |  |             |  | 2,098     |  |                  |  |                                              |  |               |  | (2,098)                   |  |          
|Balance at December 31,
2008                                       |  | 4,578,910                            |  | $  26,331                             |  | $  4,901     |  | $  41,922 |  | $  81,110         |  | $      971                                    |  | $  (8,656)     |  | $  (2,098)                |  | $  144,481
|Comprehensive income:                                              |  |                                      |  |                                       |  |              |  |           |  |                   |  |                                               |  |                |  |                           |  |           
|Net income                                                         |  |                                     |  |                                      |  |             |  |          |  | 11,448            |  |                                              |  |               |  |                          |  | 11,448    
|Other comprehensive loss, net of taxes                             |  |                                     |  |                                      |  |             |  |          |  |                  |  | (25)                                          |  |               |  |                          |  | (25)      
|Total comprehensive income                                         |  |                                     |  |                                      |  |             |  |          |  |                  |  |                                              |  |               |  |                          |  | 11,423    
|Redemption of preferred stock                                      |  |                                     |  | (26,918)                              |  |             |  |          |  |                  |  |                                              |  |               |  |                          |  | (26,918)  
|Accretion of preferred stock discount                              |  |                                     |  | 587                                   |  |             |  |          |  | (587)             |  |                                              |  |               |  |                          |  |          
|Issuance of restricted stock                                       |  | 11,850                               |  |                                      |  | 12           |  | (12)      |  |                  |  |                                              |  |               |  |                          |  |          
|Forfeiture of restricted stock                                     |  | (16,450)                             |  |                                      |  | (16)         |  | (49)      |  |                  |  |                                              |  |               |  |                          |  | (65)      
|Retirement of common stock                                         |  | (14,078)                             |  |                                      |  | (14)         |  | (407)     |  |                  |  |                                              |  |               |  |                          |  | (421)     



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders Equity (contd)

Years Ended December 31, 2009, 2008 and 2007





|                                        |  |                                      |  |                 |  |              |  |           |  |                   |  |                                               |  |                |  |                           |  |          |  |  |  | 
|--------------------------------------- |  | ------------------------------------ |  | --------------- |  | ------------ |  | --------- |  | ----------------- |  | --------------------------------------------- |  | -------------- |  | ------------------------- |  | -------- |  |  |  | 
|                                        |  | Issued and Outstanding Common Shares |  | Preferred Stock |  | Common Stock |  | Surplus   |  | Undivided Profits |  | Accumulated Other Comprehensive Income (Loss) |  | Treasury Stock |  | Directors Deferred Stock |  | Total    |  | 
|Amortization of restricted stock        |  |                                     |  |                |  |             |  | 373       |  |                  |  |                                              |  |               |  |                          |  | 373      |  | 
|Stock options exercised                 |  | 54,689                               |  |                 |  | 54           |  | 1,298     |  |                  |  |                                              |  |               |  |                          |  | 1,352    |  | 
|Tax benefit of stock-based compensation |  |                                     |  |                |  |             |  | 80        |  |                  |  |                                              |  |               |  |                          |  | 80       |  | 
|Cash dividend $1.08 per common share    |  |                                     |  |                |  |             |  |          |  | (4,973)           |  |                                              |  |               |  |                          |  | (4,973)  |  | 
|Preferred stock dividend                |  |                                     |  |                |  |             |  |          |  | (497)             |  |                                              |  |               |  |                          |  | (497)    |  | 
|Repurchase of warrant                   |  |                                     |  |                |  |             |  | (593)     |  | (307)             |  |                                              |  |               |  |                          |  | (900)    |  | 
|Directors deferred stock plan purchase |  |                                     |  |                |  |             |  | 401       |  |                  |  |                                              |  |               |  | (401)                     |  |         |  | 
|Balance at December 31,
2009            |  | 4,614,921                            |  | $              |  | $  4,937     |  | $  43,013 |  | $  86,194         |  | $    946                                      |  | $  (8,656)     |  | $  (2,499)                |  | $123,935 |  | 

The
accompanying notes are an integral part of the consolidated financial statements



38



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income

Years Ended December 31, 2009, 2008 and 2007





|                                                                                                                                                                                            |  |           |  |                |  |          
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | --------- |  | -------------- |  | ---------
|                                                                                                                                                                                            |  | 2009      |  | 2008           |  | 2007     
|                                                                                                                                                                                            |  |           |  | (In thousands) |  |          
|Net income                                                                                                                                                                                  |  | $  11,448 |  | $ 10,357       |  | $   9,477
|Other comprehensive income (loss) net of tax:                                                                                                                                               |  |           |  |                |  |          
|Net unrealized gains for the period on securities available for sale, net of tax expense of $816 in 2009, $1,275 in 2008, and
$1,222 in 2007                                                |  | 1,291     |  | 2,021          |  | 1,924    
|Reclassification adjustment for security (gains) losses included in net income, net of tax expense (benefit) of $839 in 2009, $53
in 2008, and $(5) in 2007                                 |  | (1,329)   |  | (84)           |  | 7        
|Change in accumulated unrealized loss and prior service costs for pension and other post-retirement benefits, net of tax
(benefit) expense of $9 in 2009, $(1,371) in 2008 and $310 in 2007 |  | 13        |  | (2,132)        |  | 569      
|Post-retirement plan amendment net of tax benefit of $(521)                                                                                                                                 |  |          |  |               |  | 827      
|                                                                                                                                                                                            |  |           |  |                |  |          
|Total other comprehensive (loss) income                                                                                                                                                     |  | (25)      |  | (195)          |  | 3,327    
|                                                                                                                                                                                            |  |           |  |                |  |          
|Comprehensive income                                                                                                                                                                        |  | $  11,423 |  | $ 10,162       |  | $ 12,804 
|                                                                                                                                                                                            |  |           |  |                |  |          

The accompanying notes are an integral part of the consolidated
financial statements.



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows

Years Ended December 31, 2009, 2008 and 2007





|                                                                                                                   |  |             |  |                |  |             
|------------------------------------------------------------------------------------------------------------------ |  | ----------- |  | -------------- |  | ------------
|                                                                                                                   |  | 2009        |  | 2008           |  | 2007        
|Operating Activities:                                                                                              |  |             |  | (In thousands)
|Net income                                                                                                         |  | $    11,448 |  | $    10,357    |  | $      9,477
|Adjustments to reconcile net income to net cash provided by operating activities:                                  |  |             |  |                |  |             
|Provision for credit losses                                                                                        |  | 6,100       |  | 5,502          |  | 3,790       
|Depreciation expense                                                                                               |  | 2,405       |  | 2,516          |  | 2,456       
|Increase in surrender value of life insurance                                                                      |  | (1,014)     |  | (856)          |  | (635)       
|Deferred income tax benefit                                                                                        |  | 150         |  | 439            |  | (488)       
|Amortization (accretion) of investment security discounts and premiums, net                                        |  | 1,488       |  | 189            |  | (38)        
|Net (gain) loss on sale of securities available-for-sale                                                           |  | (2,168)     |  | (137)          |  | 12          
|Net gain on sale of premises and equipment                                                                         |  | (16)        |  |               |  | (10)        
|Impairment write-down on premises                                                                                  |  | 105         |  |               |  |            
|Proceeds from the sale of loans and leases held-for-sale                                                           |  | 46,968      |  | 25,281         |  | 13,043      
|Origination of loans held-for-sale                                                                                 |  | (46,752)    |  | (12,223)       |  | (14,973)    
|Net gains on sale of loans and leases                                                                              |  | (748)       |  | (252)          |  | (192)       
|Write-down of leases transferred to held-for-sale                                                                  |  |            |  | 160            |  |            
|Gain on lease prepayment                                                                                           |  |            |  |               |  | (286)       
|Gain on sale of assets held-for-sale                                                                               |  |            |  | (99)           |  |            
|Loss (gain) on foreclosed real estate-owned                                                                        |  | 8           |  | (71)           |  | 43          
|Amortization of capitalized servicing rights                                                                       |  | 321         |  | 272            |  | 296         
|Amortization of intangible assets                                                                                  |  | 1,453       |  | 1,622          |  | 1,729       
|Restricted stock expense, net                                                                                      |  | 308         |  | 359            |  | 240         
|Change in prepaid/accrued FDIC insurance premium                                                                   |  | (5,551)     |  | 133            |  |            
|Change in other assets and liabilities                                                                             |  | (1,924)     |  | 1, 130         |  | 235         
|                                                                                                                   |  |             |  |                |  |             
|Net cash provided by operating activities                                                                          |  | 12,581      |  | 34,322         |  | 14,699      
|                                                                                                                   |  |             | 
|Investing Activities:                                                                                              |  |             |  |                |  |             
|Proceeds from maturities, redemptions, calls and principal repayments of investment securities,
available-for-sale |  | 139,782     |  | 84,456         |  | 79,347      
|Proceeds from sales of investment securities available-for-sale                                                    |  | 94,943      |  | 6,299          |  | 6,975       
|Purchase of investment securities available-for-sale                                                               |  | (297,115)   |  | (114,040)      |  | (101,852)   
|Purchase of FRB and FHLB stock                                                                                     |  | (25,997)    |  | (22,466)       |  | (26,197)    
|Redemption of FRB and FHLB stock                                                                                   |  | 27,767      |  | 20,129         |  | 24,675      
|Net increase in loans and leases                                                                                   |  | (9,694)     |  | (31,468)       |  | (16,670)    
|Purchases of premises and equipment                                                                                |  | (1,409)     |  | (1,553)        |  | (2,596)     
|Proceeds from the sale of premises and equipment                                                                   |  | 31          |  | 119            |  | 174         
|Proceeds from disposition of assets held-for-sale                                                                  |  |            |  | 176            |  | 107         
|Proceeds from disposition of foreclosed assets                                                                     |  | 211         |  | 689            |  |            
|Purchase of bank-owned life insurance                                                                              |  | (1,400)     |  | (7,000)        |  |            
|                                                                                                                   |  |             |  |                |  |             
|Net cash used in investing activities                                                                              |  | (72,881)    |  | (64,659)       |  | (36,037)    
|                                                                                                                   |  |             | 
|Financing Activities:                                                                                              |  |             |  |                |  |             
|Net increase in demand deposits, NOW, money market and savings accounts                                            |  | 118,321     |  | 56,886         |  | 26,306      
|Net increase (decrease) in time deposits                                                                           |  | 19,468      |  | (64,234)       |  | (17,689)    
|Net (decrease) increase in short-term borrowings                                                                   |  | (32,488)    |  | 5,215          |  | (12,021)    
|Payments on long-term borrowings                                                                                   |  | (68,777)    |  | (17,000)       |  | (15,700)    
|Proceeds from long-term borrowings                                                                                 |  | 35,000      |  | 50,000         |  | 50,000      
|Proceeds from the exercise of stock options                                                                        |  | 1,352       |  |               |  | 178         
|Retirement of common stock                                                                                         |  | (421)       |  |               |  |            
|Treasury stock purchased                                                                                           |  |            |  | (3,431)        |  | (2,314)     
|Purchase of shares for directors deferred stock-based plan                                                        |  | (401)       |  | (2,098)        |  |            
|Tax benefit of stock-based compensation                                                                            |  | 80          |  | 37             |  | 97          
|Issuance of preferred stock and warrants                                                                           |  |            |  | 26,918         |  |            
|Redemption of preferred stock                                                                                      |  | (26,918)    |  |               |  |            
|Repurchase of warrant                                                                                              |  | (900)       |  |               |  |            
|Cash dividends paid to common shareholders                                                                         |  | (4,872)     |  | (4,570)        |  | (4,213)     
|Cash dividends paid to preferred shareholders                                                                      |  | (538)       |  |               |  |            
|                                                                                                                   |  |             |  |                |  |             
|Net cash provided by financing activities                                                                          |  | 38,906      |  | 47,723         |  | 24,644      
|                                                                                                                   |  |             |  |                |  |             
|Net (decrease) increase in cash and cash equivalents                                                               |  | (21,394)    |  | 17,386         |  | 3,306       
|Cash and cash equivalents at beginning of year                                                                     |  | 48,090      |  | 30,704         |  | 27,398      
|                                                                                                                   |  |             |  |                |  |             
|Cash and cash equivalents at end of year                                                                           |  | $    26,696 |  | $    48,090    |  | $    30,704 
|                                                                                                                   |  |             |  |                |  |             



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Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (contd)

Years Ended December 31, 2009, 2008 and 2007





|                                                                 |  |             |  |             |  |            
|---------------------------------------------------------------- |  | ----------- |  | ----------- |  | -----------
|                                                                 |  | 2009        |  | 2008        |  | 2007       
|Supplemental Disclosures of Cash Flow Information:               |  |             |  |             |  |            
|Interest received during the year                                |  | $    64,013 |  | $    68,336 |  | $    71,136
|Interest paid during the year                                    |  | 21,873      |  | 31,113      |  | 37,300     
|Income taxes paid                                                |  | 3,657       |  | 1,377       |  | 2,971      
|Non-cash investing activities:                                   |  |             |  |             |  |            
|Change in unrealized loss on securities available-for-sale       |  | (61)        |  | 3,203       |  | 3,155      
|Transfer between premises and equipment and assets held-for-sale |  |            |  | 724         |  | (1,459)    
|Transfer of loans to foreclosed real estate                      |  | 440         |  | 660         |  | 441        
|Transfer of leases to held-for-sale                              |  |            |  | 10,819      |  |           
|Non-cash financing activities:                                   |  |             |  |             |  |            
|Dividends declared and unpaid                                    |  | 1,292       |  | 1,232       |  | 1,135      

The accompanying notes
are an integral part of the consolidated financial statements.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



Nature of Operations

Alliance Financial Corporation (the Company) is a financial holding company which owns and operates Alliance Bank, N.A. (the
Bank), Alliance Financial Capital Trust I, Alliance Financial Capital Trust II (collectively the Capital Trusts) and Ladds Agency, Inc., a multi-line insurance agency. The Company provides financial services through its
Bank subsidiary from 29 retail branches and customer service facilities in the New York counties of Cortland, Madison, Oneida, Onondaga, Oswego, and from a Trust Administration Center in Buffalo, NY. Primary services include commercial, retail and
municipal banking, consumer finance, mortgage financing and servicing, and investment management services. The Capital Trusts were formed for the purpose of issuing corporation-obligated mandatorily redeemable capital securities to third-party
investors and investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of the Company. The Bank has a substantially wholly-owned subsidiary, Alliance Preferred Funding Corp., which is engaged in
residential real estate activity, and a wholly-owned subsidiary, Alliance Leasing, Inc., which was engaged in commercial equipment financing activity in over thirty states until the third quarter of 2008, at which time Alliance Leasing, Inc. ceased
the origination of new leases.

1. Basis of Presentation and Significant Accounting Policies

Principles of Consolidation

The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, Alliance Bank, N.A. and Ladds Agency, Inc., after elimination of intercompany accounts and transactions. The Companys
wholly-owned subsidiaries, Alliance Financial Capital Trust I and II, qualify as variable interest entities under FASB Interpretation No. 46 (FIN 46), Consolidation of Variable Interest Entities (Accounting
StandardsTopic 810-10-05). However, the Company is not the primary beneficiary and therefore has not consolidated the accounts of Alliance Financial Capital Trust I and II in its consolidated financial statements.

Critical Accounting Estimates and Policies

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 revenues and expenses during the reporting period. Management has identified the
allowance for credit losses, income taxes, and the carrying value of goodwill and intangible assets to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new
information becomes available. Actual results could differ from those estimates.

Risk and Uncertainties

In the normal course of its business, the Company encounters economic and regulatory risks. There are three main components of economic
risk: interest rate risk, credit risk and market risk. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities mature or reprice at different speeds, or on different bases, from its interest-earning assets.
The Companys primary credit risk is the risk of default on the Companys loan and lease portfolio that results from the borrowers inability or unwillingness to make contractually required payments. Market risk reflects potential
changes in the value of collateral underlying loans, the fair value of investment securities, and the value of loans held for sale.

The Company is subject to regulations of various governmental agencies. These regulations can and do change significantly from period to period. The Company also undergoes periodic examinations by the regulatory agencies, which may subject
it to further changes with respect to asset valuations, amounts of required loan and lease loss allowances, and operating restrictions resulting from the regulators judgments based on information available to them at the time of their
examinations.

The Company is also subject to liquidity risk which is the current and prospective risk to earnings or capital
arising from a banks ability to meet its obligations when they come due without incurring unacceptable losses. The Companys liquidity is primarily measured by the Banks ability to provide funds to meet loans requests, to
accommodate possible outflows of deposits, and to take advantage of market interest rate opportunities.

Cash Flows

Cash and cash equivalents include cash, deposits with other financial institutions with maturities fewer than 90 days, and federal funds
sold. Net cash flows are reported for customer loan, lease and deposit transactions, interest bearing deposits in other financial institutions, and federal funds purchased and repurchase agreements.

Securities

The Company
classifies debt securities as held-to-maturity or available-for-sale at the time of purchase. Held-to-maturity debt securities are those that the Company 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 are reported at fair value, with net unrealized gains and losses reflected as a separate component of
accumulated other comprehensive income, net of taxes. None of the Companys debt securities have been classified as trading securities or held-to-maturity. Equity securities with readily determinable fair values are classified as
available-for-sale.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



1. Basis of Presentation and Significant Accounting
Policies (contd)



Gains and losses on the sale of securities are based on the specific identification
method. Premiums and discounts on securities are amortized and accreted into income using the interest method over the life of the security. Purchases and sales of securities are recognized on a trade-date basis.

Securities are reviewed regularly for other than temporary impairment. When an investment is impaired, we assess whether we intend to sell
the security, or it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis less any current-period credit losses. For debt securities, that are considered other than temporarily impaired and
that we do not intend to sell and will not be required to sell prior to recovery of our amortized cost basis, we separate the amount of the impairment into the amount that is credit related (credit loss component) and the amount due to all other
factors. The credit loss component is recognized in earnings and is calculated as the difference between the investments amortized cost basis and the present value of its expected future cash flows. The cost basis of individual equity
securities is written down to estimated fair value through a charge to earnings when decline in value below cost are considered to be other than temporary.

Federal Home Loan Bank of New York and Federal Reserve Bank Stock

Investments in Federal Reserve and Federal Home Loan Bank stock are required for membership in those organizations and are carried at cost since there is no market value available.

Securities Sold under Agreements to Repurchase

Repurchase agreements are accounted for as collateralized borrowings, and the obligations to repurchase securities sold are reflected as a liability in the balance sheet, since the Company maintains
effective control over the transferred securities. The securities underlying the agreements remain in the Companys securities portfolio. The fair value of the collateral provided to a third party is continually monitored, and additional
collateral is provided to the third party, or surplus collateral is returned to the Company as deemed appropriate.

Loans Held for Sale and
Mortgage Servicing Rights

Mortgage loans originated and intended for sale in the secondary market are carried at the
lower of aggregate cost or fair value, as determined by outstanding commitments from investors. Net unrealized losses, if any, are charged to earnings.

Mortgage loans held for sale are generally sold with servicing rights retained. The carrying value of mortgage loans sold is reduced by the amount allocated to the servicing right. Gains and losses on
sales of mortgage loans are based on the difference between the selling price and the carrying value of the related loan sold.

Mortgage servicing rights are recognized separately when they are acquired through sales of loans. When mortgage loans are sold, servicing rights are initially recorded at fair value with the income statement effect recorded in gains on
sale of loans. Fair value is based on a valuation model that calculates the present value of estimated future net servicing income. The valuation model incorporates assumptions that market participants would use in estimating future net servicing
income, such as the cost to service, the discount rate, the custodial earnings rate, an inflation rate, ancillary income, prepayment speeds and default rates and losses. All classes of servicing assets are subsequently measured using the
amortization method which requires servicing rights to be amortized into non-interest income in proportion to, and over the period of, the estimated future net servicing income of the underlying loans.

Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to carrying amount. Impairment is
determined by stratifying rights into groupings based on predominant risk characteristics, such as interest rate, loan type and investor type. Impairment is recognized through a valuation allowance for an individual grouping, to the extent that fair
value is less than the carrying amount. If the Company later determines that all or a portion of the impairment no longer exists for a particular grouping, a reduction of the allowance may be recorded as an increase to income. The fair values of
servicing rights are subject to significant fluctuations as a result of changes in estimated and actual prepayment speeds and default rates and losses.

Servicing fee income which is reported on the income statement as other non-interest income is recorded for fees earned for servicing loans and recorded as income when earned. The amortization of mortgage
servicing rights is netted against loans servicing fee income.

Loans and Leases

Loans and leases held for investment are stated at unpaid principal balances less the allowance for credit losses, unearned interest income
and net deferred loan origination fees and costs. Interest on loans is based upon the principal amount outstanding. Interest on loans is accrued except when in managements opinion the collectibility of interest is doubtful, at which time the
accrual of interest on the loan is discontinued. Loan and lease origination fees and certain direct origination costs are deferred and the net amount is amortized as a yield adjustment over the life of the loan or lease.

Operating leases are stated at cost of the equipment less scheduled depreciation. Equipment on operating leases is depreciated on a
straight-line basis to its estimated residual value over the lease term. Operating lease income is recognized on a straight-line basis over the term of the lease. Lease



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



1. Basis of Presentation and Significant Accounting
Policies (contd)



financings, included in portfolio loans on the consolidated balance sheet consist of direct financing leases of commercial equipment, primarily computers and office equipment, manufacturing
equipment, commercial truck and trailers, and medical equipment. Income attributable to finance leases is initially recorded as unearned income and subsequently recognized as finance income at level rates of return over the term of the leases. The
recorded residual values of the Companys leased assets are estimated at the inception of the lease to be the expected fair market value of the assets at the end of the lease term. The Company reviews commercial lease residual values at least
annually and recognizes residual value impairments deemed to be other than temporary. In accordance with U.S. generally accepted accounting principles, anticipated increases in specific future residual values are not recognized before realization.

Allowance for Credit Losses

The allowance for credit losses represents managements best estimate of probable incurred credit losses in the Companys loan and lease portfolio. Managements quarterly evaluation of the
allowance for credit losses is a comprehensive analysis that builds a total allowance by evaluating the probable incurred losses within each loan and lease type, or pool, of similar loans and leases. The Company uses a general allocation methodology
for all residential and consumer loan pools. This methodology estimates an allowance for each pool based on the average loss rate for the time period that includes the current year and two full prior years. The average loss rate is adjusted to
reflect the expected impact that current trends regarding loan growth, delinquency, losses, economic conditions, loan concentrations, policy changes, experience and ability of lending personnel, and current interest rates have. For commercial loan
and lease pools, the Company establishes a specific allocation for all loans and leases classified as being impaired in excess of $250,000, which have been risk rated under the Companys risk rating system as substandard, doubtful, or loss. For
all other commercial loans and leases, the Company uses the general allocation methodology that establishes an allowance to estimate the probable incurred loss for each risk-rating category. The general allocation methodology for commercial loans
and leases considers the same factors that are considered when evaluating residential mortgage and consumer loan pools. The combination of using both the general and specific allocation methodologies reflects managements best estimate of the
probable incurred credit losses in the Companys loan and lease portfolio.

A loan or lease is considered impaired when,
based on current information and events, if it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. Loans for which the
terms have been modified and for which the borrower is experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. The measurement of impaired loans and leases is generally discounted at the
historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on fair value of the collateral. Large groups of smaller balance homogeneous loans, such as consumer and residential real
estate loans less than $250,000, are collectively evaluated for impairment, and accordingly, they are not separately identified for impairment disclosures. Troubled debt restructurings are measured at the present value of estimated future cash flows
using the loans effective rate at inception.

Loans and leases are charged off when they are considered a loss
regardless of the delinquency status. From a delinquency standpoint, the policy of the Company is to charge off loans when they are 120 days past due unless extenuating circumstances are documented that attest to the ability to collect the loan. In
special circumstances loans and leases will be charged off no later than 90 days of discovery or 120 days delinquent, whichever is shorter. In lieu of charging off the entire loan balance, loans with collateral may be written down to the value of
the collateral, less cost to sell, if foreclosure or repossession of collateral is assured and is in process.

Income Recognition on
Impaired and Non-accrual Loans and Leases

Loans and leases, including impaired loans or leases, are generally classified
as non-accrual if they are past due as to maturity of payment of principal or interest for a period of more than 90 days unless they are well secured and are in the process of collection. While a loan or lease is classified as non-accrual and the
future collectibility of the recorded loan or lease balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding.

Goodwill and Intangible Assets

Goodwill represents the excess of the
purchase price over the fair value of net assets acquired for transactions accounted for under the purchase method of accounting for business combinations. Goodwill is not being amortized, but is evaluated at least annually for impairment. The
Company has selected October 31 as the date to perform the annual impairment test. Intangible assets resulting from the acquisition of Bridge Street Financial, Inc. in 2006 include core deposit intangibles, customer relationship intangibles and
a covenant to not compete. The core deposit intangible and customer list intangible are being amortized over 10 years using an accelerated method. The non-compete covenant is being amortized on a straight-line basis over a period of 3 years based on
the agreement. The investment management intangible related to the purchase of certain trust accounts and related assets under management from HSBC, USA, N.A. in 2005 is being amortized over the expected useful life of the relationships acquired.
These intangibles are tested for impairment whenever events or changes in circumstances indicate that the carrying amounts may not be recoverable. Goodwill is the only intangible asset with an indefinite life on the Companys balance sheet.

Premises, Furniture, and Equipment

Land is carried at cost. Bank premises, furniture, and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are calculated using the straight-line
method over the estimated useful lives of the assets. Useful lives range from one year to 10 years for furniture, fixtures and equipment; three to five years for software, hardware, and data handling equipment; and 10 to 39 years for buildings and



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



1. Basis of Presentation and Significant Accounting
Policies (contd)



building improvements. Leasehold improvements are amortized over the term of the respective lease. Maintenance and repairs are charged to operating expenses as incurred. The asset cost and
accumulated depreciation are removed from the accounts for assets sold or retired and any resulting gain or loss is included in the determination of the income.

Long-Term Assets

Premises and equipment, core deposit and other
intangible assets, and other long-term assets are reviewed for impairment when events indicate their carrying amount may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

Bank-Owned Life Insurance

The Bank has purchased life insurance policies on certain employees, key executives and directors. Bank-owned life insurance is recorded at the amount that can be realized under the insurance contract at the balance sheet date, which is the
cash surrender value adjusted for other charges or other amounts due that are probable at settlement.

Foreclosed Assets

Assets acquired through or instead of loan foreclosure are initially recorded at fair value less costs to sell when acquired, establishing a
new cost basis. If fair value declines subsequent to foreclosure, a valuation allowance is recorded through expense. Operating costs after acquisition are expensed.

Loan Commitments and Related 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.

Retirement Plans

Pension expense is the net of service and interest cost, return on plan assets and amortization of gains and losses not immediately
recognized. Employee 401(k) and profit sharing plan expense is the amount of matching contributions and employer fixed and discretionary contributions. Deferred compensation and supplemental retirement plan expense allocates the benefits over years
of service.

Stock-Based Compensation

Compensation cost is recognized for stock options and restricted stock awards issued to employees, based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to
estimate the fair value of stock options, while the market price of the Corporations common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as
the vesting period. For awards with graded vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award.

Directors Stock-Based Deferral Plan

In accordance with Accounting
Standards Codification Topic 710-10-25 Deferred Compensation  Rabbi Trusts, the stock held in the trust is classified in equity similar to the manner in which treasury stock is classified.

Earnings Per Common Share

Earnings per share is computed using the two-class method. Basic earnings per common share is computed by dividing net income allocated to common stock by the weighted average number of common shares outstanding during the period which
excludes the participating securities. All outstanding unvested restricted stock awards containing rights to nonforfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share includes the
dilutive effect of additional potential common shares from stock compensation awards and warrants, but excludes awards considered participating securities.

Loss Contingencies

Loss contingencies, including claims and legal actions
arising in the ordinary course of business, are recorded as liabilities when the likelihood of loss is probable and an amount or range of loss can be reasonably estimated. Management does not believe there now are such matters that will have a
material effect on the financial statements.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



1. Basis of Presentation and Significant Accounting
Policies (contd)



Comprehensive Income

Comprehensive income consists of net income and other comprehensive income. Other comprehensive income includes unrealized gains and losses on securities available for sale and
changes in funded status of the pension plan, post-retirement medical plan and supplemental executive retirement plans which are also recognized as separate components of equity.

Income Taxes

Provision for income taxes is based on taxes currently
payable or refundable and deferred income taxes on temporary differences between the tax basis of assets and liabilities and their reported amount in the financial statements. Deferred tax assets and liabilities are reported in the financial
statements at currently enacted income tax rates applicable to the period in which the deferred tax assets and liabilities are expected to be realized or settled.

The Company adopted the guidance issued by the FASB with respect to accounting for uncertainty in income taxes as of January 1, 2007. A tax position is recognized as a benefit only if it is
more likely than not that the tax position would be sustained in a tax examination, with a tax examination being presumed to occur. The amount recognized is the largest amount of tax benefit that is greater than 50% likely of being
realized on examination. For tax positions not meeting the more likely than not test, no tax benefit is recorded. The adoption had no affect on the Companys financial statements. The Company accounts for interest and penalties
related to uncertain tax positions as part of its provision for federal and state income taxes.

Restrictions on Cash

Cash on hand or on deposit with the Federal Reserve Bank was required to meet regulatory reserve and clearing requirements.

Dividend Restriction

Banking regulations require maintaining certain capital levels and may limit the dividends paid by the Bank to the holding company or by the holding company to shareholders.

Fair Value of Financial Instruments

Fair values of financial instruments
are estimated using relevant market information and other assumptions, as more fully disclosed in a separate note. Fair value estimates involve uncertainties and matters of significant judgment regarding interest rates, credit risk, prepayments, and
other factors, especially in the absence of broad markets for particular items. Changes in assumptions or in market conditions could significantly affect the estimates.

Segment Reporting

The Companys operations are solely in the
financial services industry and include providing to its customers traditional banking, equipment leasing and other financial services including investment management services. The Company operates primarily in the geographical regions of Cortland,
Madison, Oneida, Onondaga, and Oswego counties of New York State, and from a Trust Administration Center in Buffalo, NY. In addition, Alliance Leasing conducted business in over thirty states. While the Companys chief decision-makers monitor
the revenue streams of the various Company products and services, the segments that could be separated from the Companys primary business of banking do not meet the criteria for separate disclosure. Accordingly, all of the Companys
financial service operations are considered by management to be combined in one reportable operating segment.

Investment Assets Under
Management

Assets held in fiduciary or agency capacities for customers are not included in the accompanying consolidated
statements of condition, since such items are not assets of the Company. Fees associated with providing investment management services are recorded using a method that approximates the accrual basis.

Reclassification

Reclassifications are made to prior years consolidated financial statements, when necessary, to conform to the current years presentation. These reclassifications have no effect on net income as previously reported.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



1. Basis of Presentation and Significant Accounting
Policies (contd)



Adoption of New Accounting Standards

The Company adopted ASC Topic 260-10-45-59A through 61A (ASC 260-10-45), Participating Securities and the Two Class Method. ASC 206-10-45 requires the use of
the two-class method for computing earnings per share when stock compensation awards with non-forfeitable dividend rights are present. Prior earnings per share amounts have been retrospectively adjusted to conform to the provisions of ASC 206-10-45.
See Note 9 to the Companys consolidated financial statements for disclosure of the earnings per share calculation in accordance with ASC 206-10-45.

The FASB issued ASC Topic 820-10-15 Fair Value Measures and Disclosures - Scope, and ASC Topic 820-10-65-1 Fair Value Measurements and Disclosures  Transition Related to FAS
157-2. ASC Topic 820-10-15 excludes certain leasing transactions accounted for under ASC Topic 840 from the scope of ASC Topic 820. ASC Topic 820-10-65-1 defers the effective date in ASC Topic 820 for one year (January 1, 2009 for the Company)
for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The impact on the Companys current practice of
measuring fair value for these assets did not have a material effect on the financial statements.

In December 2007, the
FASB issued SFAS No. 160, Noncontrolling Interest in Consolidated Financial Statements, an amendment of ARB No. 51 (ASC 810-10). ASC 810-10 changes the accounting and reporting for minority interests, which is recharacterized as
noncontrolling interests and classified as a component of equity within the consolidated balance sheets. ASC 810-10 was effective as of the beginning of the first fiscal year beginning on or after December 15, 2008. The effect of
adopting this new guidance did not have a material effect on the financial statements.

In December 2008, the FASB issued
Staff Position (FSP) No. 132(R)-1, Employers Disclosures about Postretirement Benefit Plan Assets (ASC 715-20). The FSP provides guidance on an employers disclosures about plan assets of a defined benefit pension or
other post-retirement plan. These additional disclosures include disclosure of investment policies and fair value disclosures of plan assets, including fair value hierarchy. The FSP also includes a technical amendment that requires a nonpublic
entity to disclose net periodic benefit cost for each annual period for which a statement of income is presented. This FSP is effective for fiscal years ending after December 15, 2009. Upon initial application, provisions of the FSP are not
required for earlier periods that are presented for comparative purposes. The new disclosures have been presented in the notes to the consolidated financial statements.

In April 2009, the FASB issued ASC Topic 320-10-65, Transition Related to FSP 115-2 & 124-2 Recognition and Presentation of Other-Than Temporary Impairments, which amended
guidance for determining other-than-temporary impairment (OTTI) on debt securities. The ASC eliminates the requirement for the issuer to evaluate whether it has the intent and ability to hold an impaired investment until
maturity. Conversely, the new ASC requires the issuer to recognize an OTTI in the event that the issuer intends to sell the impaired security or in the event that it is more likely than not that the issuer will sell the security prior to
recovery. In the event that the sale of the security in question prior to its maturity is not probable but the entity does not expect to recover its amortized cost basis in that security, then the entity will be required to recognize an
OTTI. In the event that the recovery of the securitys cost basis prior to maturity is not probable and an OTTI is recognized, the ASC provides that any component of the OTTI relating to a decline in the creditworthiness of the debtor
should be reflected in earnings, with the remainder being recognized in Other Comprehensive Income. Conversely, in the event that the issuer intends to sell the security before the recovery of its cost basis or if it is more likely than not
that the Company will have to sell the security before recovery of its cost basis, then the entire OTTI will be recognized in earnings. The ASC is effective for interim and annual reporting periods ending after June 15, 2009. The adoption
did not have a material impact on the Companys consolidated financial position, results of operations or cash flows.

In
April 2009, the FASB issued ASC Topic 820-10-35-51, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly. The ASC
provides additional guidance for determining fair value based on observable transactions. The ASC provides that if evidence suggests that an observable transaction was not executed in an orderly way that little, if any, weight should be
assigned to this indication of an asset or liabilitys fair value. Conversely, if evidence suggests that the observable transaction was executed in an orderly way, the transaction price of the observable transaction may be appropriate to
use in determining the fair value of the asset/liability in question, with appropriate weighting given to this indication based on facts and circumstances. Finally, if there is no way for the entity to determine whether the observable transaction
was executed in an orderly way, relatively less weight should be ascribed to this indicator of fair value. The ASC is effective for interim and annual reporting periods ending after June 15, 2009. The adoption did not have a material
impact on the Companys consolidated financial position, results of operations or cash flows.

In June 2009, the
FASB replaced Statement of Financial Accounting Standards No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles, with Statement 162, The Hierarchy of Generally Accepted Accounting
Principles, and to establish the FASB Accounting Standards Codification TM as the source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity
with GAAP. Rules and interpretive releases of the Securities and Exchange Commission under authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. The Codification was effective for financial statements
issued for periods after September 15, 2009.

Newly Issued Not Yet Effective Standards

In June 2009, FASB issued Statement No. 166: Accounting for Transfers of Financial Assets - An Amendment of FASB Statement No. 140
(ASC 810). The new accounting requirement amends previous guidance relating to the transfers of financial assets and eliminates the concept of a qualifying special purpose entity. This Statement must be applied as of the beginning of each reporting
entitys first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



1.  Basis of Presentation and Significant
Accounting Policies (contd)



This Statement must be applied to transfers occurring on or after the effective date.
Additionally, on and after the effective date, the concept of a qualifying special-purpose entity is no longer relevant for accounting purposes. Therefore, formerly qualifying special-purpose entities should be evaluated for consolidation by
reporting entities on and after the effective date in accordance with the applicable consolidation guidance. Additionally, the disclosure provisions of this Statement were also amended and apply to transfers that occurred both before and after the
effective date of this Statement. The Company does not expect the adoption to have a material impact on the Companys consolidated financial position, results of operations or cash flows.

FASB No. 167, Amendments to FASB Interpretation No. 46(R), which amended guidance for consolidation of variable interest entities by replacing the quantitative-based risks
and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with an approach focused on identifying which enterprise has the power to direct the activities of a variable
interest entity that most significantly impact the entitys economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. This Statement also requires additional
disclosures about an enterprises involvement in variable interest entities. This Statement will be effective as of the beginning of each reporting entitys first annual reporting period that begins after November 15, 2009, for
interim periods within that first annual reporting period, and for interim and annual reporting periods thereafter. Early adoption is prohibited. The Company does not expect the adoption to have a material impact on the Companys consolidated
financial position, results of operations or cash flows.

2.  Securities

The amortized cost and estimated fair value of securities at December 31 are as follows (in thousands):



|                                                      |  |                   |  |                                 |  |                                  |  |                     
|----------------------------------------------------- |  | ----------------- |  | ------------------------------- |  | -------------------------------- |  | --------------------
|                                                      |  | December 31, 2009
|                                                      |  | Amortized Cost    |  | Gross Unrealized          Gains |  | Gross Unrealized          Losses |  | Estimated Fair Value
|Debt Securities:                                      |  |                   |  |                                 |  |                                  |  |                     
|U.S. Treasury obligations                             |  | $        100      |  | $        1                      |  | $                               |  | $        101        
|Obligations of U.S. government-sponsored corporations |  | 5,864             |  | 265                             |  |                                 |  | 6,129               
|Obligations of states and political subdivisions      |  | 75,104            |  | 2,135                           |  | 92                               |  | 77,147              
|Mortgage-backed securities - residential              |  | 273,499           |  | 4,030                           |  | 1,849                            |  | 275,680             
|                                                      |  |                   |  |                                 |  |                                  |  |                     
|Total debt securities                                 |  | 354,567           |  | 6,431                           |  | 1,941                            |  | 359,057             
|Stock Investments:                                    |  |                   |  |                                 |  |                                  |  |                     
|Equity securities                                     |  | 1,958             |  | 153                             |  | 7                                |  | 2,104               
|Mutual Funds                                          |  | 1,000             |  | 19                              |  | 22                               |  | 997                 
|                                                      |  |                   |  |                                 |  |                                  |  |                     
|Total stock investments                               |  | 2,958             |  | 172                             |  | 29                               |  | 3,101               
|                                                      |  |                   |  |                                 |  |                                  |  |                     
|Total available-for-sale                              |  | $ 357,525         |  | $ 6,603                         |  | $ 1,970                          |  | $ 362,158           
|                                                      |  |                   |  |                                 |  |                                  |  |                     

Mortgage-backed securities, which totaled $275.7
million at December 31, 2009, are comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie-Mae, Freddie-Mac or Ginnie Mae, which in turn are backed by the federal government. The
Company does not invest in any securities backed by sub-prime, Alt-A or other high-risk mortgages. The Company also does not hold any preferred stock, corporate debt or trust preferred securities in its investment portfolio.



|                                                      |  |                   |  |                                 |  |                                  |  |                     
|----------------------------------------------------- |  | ----------------- |  | ------------------------------- |  | -------------------------------- |  | --------------------
|                                                      |  | December 31, 2008
|                                                      |  | Amortized Cost    |  | Gross Unrealized          Gains |  | Gross Unrealized          Losses |  | Estimated Fair Value
|Debt Securities:                                      |  |                   |  |                                 |  |                                  |  |                     
|U.S. Treasury obligations                             |  | $        101      |  | $        1                      |  | $                               |  | $        102        
|Obligations of U.S. government-sponsored corporations |  | 34,489            |  | 654                             |  |                                 |  | 35,143              
|Obligations of states and political subdivisions      |  | 89,154            |  | 2,148                           |  | 269                              |  | 91,033              
|Mortgage-backed securities - residential              |  | 167,753           |  | 2,521                           |  | 314                              |  | 169,960             
|                                                      |  |                   |  |                                 |  |                                  |  |                     
|Total debt securities                                 |  | 291,497           |  | 5,324                           |  | 583                              |  | 296,238             
|Stock Investments:                                    |  |                   |  |                                 |  |                                  |  |                     
|Equity securities                                     |  | 1,958             |  |                                |  | 35                               |  | 1,923               
|Mutual Funds                                          |  | 1,000             |  | 14                              |  | 26                               |  | 988                 
|                                                      |  |                   |  |                                 |  |                                  |  |                     
|Total stock investments                               |  | 2,958             |  | 14                              |  | 61                               |  | 2,911               
|                                                      |  |                   |  |                                 |  |                                  |  |                     
|Total available-for-sale                              |  | $ 294,455         |  | $ 5,338                         |  | $    644                         |  | $ 299,149           
|                                                      |  |                   |  |                                 |  |                                  |  |                     



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



2.  Securities (contd)



The carrying value and estimated fair value of debt securities at December 31, by
contractual maturity, are shown as follows (in thousands). The maturities of mortgage-backed securities are based on average life of the security. All other expected maturities differ from contractual maturities because borrowers may have the right
to call or prepay obligations with or without call or prepayment penalties.



|                                       |  |                   |  |                     
|-------------------------------------- |  | ----------------- |  | --------------------
|                                       |  | December 31, 2009
|                                       |  | Amortized Cost    |  | Estimated Fair Value
|Due in one year or less                |  | $    85,572       |  | $    86,901         
|Due after one year through five years  |  | 177,199           |  | 179,738             
|Due after five years through ten years |  | 71,930            |  | 72,368              
|Due after ten years                    |  | 19,866            |  | 20,050              
|                                       |  |                   |  |                     
|Total debt securities                  |  | $  354,567        |  | $  359,057          
|                                       |  |                   |  |                     
|                                       | 
|                                       |  | December 31, 2008
|                                       |  | Amortized Cost    |  | Estimated Fair Value
|Due in one year or less                |  | $    75,606       |  | $    76,391         
|Due after one year through five years  |  | 150,894           |  | 153,745             
|Due after five years through ten years |  | 47,396            |  | 48,413              
|Due after ten years                    |  | 17,601            |  | 17,689              
|                                       |  |                   |  |                     
|Total debt securities                  |  | $  291,497        |  | $  296,238          
|                                       |  |                   |  |                     

At December 31, 2009 and 2008, securities with a
carrying value of $319.0 million and $293.1 million, respectively, were pledged as collateral for certain deposits and other purposes as required or permitted by law.

The Company recognized gross gains on sales of securities of $2.2 million, $137,000, and $0, for 2009, 2008, and 2007, respectively, and gross losses of $0, $0, and $12,000, for 2009, 2008, and 2007,
respectively. The tax provision (benefit) related to these net realized gains and losses was $839,000, $53,000, and $(5,000), respectively.

The following table shows the securities with unrealized losses at year end, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss
position, at the dates indicated (in thousands):



|                                                 |  |                         |  |                      |  |                         |  |                      |  |                         |  |                     
|------------------------------------------------ |  | ----------------------- |  | -------------------- |  | ----------------------- |  | -------------------- |  | ----------------------- |  | --------------------
|                                                 |  | December 31, 2009      
|                                                 |  | Less than 12 Months     |  | 12 Months or Longer  |  | Total                  
|Type of Security                                 |  | Estimated    Fair Value |  | Unrealized    Losses |  | Estimated    Fair Value |  | Unrealized    Losses |  | Estimated    Fair Value |  | Unrealized    Losses
|Obligations of states and political subdivisions |  | $    7,013              |  | $       87           |  | $     200               |  | $      5             |  | $    7,213              |  | $       92          
|Mortgage-backed securities                       |  | 82,274                  |  | 1,773                |  | 1,747                   |  | 76                   |  | 84,021                  |  | 1,849               
|                                                 |  |                         |  |                      |  |                         |  |                      |  |                         |  |                     
|Subtotal, debt securities                        |  | 89,287                  |  | 1,860                |  | 1,947                   |  | 81                   |  | 91,234                  |  | 1,941               
|Equity securities                                |  |                        |  |                     |  | 23                      |  | 7                    |  | 23                      |  | 7                   
|Mutual Funds                                     |  |                        |  |                     |  | 478                     |  | 22                   |  | 478                     |  | 22                  
|                                                 |  |                         |  |                      |  |                         |  |                      |  |                         |  |                     
|Total temporarily impaired securities            |  | $  89,287               |  | $  1,860             |  | $  2,448                |  | $  110               |  | $  91,735               |  | $  1,970            
|                                                 |  |                         |  |                      |  |                         |  |                      |  |                         |  |                     
|                                                 | 
|                                                 |  | December 31, 2008      
|                                                 |  | Less than 12 Months     |  | 12 Months or Longer  |  | Total                  
|Type of Security                                 |  | Estimated Fair Value    |  | Unrealized    Losses |  | Estimated    Fair Value |  | Unrealized    Losses |  | Estimated    Fair Value |  | Unrealized    Losses
|Obligations of states and political subdivisions |  | $    8,342              |  | $    269             |  | $                      |  | $                   |  | $      8,342            |  | $    269            
|Mortgage-backed securities                       |  | 22,804                  |  | 164                  |  | 5,636                   |  | 150                  |  | 28,440                  |  | 314                 
|                                                 |  |                         |  |                      |  |                         |  |                      |  |                         |  |                     
|Subtotal, debt securities                        |  | 31,146                  |  | 433                  |  | 5,636                   |  | 150                  |  | 36,782                  |  | 583                 
|Equity securities                                |  | 1,923                   |  | 35                   |  |                        |  |                     |  | 1,923                   |  | 35                  
|Mutual Funds                                     |  |                        |  |                     |  | 474                     |  | 26                   |  | 474                     |  | 26                  
|                                                 |  |                         |  |                      |  |                         |  |                      |  |                         |  |                     
|Total temporarily impaired securities            |  | $  33,069               |  | $    468             |  | $  6,110                |  | $    176             |  | $    39,179             |  | $    644            
|                                                 |  |                         |  |                      |  |                         |  |                      |  |                         |  |                     

Management does not believe any individual unrealized
loss as of December 31, 2009 represents an other-than-temporary impairment. A total of 54 available-for-sale securities were in a continuous unrealized loss position for less than 12 months and 5 securities for 12 months or longer. The
unrealized losses relate primarily to debt securities issued by FNMA, GNMA, FHLMC, FHLB, the State of New York, and various political subdivisions within the State of New York. These unrealized losses are primarily attributable to changes in
interest rates and other market conditions. The Company does not intend to sell these securities and does not believe it will be required to sell them prior to recovery of the amortized cost.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



3. Loans and Leases



Major classifications of loans and leases at December 31 are as follows (in thousands):



|                            |  |            |  |           
|--------------------------- |  | ---------- |  | ----------
|                            |  | 2009       |  | 2008      
|                            |  |           
|Residential real estate     |  | $  356,906 |  | $  314,039
|Commercial loans            |  | 207,996    |  | 214,315   
|Leases                      |  | 76,224     |  | 117,691   
|Indirect auto loans         |  | 184,947    |  | 182,807   
|Other consumer loans        |  | 92,022     |  | 90,906    
|                            |  |            |  |           
|Total                       |  | 918,095    |  | 919,758   
|                            |  |           
|Unearned income             |  | (8,000)    |  | (13,036)  
|Net deferred loan costs     |  | 4,067      |  | 4,033     
|                            |  |            |  |           
|Total loans and leases      |  | 914,162    |  | 910,755   
|Allowance for credit losses |  | (9,414)    |  | (9,161)   
|                            |  |            |  |           
|Net loans & leases          |  | $  904,748 |  | $  901,594
|                            |  |            |  |           

Mortgage loans serviced for others are not included in
the accompanying consolidated balance sheet. The unpaid principal balances of mortgage loans serviced for others were $151.0 million and $135.3 million at December 31, 2009 and 2008, respectively. Servicing fee income, net of mortgage servicing
rights amortization, totaled $42,000, $82,000, and $75,000 for the years ended December 31, 2009, 2008 and 2007.

The following table
summarizes the changes in the carrying value of mortgage servicing rights (in thousands):



|                       |  |        |  |        |  |           
|---------------------- |  | ------ |  | ------ |  | ----------
|                       |  | 2009   |  | 2008   |  | 2007      
|Balance at January 1   |  | $  845 |  | $  976 |  | $   1,158 
|Additions              |  | 385    |  | 141    |  | 114       
|Amortization           |  | (321)  |  | (272)  |  | (296)     
|                       |  |        |  |        |  |           
|Balance at December 31 |  | $  909 |  | $  845 |  | $      976
|                       |  |        |  |        |  |           

The fair value of mortgage servicing rights was $1.1
million and $1.0 million at December 31, 2009 and 2008, respectively. Fair value at December 31, 2009 was determined using a discount rate of 8.28%, prepayment speed assumptions (PSA) ranging from 339% in the first year to 241% in the
third year and servicing cost per loan of $56. Fair value at December 31, 2008 was determined using a discount rate of 8.50%, prepayment speed assumptions (PSA) ranging from 319% in the first year to 218% in the third year and servicing cost
per loan of $55.

The estimated residual value of leased assets was $297,000 and $581,000 at December 31, 2009 and 2008, respectively.

At December 31, 2009, the minimum future lease payments to be received from lease financings were as follows (in
thousands):



|                         |  |          
|------------------------ |  | ---------
|Year ending December 31:
|2010                     |  | $  25,827
|2011                     |  | 19,046   
|2012                     |  | 13,503   
|2013                     |  | 5,794    
|2014                     |  | 3,362    
|Thereafter               |  | 8,692    

Nonperforming loans and
leases at December 31 are as follows (in thousands):



|                                                     |  |           |  |            
|---------------------------------------------------- |  | --------- |  | -----------
|                                                     |  | 2009      |  | 2008       
|Loans and leases 90 days past due and still accruing |  | $        |  | $       126
|Non-accrual loans and leases                         |  | 8,582     |  | 4,352      
|                                                     |  |           |  |            
|Total nonperforming loans and leases                 |  | $  8,582  |  | $    4,478 
|                                                     |  |           |  |            

As of December 31, 2009 and 2008, impaired loans
and leases totaled approximately $3.6 million and $1.4 million, respectively. The recorded investment in loans considered impaired for which there was a related valuation allowance for impairment included in the allowance for credit losses and the
amount of such impairment allowance were $908,000 and $332,000, respectively at December 31, 2009 and $217,000 and $193,000, respectively, at December 31, 2008. The recorded investment in loans considered impaired for which there was no
related valuation allowance for impairment was $2.7 million at December 31, 2009 and $1.2 million at December 31, 2008. The average recorded investment in impaired loans for 2009 and 2008 totaled $3.2 million and $2.1 million,
respectively. There was no interest recognized on impaired loans while they were considered to be impaired.



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



3. Loans and Leases (contd)



Changes in the allowance for credit losses for the years ended December 31 are
summarized as follows (in thousands):



|                             |  |            |  |            |  |           
|---------------------------- |  | ---------- |  | ---------- |  | ----------
|                             |  | 2009       |  | 2008       |  | 2007      
|Balance at beginning of year |  | $    9,161 |  | $    8,426 |  | $    7,029
|Loans and leases charged off |  | (7,272)    |  | (5,639)    |  | (3,227)   
|Recoveries                   |  | 1,425      |  | 872        |  | 834       
|Provision for credit losses  |  | 6,100      |  | 5,502      |  | 3,790     
|                             |  |            |  |            |  |           
|Balance at end of year       |  | $    9,414 |  | $    9,161 |  | $    8,426
|                             |  |            |  |            |  |           

Directors and executive officers of the Company and
their affiliated companies were customers of, and had other transactions with, the Company in the ordinary course of business during 2009. Loan transactions with related parties are summarized as follows (in thousands):



|                             |  |           
|---------------------------- |  | ----------
|                             |  | 2009      
|Balance at beginning of year |  | $    3,584
|New loans and advances       |  | 2,664     
|Loan payments                |  | (2,751)   
|                             |  |           
|Balance at end of year       |  | $    3,497
|                             |  |           

4. Bank Premises, Furniture, and Equipment

Bank premises, furniture, and equipment at December 31 consist of the following (in thousands):



|                               |  |              |  |             
|------------------------------ |  | ------------ |  | ------------
|                               |  | 2009         |  | 2008        
|Land                           |  | $      3,063 |  | $      3,168
|Bank premises                  |  | 20,092       |  | 19,804      
|Furniture and equipment        |  | 25,141       |  | 24,218      
|                               |  |              |  |             
|Total cost                     |  | 48,296       |  | 47,190      
|Less: Accumulated depreciation |  | 28,210       |  | 25,988      
|                               |  |              |  |             
|                               |  | $    20,086  |  | $    21,202 
|                               |  |              |  |             

At December 31, 2009 and 2008, furniture and
equipment included $1.3 million in equipment leased to others under operating leases and the related accumulated depreciation of $569,000 and $351,000 at December 31, 2009 and 2008, respectively. Depreciation expense on equipment leased to
others totaled $218,000, $226,000, and $93,000 in 2009, 2008 and 2007, respectively.

At December 31, 2009, the minimum
future lease payments to be received from equipment leased to others were as follows (in thousands):



|                         |  |         
|------------------------ |  | --------
|Year ending December 31:
|2010                     |  | $    206
|2011                     |  | 236     
|2012                     |  | 201     
|2013                     |  | 174     
|2014                     |  |        

5. Goodwill and Other
Intangible Assets

The carrying value of goodwill was $32.1 million at December 31, 2009 and 2008. No goodwill
impairment adjustments were recognized in 2009 or 2008. The following table summarizes the companys intangible assets that are subject to amortization (in thousands):



|                                     |  |                       |  |                          |  |                    
|------------------------------------ |  | --------------------- |  | ------------------------ |  | -------------------
|                                     |  | December 31, 2009    
|                                     |  | Gross Carrying Amount |  | Accumulated Amortization |  | Net Carrying Amount
|Intangible Assets                    |  |                       |  |                          |  |                    
|Core deposit intangible              |  | $      4,202          |  | $    2,197               |  | $      2,005       
|Non-compete covenant                 |  | 894                   |  | 894                      |  |                   
|Investment management intangible     |  | 10,089                |  | 2,436                    |  | 7,653              
|Insurance agency customer intangible |  | 909                   |  | 492                      |  | 417                
|                                     |  |                       |  |                          |  |                    
|Total                                |  | $    16,094           |  | $    6,019               |  | $    10,075        
|                                     |  |                       |  |                          |  |                    
|                                     | 
|                                     |  | December 31, 2008    
|                                     |  | Gross Carrying Amount |  | Accumulated Amortization |  | Net Carrying Amount
|Intangible Assets                    |  |                       |  |                          |  |                    
|Core deposit intangible              |  | $      4,202          |  | $    1,604               |  | $      2,598       
|Non-compete covenant                 |  | 894                   |  | 670                      |  | 224                
|Investment management intangible     |  | 10,089                |  | 1,932                    |  | 8,157              
|Insurance agency customer intangible |  | 909                   |  | 360                      |  | 549                
|                                     |  |                       |  |                          |  |                    
|Total                                |  | $    16,094           |  | $    4,566               |  | $    11,528        
|                                     |  |                       |  |                          |  |                    



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



5.  Goodwill and Other Intangible Assets
(contd.)



Amortization expense for intangible assets for the next five years is estimated as
follows (in thousands):



|           |  |                          |  |                                    |  |                                         |  |         
|---------- |  | ------------------------ |  | ---------------------------------- |  | --------------------------------------- |  | --------
|           |  | Core Deposit  Intangible |  | Investment  Management  Intangible |  | Insurance Agency    Customer Intangible |  | Total   
|2010       |  | $  516                   |  | $  504                             |  | $  116                                  |  | $  1,136
|2011       |  | 439                      |  | 504                                |  | 99                                      |  | 1,042   
|2012       |  | 363                      |  | 504                                |  | 81                                      |  | 948     
|2013       |  | 287                      |  | 504                                |  | 64                                      |  | 855     
|2014       |  | 210                      |  | 504                                |  | 47                                      |  | 761     
|Thereafter |  | 190                      |  | 5,133                              |  | 10                                      |  | 5,333   

6. Deposits

Deposits consisted of the following at December 31 (in thousands):



|                              |  |               |  |           
|----------------------------- |  | ------------- |  | ----------
|                              |  | 2009          |  | 2008      
|Non-interest-bearing checking |  | $     159,149 |  | $  140,845
|Interest-bearing checking     |  | 130,368       |  | 106,292   
|Savings accounts              |  | 94,524        |  | 88,242    
|Money market accounts         |  | 317,051       |  | 247,392   
|Time deposits                 |  | 374,579       |  | 355,111   
|                              |  |               |  |           
|Total deposits                |  | $  1,075,671  |  | $  937,882
|                              |  |               |  |           

The following table indicates the maturities of the
Companys time deposits at December 31 (in thousands):



|                          |  |             |  |            
|------------------------- |  | ----------- |  | -----------
|                          |  | 2009        |  | 2008       
|Due in one year           |  | $   286,611 |  | $   255,645
|Due in two years          |  | 23,549      |  | 59,391     
|Due in three years        |  | 47,666      |  | 9,757      
|Due in four years         |  | 15,021      |  | 18,082     
|Due in five years or more |  | 1,732       |  | 12,236     
|                          |  |             |  |            
|Total time deposits       |  | $  374,579  |  | $  355,111 
|                          |  |             |  |            

Total time deposits in excess of $100,000 as of
December 31, 2009 and 2008 were $108.3 million and $102.0 million, respectively. Time deposits include $97.7 million and $67.9 million in accounts acquired through third party brokers at December 31, 2009 and 2008, respectively.

7. Borrowings

The following is a summary of borrowings outstanding at December 31 (in thousands):



|                                                   |  |              |  |              
|-------------------------------------------------- |  | ------------ |  | -------------
|                                                   |  | 2009         |  | 2008         
|Short-term:                                        |  |              |  |              
|Federal Home Loan Bank (FHLB) overnight advances |  | $      5,500 |  | $      34,700
|FHLB advances                                      |  | 20,000       |  |             
|Repurchase agreements                              |  | 17,207       |  | 40,495       
|                                                   |  |              |  |              
|Total short-term borrowings                        |  | 42,707       |  | 75,195       
|Long-term:                                         |  |              |  |              
|FHLB advances                                      |  | 110,000      |  | 141,000      
|Repurchase agreements                              |  | 20,000       |  | 22,777       
|                                                   |  |              |  |              
|Total long-term borrowings                         |  | 130,000      |  | 163,777      
|                                                   |  |              |  |              
|Total borrowings                                   |  | $  172,707   |  | $  238,972   
|                                                   |  |              |  |              



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



7. Borrowings (contd)



The following table sets forth certain information with respect to the overnight lines
of credit, federal funds purchased and short term repurchase agreements (dollars in thousands):



|                                                 |  |           |  |           |  |          
|------------------------------------------------ |  | --------- |  | --------- |  | ---------
|                                                 |  | 2009      |  | 2008      |  | 2007     
|FHLB overnight advances and short-term advances: |  |           |  |           |  |          
|Maximum month-end balance                        |  | $  37,700 |  | $  48,900 |  | $  49,700
|Balance at end of year                           |  | 25,500    |  | 34,700    |  | 15,500   
|Average balance during the year                  |  | 16,514    |  | 19,284    |  | 29,459   
|Weighted average interest rate at end of year    |  | 0.36%     |  | 0.44%     |  | 4.11%    
|Weighted average interest rate during the year   |  | 0.44%     |  | 2.02%     |  | 5.26%    
|                                                 |  |           | 
|Repurchase agreements:                           |  |           |  |           |  |          
|Maximum month-end balance                        |  | $  35,982 |  | $  45,667 |  | $  58,617
|Balance at end of year                           |  | 17,207    |  | 40,495    |  | 52,780   
|Average balance during the year                  |  | 27,249    |  | 43,400    |  | 49,456   
|Weighted average interest rate at end of year    |  | 0.04%     |  | 0.15%     |  | 2.74%    
|Weighted average interest rate during the year   |  | 0.13%     |  | 1.34%     |  | 3.84%    

As of the
dates indicated, the contractual amounts of FHLB long term advances mature as follows (dollars in thousands):



|                         |  |                   |  |                            |  |             |  |                      
|------------------------ |  | ----------------- |  | -------------------------- |  | ----------- |  | ---------------------
|                         |  | December 31, 2009 |  | December 31, 2008         
|Maturing                 |  | Amount            |  | Weighted      Average Rate |  | Amount      |  | Weighted Average Rate
|2009                     |  | $                |  |                           |  | $    31,000 |  | 4.10%                
|2010                     |  | 15,000            |  | 3.20%                      |  | 50,000      |  | 4.18%                
|2011                     |  | 15,000            |  | 3.47%                      |  | 15,000      |  | 3.47%                
|2012                     |  | 10,000            |  | 3.54%                      |  | 10,000      |  | 3.54%                
|2013                     |  | 35,000            |  | 3.33%                      |  | 15,000      |  | 4.08%                
|2014                     |  | 15,000            |  | 3.25%                      |  |            |  |                     
|Thereafter               |  | 20,000            |  | 3.75%                      |  | 20,000      |  | 3.75%                
|                         |  |                   |  |                            |  |             |  |                      
|Total FHLB term advances |  | $  110,000        |  | 3.42%                      |  | $  141,000  |  | 3.97%                
|                         |  |                   |  |                            |  |             |  |                      

As of the dates indicated, the contractual amounts of long-term repurchase agreements mature as
follows (in thousands):



|                            |  |                   |  |                            |  |            |  |                      
|--------------------------- |  | ----------------- |  | -------------------------- |  | ---------- |  | ---------------------
|                            |  | December 31, 2009 |  | December 31, 2008         
|Maturing                    |  | Amount            |  | Weighted      Average Rate |  | Amount     |  | Weighted Average Rate
|2009                        |  | $                |  |                           |  | $    2,777 |  | 3.99%                
|2010                        |  |                  |  |                           |  |           |  |                     
|2011                        |  |                  |  |                           |  |           |  |                     
|2012                        |  |                  |  |                           |  |           |  |                     
|2013                        |  |                  |  |                           |  |           |  |                     
|2014                        |  |                  |  |                           |  |           |  |                     
|Thereafter                  |  | 20,000            |  | 4.01%                      |  | 20,000     |  | 4.01%                
|                            |  |                   |  |                            |  |            |  |                      
|Total repurchase agreements |  | $  20,000         |  | 4.01%                      |  | $  22,777  |  | 4.01%                
|                            |  |                   |  |                            |  |            |  |                      

The Company has access to various credit facilities through the FHLB, including an overnight line
of credit, a one-month line of credit, and a Term Advance Program, under which it can borrow at various terms and interest rates. All of the credit facilities are subject to meeting certain ongoing collateral requirements of the FHLB. In addition to
pledging securities, the Company has also pledged, under a blanket collateral agreement, certain residential mortgage loans with balances at December 31, 2009 of $284.6 million. At December 31, 2009, the Company had borrowed $135.5 million
against the pledged mortgages. At December 31, 2009, the Company had $152.0 million available under its various credit facilities with the FHLB.

The Company had a $127.7 million line of credit at December 31, 2009 with the Federal Reserve Bank of New York through its Discount Window. The Company has pledged indirect loans and securities
totaling $186.7 million and $4.5 million, respectively, at December 31, 2009. At December 31, 2009, the Company also had available $76.5 million of federal funds lines of credit with other financial institutions, none of which was in use
at December 31, 2009.

The Company offers retail repurchase agreements primarily to certain business customers. Under the
terms of the agreement, the Company sells investment portfolio securities to such customers agreeing to repurchase the securities on the next business day. The Company views the borrowing as a deposit alternative for its business customers. On
December 31, 2009, the Company had securities with a market value of $29.3 million pledged as collateral for these agreements. The Company also has agreements with the Federal Home Loan Bank of New York (FHLB), and Bank approved brokers to sell
securities under agreements to repurchase. At December 31, 2009, securities with a market value of $22.9 million were pledged against repurchase agreements in the amount of $20.0 million. All of these repurchase agreements at December 31,
2009 were transacted with the FHLB.



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



8. Junior Subordinated Obligations

In September 2006, the Company formed a wholly-owned subsidiary, Alliance Financial Capital Trust II, a Delaware business trust. The Trust
issued $15.0 million of 30-year floating rate Company-obligated pooled capital securities. The Company borrowed the proceeds of the capital securities from its subsidiary by issuing floating rate junior subordinated deferrable interest debentures
having substantially similar terms. The capital securities mature in 2036, but may be redeemed at the Companys option on predetermined dates with the first redemption date at par in five years. The capital securities of the trust are a pooled
trust preferred fund of Preferred Term Securities XXIV, Ltd., and interest rates on the securities adjust quarterly based on the 3-month LIBOR plus 1.65% (1.90% at December 31, 2009). The Company guarantees all of the securities.

In December 2003, the Company formed a wholly-owned subsidiary, Alliance Financial Capital Trust I, a Delaware business trust. The Trust
issued $10.0 million of 30-year floating rate Company-obligated pooled capital securities. The Company borrowed the proceeds of the capital securities from its subsidiary by issuing floating rate junior subordinated deferrable interest debentures
having substantially similar terms. The capital securities mature in 2034, but may be redeemed at the Companys option on predetermined dates with the first redemption date at par in five years. The capital securities of the trust are a pooled
trust preferred fund of ALESCO Preferred Funding II, Ltd., and interest rates on the securities adjust quarterly based on the 3-month LIBOR plus 2.85% (3.13% at December 31, 2009). The Company guarantees all of the securities.

The Company had a $310,000 investment in Trust I at December 31, 2009 and 2008 and a $464,000 investment in Trust II at
December 31, 2009 and 2008.

The trusts are variable interest entities (VIEs). The Company is not the
primary beneficiary of the VIEs and as such they are not consolidated in the Companys financial statements in accordance with accounting guidance. Liabilities owed to the trusts, totaling $25.8 million, were reflected as liabilities in
the consolidated balance sheets at December 31, 2009 and 2008, respectively.

9. Earnings Per Common Share

The Company has granted stock compensation awards with non-forfeitable dividend rights which are considered participating securities. As
such, earnings per share is computed using the two-class method as required by Accounting Standard Codification 206-10-45. Basic earnings per common share is computed by dividing net income allocated to common stock by the weighted average number of
common shares outstanding during the period which excludes the participating securities. Diluted earnings per common share includes the dilutive effect of additional potential common shares from stock compensation awards and warrants, but excludes
awards considered participating securities.

Basic and diluted net income per common share calculations for the years ended
December 31 are as follows (in thousands, except share and per share amounts):



|                                                                                                |  |              |  |             |  |            
|----------------------------------------------------------------------------------------------- |  | ------------ |  | ----------- |  | -----------
|                                                                                                |  | 2009         |  | 2008        |  | 2007       
|Basic                                                                                           |  |              |  |             |  |            
|Net income available to common shareholders                                                     |  | $   10,364   |  | $   10,310  |  | $    9,477 
|Less: dividends and undistributed earnings allocated to unvested restricted shares              |  | (185)        |  | (201)       |  | (168)      
|                                                                                                |  |              |  |             |  |            
|Net earnings allocated to common shareholders                                                   |  | $   10,179   |  | $   10,109  |  | $    9,309 
|                                                                                                |  |              |  |             |  |            
|                                                                                                |  |              | 
|Weighted average common shares outstanding including shares considered participating securities |  | 4,601,861    |  | 4,630,578   |  | 4,784,697  
|Less: average participating securities                                                          |  | (87,593)     |  | (87,621)    |  | (74,167)   
|                                                                                                |  |              |  |             |  |            
|Weighted average shares                                                                         |  | 4,514,268    |  | 4,542,957   |  | 4,710,530  
|                                                                                                |  |              |  |             |  |            
|                                                                                                |  |              |  |             |  |            
|Net income per common share  basic                                                             |  | $       2.25 |  | $      2.23 |  | $      1.98
|                                                                                                |  |              |  |             |  |            
|                                                                                                |  |              | 
|Diluted                                                                                         |  |              |  |             |  |            
|Net earnings allocated to common shareholders                                                   |  | $   10,179   |  | $   10,109  |  | $    9,309 
|                                                                                                |  |              |  |             |  |            
|                                                                                                |  |              | 
|Weighted average common shares outstanding for basic earnings per common share                  |  | 4,514,268    |  | 4,542,957   |  | 4,710,530  
|Incremental shares from assumed conversion of stock options and warrants                        |  | 28,801       |  | 22,752      |  | 43,515     
|                                                                                                |  |              |  |             |  |            
|Average common shares outstanding  diluted                                                     |  | 4,543,069    |  | 4,565,709   |  | 4,754,045  
|                                                                                                |  |              | 
|Net income per common share  diluted                                                           |  | $      2.24  |  | $      2.21 |  | $      1.96
|                                                                                                |  |              |  |             |  |            

Dividends of $83,000, $87,000 and $65,000 for the
years ended December 31, 2009, 2008 and 2007, respectively, were paid on unvested shares with non-forfeitable dividend rights. For the years ended 2009, 2008 and 2007, 45,506, 66,055 and 1,000 of anti-dilutive stock options were excluded from the
diluted weighted average common share calculations.



54



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



10. Income Taxes

The provision for income taxes for the years ended December 31 is summarized as follows (in thousands):



|                                 |  |          |  |          |  |         
|-------------------------------- |  | -------- |  | -------- |  | --------
|                                 |  | 2009     |  | 2008     |  | 2007    
|Current tax expense              |  |          |  |          |  |         
|Federal                          |  | $  3,055 |  | $  2,236 |  | $  2,882
|State                            |  | 231      |  | 145      |  | 475     
|                                 |  |          |  |          |  |         
|                                 |  | 3,286    |  | 2,381    |  | 3,357   
|                                 |  |          | 
|Deferred tax provision (benefit) |  |          |  |          |  |         
|Federal                          |  | 244      |  | 422      |  | (373)   
|State                            |  | (94)     |  | 17       |  | (115)   
|                                 |  |          |  |          |  |         
|                                 |  | 150      |  | 439      |  | (488)   
|                                 |  |          |  |          |  |         
|Total                            |  | $  3,436 |  | $  2,820 |  | $  2,869
|                                 |  |          |  |          |  |         

A reconciliation between the statutory federal income
tax rate and the effective income tax rate for the years indicated is as follows:



|                                                |  |        |  |         |  |        
|----------------------------------------------- |  | ------ |  | ------- |  | -------
|                                                |  | 2009   |  | 2008    |  | 2007   
|Statutory federal income tax rate               |  | 34.0%  |  | 34.0%   |  | 34.0%  
|State franchise tax, net of federal tax benefit |  | 0.6%   |  | 0.8%    |  | 1.9%   
|Tax exempt interest income                      |  | (9.6)% |  | (11.3%) |  | (11.4%)
|Tax exempt insurance income                     |  | (2.3)% |  | (2.2%)  |  | (1.8%) 
|Other, net                                      |  | 0.4%   |  | 0.1%    |  | 0.5%   
|                                                |  |        |  |         |  |        
|Total                                           |  | 23.1%  |  | 21.4%   |  | 23.2%  
|                                                |  |        |  |         |  |        

The components of deferred income taxes, included in
other assets, at December 31, are as follows (in thousands):



|                                                      |  |             |  |            
|----------------------------------------------------- |  | ----------- |  | -----------
|                                                      |  | 2009        |  | 2008       
|Assets:                                               |  |            
|Loans                                                 |  | $       327 |  | $       445
|Allowance for credit losses                           |  | 3,607       |  | 3,509      
|Retirement benefits                                   |  | 1,394       |  | 1,336      
|Deferred compensation                                 |  | 2,765       |  | 2,616      
|Pension costs                                         |  | 1,193       |  | 1,200      
|Tax attribute carry-forwards                          |  |            |  | 672        
|Incentive compensation plans                          |  | 119         |  | 487        
|Covenant not to compete                               |  | 235         |  | 255        
|Other                                                 |  | 554         |  | 559        
|                                                      |  |             |  |            
|Total deferred tax assets                             |  | 10,194      |  | 11,079     
|Liabilities:                                          |  |             |  |            
|Securities                                            |  | 53          |  | 87         
|Premises, furniture and equipment                     |  | 458         |  | 510        
|Depreciation and leasing                              |  | 2,679       |  | 3,319      
|Deferred fees                                         |  | 1,428       |  | 1,045      
|Intangible assets                                     |  | 937         |  | 1,326      
|Net unrealized gains on available-for-sale securities |  | 1,790       |  | 1,813      
|Other                                                 |  | 452         |  | 412        
|                                                      |  |             |  |            
|Total deferred tax liabilities                        |  | 7,797       |  | 8,512      
|                                                      |  |             |  |            
|Net deferred tax asset at year-end                    |  | $    2,397  |  | $    2,567 
|                                                      |  |             |  |            

Realization of deferred tax assets is dependent upon
the generation of future taxable income or the existence of sufficient taxable income. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. In assessing the need for a
valuation allowance, management considers the scheduled reversal of the deferred tax liabilities, the level of historical taxable income, and the projected future taxable income over the periods in which the temporary differences comprising the
deferred tax assets will be deductible. Based on its assessment, management determined that no valuation allowance is necessary.

At December 31, 2009 and 2008, the Company had approximately $115,000 and $173,000, respectively, of net unrecognized tax benefits and interest.



55



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



10. Income Taxes (contd)



A reconciliation of the beginning and ending amount of unrecognized tax benefits
(excluding interest and the federal income tax benefit of unrecognized state tax benefits) is as follows (in thousands):



|                                            |  |        |  |        |  |       
|------------------------------------------- |  | ------ |  | ------ |  | ------
|                                            |  | 2009   |  | 2008   |  | 2007  
|Balance at January 1                        |  | $  180 |  | $  180 |  | $  134
|Additions for tax positions of prior years  |  |       |  |       |  | 115   
|Reductions for tax positions of prior years |  |       |  |       |  | (69)  
|Settlements                                 |  | (65)   |  |       |  |      
|                                            |  |        |  |        |  |       
|Balance at December 31                      |  | $  115 |  | $  180 |  | $  180
|                                            |  |        |  |        |  |       

As of December 31, 2009, $115,000 of unrecognized
tax benefits and interest would impact the Companys effective tax rate, if recognized or reversed. As of December 31, 2009 and 2008, accrued interest related to uncertain tax positions was $12,000 and $27,000, respectively, net of the
related tax benefit. The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes.

The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and various state jurisdictions. The Company is no longer subject to U.S. Federal or state examination for
tax years prior to 2006. In 2009, the Companys 2004-2006 New York State examination closed with no material impact to the Companys financial position. The Company anticipates that a reduction in the unrecognized tax benefits of up to
$115,000 may occur in the next twelve months from the expiration of statutes of limitations.

11. Accumulated Other Comprehensive Income

A summary of activity in accumulated other comprehensive income follows (in thousands):



|                                                                                                                                                      |  |            |  |            |  |            
|----------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------- |  | ---------- |  | -----------
|                                                                                                                                                      |  | 2009       |  | 2008       |  | 2007       
|Effect from unrealized gains (losses) on securities available for sale                                                                                |  |           
|Accumulated unrealized gains (losses) on securities available-for-sale at January 1, net of tax                                                       |  | $   2,870  |  | $     933  |  | $     (998)
|Net unrealized gains for the period, net of tax expense of $816 in 2009, $1,275 in 2008, and $1,222 in 2007                                           |  | 1,291      |  | 2,021      |  | 1,924      
|Reclassification adjustment for (gains) losses included in net income, net of tax expense (benefit) of $839 in 2009, $53 in 2008,
and $(5) in 2007    |  | (1,329)    |  | (84)       |  | 7          
|                                                                                                                                                      |  |            |  |            |  |            
|Effect on other comprehensive income for the period                                                                                                   |  | (38)       |  | 1,937      |  | 1,931      
|Accumulated unrealized gains (losses) on securities available-for-sale at December 31, net of tax                                                     |  | $   2,832  |  | $   2,870  |  | $       933
|                                                                                                                                                      |  |            | 
|Effect from retirement benefit plans                                                                                                                  |  |            |  |            |  |            
|Accumulated unrealized (losses) gains for retirement benefit plans at January 1, net of tax                                                           |  | $ (1,899)  |  | $     272  |  | $  (1,124) 
|Amortization of prior service costs, net of tax benefit of $(6) in 2009, $(4) in 2008 and $(6) in 2007                                                |  | 8          |  | 6          |  | 10         
|Amortization of net (gain) loss, net of tax expense (benefit) of $(71) in 2009, $3 in 2008 and $(12) in 2007                                          |  | 113        |  | (7)        |  | 18         
|Change in accumulated unrealized net (losses) gains for plan benefits, net of tax expense (benefit) of $36 in 2009, $1,185 in
2008 and $(292) in 2007 |  | (57)       |  | (1,839)    |  | 541        
|Change in unrecognized prior service cost, net of tax expense of $32 in 2009 and $185 in 2008                                                         |  | (51)       |  | (292)      |  |           
|Post-retirement plan amendment, net of tax benefit $(521)                                                                                             |  |           |  |           |  | 827        
|                                                                                                                                                      |  |            |  |            |  |            
|Effect on other comprehensive income for the period                                                                                                   |  | 13         |  | (2,132)    |  | 1,396      
|                                                                                                                                                      |  |            | 
|Cumulative effect of change in accounting for pension obligations                                                                                     |  |            |  |            |  |            
|Net loss, net of tax benefit of $25 in 2008                                                                                                           |  |           |  | (39)       |  |           
|                                                                                                                                                      |  |            |  |            |  |            
|                                                                                                                                                      |  |           |  | (39)       |  |           
|                                                                                                                                                      |  |            | 
|Accumulated unrealized (losses) gains for benefit obligations at December 31, net of tax                                                              |  | $ (1,886)  |  | $ (1,899)  |  | $      272 
|                                                                                                                                                      |  |            | 
|Accumulated other comprehensive income (loss) at January 1, net of tax                                                                                |  | 971        |  | 1,205      |  | (2,122)    
|Other comprehensive (loss) income, net of tax                                                                                                         |  | (25)       |  | (195)      |  | 3,327      
|Cumulative effect of change in accounting for adoption of SFAS No. 158                                                                                |  |           |  | (39)       |  |           
|                                                                                                                                                      |  |            |  |            |  |            
|                                                                                                                                                      |  |            | 
|Accumulated other comprehensive income at December 31, net of tax                                                                                     |  | $      946 |  | $      971 |  | $   1,205  
|                                                                                                                                                      |  |            |  |            |  |            



56



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



12. Employee and Director Benefit Plans

Defined Contribution Plan

The Company provides retirement benefits through a defined contribution 401(k) plan that covers substantially all of its employees. Contributions to the Companys 401(k) plan are determined by the
Board of Directors and are based on percentages of compensation for participating employees. Contributions are funded following the end of the plan (calendar) year. Company contributions to the plan were $472,000, $484,000, and $42,000 in 2009,
2008, and 2007, respectively.

Executive Incentive Retirement Plan

In 2008, the Company established an executive incentive retirement defined contribution plan (Executive Plan) which provides certain senior officers of Alliance Bank N.A.
the opportunity to earn performance-based deferred cash bonuses, equal to 10% of the participants base salary, upon attainment by the Company of certain financial performance targets defined by the Board of Directors annually. The deferred
balances earn interest at the Banks one-year rate for certificates of deposit. The deferred bonuses vest ratably over a five year period on the anniversary date of the bonus payment. Upon the participants separation from service (other
than for cause), the Company pays the participant or his or her beneficiary either a lump sum or an annuity based on the amount of the vested benefit. At December 31, 2009 and 2008, other liabilities included approximately $123,000 and
$135,000, respectively accrued under the Executive Plan. The Board of Directors elected to not pay deferred bonuses in 2009.

Defined
Benefit Plan and Post-Retirement Benefits

The Company has a noncontributory defined benefit pension plan (Pension
Plan) which it assumed from Bridge Street. The Pension Plan covers substantially all former Bridge Street full-time employees who met eligibility requirements on October 6, 2006, at which time all benefits were frozen. Under the Pension
Plan, retirement benefits are primarily a function of both the years of service and the level of compensation. The amount contributed to the Pension Plan is determined annually on the basis of (a) the maximum amount that can be deducted for
federal income tax purposes, or (b) the amount certified by an actuary as necessary to avoid an accumulated funding deficiency as defined by the Employee Retirement Income Security Act of 1974.

In accordance with Accounting Standards Codification (ASC) Number 715-20-65-1, defined benefit plan assets and obligations are
to be measured as of the date of the employers fiscal year-end, starting in 2008. Through 2007, the Company utilized the early measurement date option available under previous accounting guidance and measured the funded status of the defined
benefit plan assets and obligations as of October 1 each year. In accordance with the adoption provisions, the net periodic benefit cost for the period between the October 1 measurement date and the 2008 fiscal year end measurement were
allocated proportionately between amounts to be recognized as an adjustment to retained earnings and net periodic benefit cost for the fiscal year. As a result of this adoption, the Company reduced January 1, 2008 opening retained earnings by
$44,000, increased deferred income taxes by $25,000, increased the pension liability by $20,000 and credited accumulated other comprehensive income for $39,000.

Prior to September 30, 2007, post-retirement medical and life insurance benefits (Post-Retirement Plan) were available to full-time employees who had worked 15 years and attained age 55.
Subsequent to the acquisition of Bridge Street, benefits for the Bridge Street active participants were converted to those under the Companys plan. Retirees and certain active employees with more than 20 years of service to the Company
continue to receive benefits in accordance with plans that existed at First National Bank of Cortland and Oneida Valley National Bank, prior to the merger of the banks in 1999. At September 30, 2007, the Company settled (the
Settlement) the post-retirement benefits for certain active participants that met age and service criteria at that time. In addition, a negative plan amendment (Negative Amendment) was adopted for all other active
participants who did not meet the age and service criteria. The Settlement and the Negative Amendment eliminated post-retirement benefits for all active employees. The only remaining participants in the Post-Retirement Plan after September 30,
2007 are retired participants and their respective spouses.



57



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



12. Employee and Director Benefit Plans
(contd)



The following table represents a reconciliation of the change in the benefit obligation,
plan assets and funded status of the Pension Plan and Post-Retirement Plan at December 31 (using a measurement date of December 31):



|                                                                                                                                                                                  |  |                |  |                      |  |            |  |           
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- |  | -------------------- |  | ---------- |  | ----------
|                                                                                                                                                                                  |  | Pension Plan   |  | Post-Retirement Plan
|                                                                                                                                                                                  |  | 2009           |  | 2008                 |  | 2009       |  | 2008      
|Change in benefit obligation:                                                                                                                                                     |  | (In thousands)
|Benefit obligation at beginning of year                                                                                                                                           |  | $    4,864     |  | $    4,192           |  | $    4,129 |  | $    3,935
|Interest cost                                                                                                                                                                     |  | 279            |  | 257                  |  | 229        |  | 241       
|Actuarial loss                                                                                                                                                                    |  | 169            |  | 625                  |  | 135        |  | 240       
|Benefits paid                                                                                                                                                                     |  | (225)          |  | (274)                |  | (222)      |  | (314)     
|Participant contributions                                                                                                                                                         |  |               |  |                     |  | 17         |  | 27        
|Adjustment for measurement date change                                                                                                                                            |  |               |  | 64                   |  |           |  |          
|                                                                                                                                                                                  |  |                |  |                      |  |            |  |           
|Benefit obligation at end of year                                                                                                                                                 |  | 5,087          |  | 4,864                |  | 4,288      |  | 4,129     
|Change in plan assets:                                                                                                                                                            |  |                |  |                      |  |            |  |           
|Fair value of plan assets at the beginning of the year                                                                                                                            |  | 3,245          |  | 4,914                |  |           |  |          
|Actual return on plan assets                                                                                                                                                      |  | 561            |  | (1,395)              |  |           |  |          
|Benefits paid                                                                                                                                                                     |  | (225)          |  | (274)                |  | (222)      |  | (314)     
|Participant contributions                                                                                                                                                         |  |               |  |                     |  | 17         |  | 27        
|Employer contributions                                                                                                                                                            |  |               |  |                     |  | 205        |  | 287       
|                                                                                                                                                                                  |  |                |  |                      |  |            |  |           
|Fair value of plan assets at the end of year                                                                                                                                      |  | 3,581          |  | 3,245                |  |           |  |          
|                                                                                                                                                                                  |  |                |  |                      |  |            |  |           
|Funded status at end of year                                                                                                                                                      |  | $(1,506)       |  | $  (1,619)           |  | $(4,288)   |  | $  (4,129)
|                                                                                                                                                                                  |  |                |  |                      |  |            |  |           
|                                                                                                                                                                                 
|Pre-tax amounts recognized in accumulated other comprehensive income (loss) at December 31 that has not been recognized as components of net
periodic benefit or cost consist of:
|                                                                                                                                                                                  |  |               
|                                                                                                                                                                                  |  | Pension Plan   |  | Post-Retirement Plan
|                                                                                                                                                                                  |  | 2009           |  | 2008                 |  | 2009       |  | 2008      
|                                                                                                                                                                                  |  | (In thousands)
|Unrecognized actuarial loss                                                                                                                                                       |  | $  2,097       |  | $    2,372           |  | $    656   |  | $     529 
|Unrecognized prior service benefit                                                                                                                                                |  |               |  |                     |  | (563)      |  | (607)     
|                                                                                                                                                                                  |  |                |  |                      |  |            |  |           
|                                                                                                                                                                                  |  | $  2,097       |  | $    2,372           |  | $      93  |  | $     (78)
|                                                                                                                                                                                  |  |                |  |                      |  |            |  |           

The composition of the plans net periodic
(benefit) cost for the years ended December 31 is as follows:



|                                                          |  |                |  |                      |  |          |  |        |  |        |  |       
|--------------------------------------------------------- |  | -------------- |  | -------------------- |  | -------- |  | ------ |  | ------ |  | ------
|                                                          |  | Pension Plan   |  | Post-Retirement Plan
|                                                          |  | 2009           |  | 2008                 |  | 2007     |  | 2009   |  | 2008   |  | 2007  
|                                                          |  | (In thousands)
|Service cost                                              |  | $             |  | $                   |  | $       |  | $     |  | $     |  | $  133
|Interest cost                                             |  | 279            |  | 257                  |  | 239      |  | 229    |  | 241    |  | 322   
|Amortization of unrecognized prior service (benefit) cost |  |               |  |                     |  |         |  | (44)   |  | (44)   |  | 6     
|Amortization of unrecognized actuarial loss               |  | 165            |  |                     |  |         |  | 8      |  |       |  | 30    
|Expected return on assets                                 |  | (282)          |  | (433)                |  | (399)    |  |       |  |       |  |      
|                                                          |  |                |  |                      |  |          |  |        |  |        |  |       
|Total net periodic cost (benefit)                         |  | $  162         |  | $  (176)             |  | $  (160) |  | $  193 |  | $  197 |  | $  491
|                                                          |  |                |  |                      |  |          |  |        |  |        |  |       

The estimated prior service benefit for the
Post-Retirement Plan that is expected to be amortized from accumulated other comprehensive income into net periodic benefit over the next fiscal year is $44,000. The estimated unrecognized actuarial loss for the Pension Plan and Post-Retirement Plan
that is expected to be amortized from accumulated other comprehensive income into net periodic benefit cost over the next fiscal year is $152,000 and $16,000, respectively.

The following weighted average assumptions were used to determine benefit obligations for these plans:



|                               |  |              |  |                      |  |       |  |      
|------------------------------ |  | ------------ |  | -------------------- |  | ----- |  | -----
|                               |  | Pension Plan |  | Post-Retirement Plan
|                               |  | 2009         |  | 2008                 |  | 2009  |  | 2008 
|Discount rate                  |  | 5.70%        |  | 5.87%                |  | 5.60% |  | 5.77%
|Expected return on plan assets |  | 9.00%        |  | 9.00%                |  |      |  |     

The
following weighted average assumptions were used to determine net periodic (benefit) cost for the years ended December 31:



|                               |  |              |  |                      |  |       |  |       |  |       |  |      
|------------------------------ |  | ------------ |  | -------------------- |  | ----- |  | ----- |  | ----- |  | -----
|                               |  | Pension Plan |  | Post-Retirement Plan
|                               |  | 2009         |  | 2008                 |  | 2007  |  | 2009  |  | 2008  |  | 2007 
|Discount rate                  |  | 5.87%        |  | 6.29%                |  | 5.90% |  | 5.77% |  | 6.38% |  | 6.00%
|Expected return on plan assets |  | 9.00%        |  | 9.00%                |  | 9.00% |  |      |  |      |  |     



58



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



12. Employee and Director Benefit Plans
(contd)



The discount rates used in determining the benefit obligations for the Pension Plan and
Post-Retirement Plan as of December 31, 2009, 2008 and 2007 were based upon the Citibank pension liability index. The Citibank pension liability index was determined to appropriately reflect the rate at which the Pension Plan and
Post-Retirement Plan obligations could be effectively settled, based upon the expected duration of each plan.

The Pension
Plans weighted-average asset allocations by asset category at December 31 are as follows:



|                                    |  |      |  |     
|----------------------------------- |  | ---- |  | ----
|Asset Category                      |  | 2009 |  | 2008
|Equity securities                   |  | 63%  |  | 59% 
|Debt Securities (Bond Mutual Funds) |  | 37%  |  | 41% 
|                                    |  |      |  |     
|Total                               |  | 100% |  | 100%
|                                    |  |      |  |     

Plan assets are invested in diversified investment
funds of the RSI Retirement Trust (the Trust), a private replacement investment fund. The investment funds include a series of equity and bond mutual funds or comingled trust funds, each with its own investment objectives, investment
strategies and risks, as detailed in the Statement of Investment Objectives and Guidelines. The Trust has been given discretion by the Plan Sponsor to determine the appropriate strategic asset allocation versus plan liabilities, as governed by the
Trusts Statement of Investment Objectives and Guidelines (the Guidelines).

The long-term investment
objectives are to maintain plan assets at a level that will sufficiently cover long-term obligations and to generate a return on plan assets that will meet or exceed the rate at which long-term obligations will grow. A broadly diversified
combination of equity and fixed income portfolios and various risk management techniques are used to help achieve these objectives.

In addition, significant consideration is paid to the plans funding levels when determining the overall asset allocation. If the plan is considered to be well-funded, approximately 65% of the plans assets are allocated to
equities and approximately 35% allocated to fixed income. If the plan does not satisfy the criteria for a well-funded plan, approximately 50% of the plans assets are allocated to equities and approximately 50% allocated to fixed income. Asset
rebalancing normally occurs when the equity and fixed income allocations vary by more than 10% from their respective targets (i.e. a 20% policy range guideline). The plan is prohibited from investing in any investment strategy, fund or with any
investment manager not specifically approved by the Board of Trustees of the RSI Retirement Trust.

The Pension Plans
investment goal is to achieve investment results that will contribute to the proper funding of the Pension Plan by exceeding the rate of inflation over the long-term. In addition, investment managers for the Trust are expected to provide above
average performance when compared to their peer managers. Performance volatility is also monitored. Risk/volatility is further managed by the distinct investment objectives of each of the Trust funds and the diversification within each fund.

Fair value of Pension Plan assets

Fair value is the exchange price that would be received for an asset in the principal or most advantageous market for the asset in an orderly transaction between market participants on the measurement
date.

The Company used the following methods and significant assumptions to estimate the fair value of each type of financial
instrument:

Equity, Debt, Investment Funds and Other Securities

The fair values for investment securities are determined by quoted market prices, if available (Level 1). For securities where quoted prices are not available, fair values are
calculated based on market prices of similar securities (Level 2). For securities where quoted prices or market prices of similar securities are not available, fair values are calculated using discounted cash flows or other market indicators (Level
3).



59



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



12. Employee and Director Benefit Plans
(contd)



The fair value of the Plan assets at December 31, 2009, by asset category, is as
follows (in thousands):



|                                      |  |           |  |                                                                         |  |                                        |  |                                               
|------------------------------------- |  | --------- |  | ----------------------------------------------------------------------- |  | -------------------------------------- |  | ----------------------------------------------
|Asset Category                        |  | Total     |  | Quoted Prices in      Active Markets for      Identical Assets(Level 1) |  | Significant Observable Inputs(Level
2) |  | Significant    Unobservable    Inputs(Level 3)
|Mutual Funds Equity                   |  |           |  |                                                                         |  |                                        |  |                                               
|Large cap value(1)                    |  | $     318 |  | $  318                                                                  |  | $                                     |  | $                                            
|Small cap core(2)                     |  | 374       |  | 374                                                                     |  |                                       |  |                                              
|Common/Collective Trusts Equity       |  |           |  |                                                                         |  |                                        |  |                                               
|Large cap core(3)                     |  | 357       |  |                                                                        |  | 357                                    |  |                                              
|Large cap value(4)                    |  | 178       |  |                                                                        |  | 178                                    |  |                                              
|Large cap growth(5)                   |  | 523       |  |                                                                        |  | 523                                    |  |                                              
|International core(6)                 |  | 506       |  |                                                                        |  | 506                                    |  |                                              
|Common/Collective Trusts Fixed Income |  |           |  |                                                                         |  |                                        |  |                                               
|Market duration fixed(7)              |  | 1,325     |  |                                                                        |  | 1,325                                  |  |                                              
|Equity Securities                     |  |           |  |                                                                         |  |                                        |  |                                               
|Company common stock                  |  |          |  |                                                                        |  |                                       |  |                                              
|                                      |  |           |  |                                                                         |  |                                        |  |                                               
|Total                                 |  | $  3,581  |  | $  692                                                                  |  | $  2,889                               |  | $                                            



|(1) | This category contains large cap stocks with above average yield. The portfolio typically holds between 60 and 70 stocks
|--- | ------------------------------------------------------------------------------------------------------------------------

|(2) | This category contains stocks whose sector weightings are maintained within a narrow band around those of the Russell 2000 Index. The portfolio will
typically hold more than 150 stocks
|--- | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(3) | This fund tracks the performance of the S&P 500 Index by purchasing the securities represented in the index in approximately the same weightings
as the Index
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------

|(4) | This category consists of investments whose sector and industry exposures are maintained within a narrow band around Russell 1000 Index. The
portfolio holds approximately 150 stocks
|--- | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(5) | This category consists of a portfolio of between 45 and 65 stocks that will typically be concentrated in the technology and health care sectors
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------

|(6) | This category consists of a broadly diversified portfolio of non-U.S. domiciled stocks. The portfolio will typically hold more than 200 stocks, with
0-35% invested in emerging markets securities
|--- | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|(7) | This category consists of an index fund that tracks a domestic bond index. The fund invests in Treasury, agency, corporate, mortgage-backed and
asset-backed securities
|--- | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------

The Pension Plans long-term rate-of-return-on-assets assumption was set based
on historical returns earned by equities and fixed income securities, adjusted to reflect expectations of future returns as applied to the plans target allocation of asset classes. Equities and fixed income securities were assumed to earn real
rates of return in the ranges of 5-9% and 2-6%, respectively. The long-term inflation rate was estimated to be 3%. When these overall return expectations were applied to the Pension Plans target allocation, the result was an expected rate of
return of 7% to 11%.

The Companys estimated expected contribution for 2010 is $42,000.

For measurement purposes, with respect to the Post-Retirement Plan, a 10% annual rate of increase in the per capita cost of covered health
care benefits is assumed for 2010. The rate is assumed to decrease gradually to 4.5% by the year 2017 and remain at that level thereafter.

Assumed health care cost trend rates have a significant effect on the amounts reported for health care plans. A one percentage point change in assumed health care cost trend rates would have the following
effects on the Post-Retirement Plan (in thousands):



|                                              |  |                                  |  |                                 
|--------------------------------------------- |  | -------------------------------- |  | --------------------------------
|                                              |  | One Percentage    Point Increase |  | One Percentage    Point Decrease
|Effect on total of service and interest cost  |  | $    14                          |  | $    (12)                       
|Effect on post-retirement benefit obligations |  | 232                              |  | (202)                           

The
following benefit payments, which reflect expected future service, as appropriate, are expected to be paid from the Pension Plan (in thousands):



|                         |  |   |      
|------------------------ |  | - | -----
|Year ending December 31:
|2010                     |  | $ | 219  
|2011                     |  |   | 256  
|2012                     |  |   | 255  
|2013                     |  |   | 261  
|2014                     |  |   | 271  
|Years 2015-2019          |  |   | 1,389



60



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



12. Employee and Director Benefit Plans
(contd)



The following healthcare benefits are expected to be paid under the Post-Retirement Plan
(in thousands):



|                         |  |            
|------------------------ |  | -----------
|Year ending December 31:
|2010                     |  | $       348
|2011                     |  | 361        
|2012                     |  | 360        
|2013                     |  | 355        
|2014                     |  | 336        
|Years 2015-2019          |  | 1,593      

The above
benefit payments include expected life insurance claims, rather than the premiums that the Company is paying to provide the life insurance.

Directors Retirement Plan

In 2008 the Company established a noncontributory defined benefit plan for
non-employee directors (Directors Plan). The Directors Plan provides for a normal retirement cash benefit equivalent to 35% of their average annual directors fees, subject to increases based on the directors length and extent
of service, payable in a number of circumstances, including normal retirement, death or disability and a change in control. Upon termination of service, the normal retirement benefit is payable in a lump sum or in ten equal installments.

The following table represents a reconciliation of the change in the benefit obligations, plan assets and funded status of the Directors
Plan at December 31:



|                                        |  |                |  |         
|--------------------------------------- |  | -------------- |  | --------
|                                        |  | 2009           |  | 2008    
|Change in benefit obligation:           |  | (in thousands)
|Benefit obligation at beginning of year |  | $    518       |  | $      
|Service cost                            |  | 64             |  | 27      
|Interest cost                           |  | 33             |  | 14      
|Prior service cost                      |  | 20             |  | 477     
|Actuarial loss                          |  | 41             |  |        
|                                        |  |                |  |         
|Benefit obligation at end of year       |  | $    676       |  | $    518
|Plan assets                             |  |               |  |        
|                                        |  |                |  |         
|Funded status at end of year            |  | $  (676)       |  | $  (518)
|                                        |  |                |  |         

Pre-tax amounts recognized in accumulated other
comprehensive income at December 31, 2009 that have not been recognized as components of net periodic benefit or cost consist of:



|                                |  |                |  |         
|------------------------------- |  | -------------- |  | --------
|                                |  | 2009           |  | 2008    
|                                |  | (in thousands)
|Unrecognized actuarial loss     |  | $    41        |  | $      
|Unrecognized prior service cost |  | 425            |  | 454     
|                                |  |                |  |         
|                                |  | $  466         |  | $    454
|                                |  |                |  |         

The composition of the Directors Plans net
periodic cost for the year ended December 31 is as follows (in thousands):



|                                                |  |                |  |        
|----------------------------------------------- |  | -------------- |  | -------
|                                                |  | 2009           |  | 2008   
|                                                |  | (in thousands)
|Service cost                                    |  | $      64      |  | $    27
|Interest cost                                   |  | 33             |  | 14     
|Amortization of unrecognized prior service cost |  | 48             |  | 24     
|                                                |  |                |  |        
|Total net periodic cost                         |  | $    145       |  | $    65
|                                                |  |                |  |        

The discount rate used in determining the benefit
obligation for the Directors Plan as of December 31, 2009 was 5.70%. The discount rate used to determine benefit obligations for the Directors Plan was based upon the Citibank pension liability index. The Citibank pension liability index was
determined to appropriately reflect the rate at which the pension liabilities could be effectively settled based upon the expected duration of the Directors Plan. Directors fees were assumed to increase at an annual rate of 3.00%.



61



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



12. Employee and Director Benefit Plans
(contd)



The following directors retirement benefit payments, which reflect expected future
service, as appropriate, are expected to be paid (in thousands):



|                         |  |         
|------------------------ |  | --------
|Year ending December 31:
|2010                     |  | $      
|2011                     |  |        
|2012                     |  | 33      
|2013                     |  | 51      
|2014                     |  | 51      
|Years 2015-2019          |  | 404     

In 2010,
$48,000 in unrecognized prior service costs and $5,000 in unrecognized actuarial losses are estimated to be amortized from accumulated other comprehensive income into the net periodic cost for the Directors Plan.

Supplemental Retirement Plans

The Company has supplemental executive retirement plans (SRPs) for certain current and former employees. Included in other assets, the Company had segregated assets of $166,000, $174,000 and $332,000 at December 31,
2009, 2008 and 2007, respectively, to fund the estimated benefit obligation associated with certain SRP plans.

The following
table represents a reconciliation of the change in the benefit obligations, plan assets and funded status of the SRPs at December 31:



|                                             |  |                |  |           
|-------------------------------------------- |  | -------------- |  | ----------
|                                             |  | 2009           |  | 2008      
|Change in benefit obligation:                |  | (In thousands)
|Benefit obligation at beginning of year      |  | $    3.466     |  | $    3,334
|Service cost                                 |  | 79             |  | 61        
|Interest cost                                |  | 192            |  | 199       
|Actuarial loss                               |  | 28             |  | 262       
|Amendments                                   |  | 63             |  |          
|Benefits paid                                |  | (264)          |  | (390)     
|                                             |  |                |  |           
|Benefit obligation at end of year            |  | 3,564          |  | 3,466     
|Change in plan assets:                       |  |                |  |           
|Benefits paid                                |  | (264)          |  | (390)     
|Employer contributions                       |  | 264            |  | 390       
|                                             |  |                |  |           
|Fair value of plan assets at the end of year |  |               |  |          
|                                             |  |                |  |           
|Funded status at end of year                 |  | $  (3,564)     |  | $  (3,466)
|                                             |  |                |  |           

Pre-tax amounts recognized in accumulated other
comprehensive income at December 31, 2009 that has not been recognized as components of net periodic benefit or cost consist of:



|                                |  |                |  |         
|------------------------------- |  | -------------- |  | --------
|                                |  | 2009           |  | 2008    
|                                |  | (In thousands)
|Unrecognized actuarial loss     |  | $    262       |  | $    243
|Unrecognized prior service cost |  | 164            |  | 111     
|                                |  |                |  |         
|                                |  | $    426       |  | $    354
|                                |  |                |  |         

The composition of the SRPs net periodic cost
for the years ended December 31 is as follows (in thousands):



|                                                |  |                |  |           |  |          
|----------------------------------------------- |  | -------------- |  | --------- |  | ---------
|                                                |  | 2009           |  | 2008      |  | 2007     
|                                                |  | (In thousands)
|Service cost                                    |  | $      79      |  | $      61 |  | $      57
|Interest cost                                   |  | 192            |  | 199       |  | 192      
|Amortization of unrecognized prior service cost |  | 10             |  | 10        |  | 10       
|Amortization of unrecognized actuarial loss     |  | 10             |  | 9         |  |         
|                                                |  |                |  |           |  |          
|Total net periodic cost                         |  | $    291       |  | $    279  |  | $    259 
|                                                |  |                |  |           |  |          

The Company amortizes unrecognized gain or losses and
prior service costs in the SRPs on a straight line basis over the future working lifetime of the participant expected to receive benefits under the plan. In the year of a participants retirement, any unrecognized gains or losses and
prior service costs are fully recognized. Future unrecognized gains or losses arising after retirement are amortized over the participants remaining life expectancy.

The discount rate used in determining the benefit obligation of the SRPs as of December 31, 2009, 2008 and 2007 was 5.60%, 5.77% and 6.38%, respectively. The discount rate
used in determining the net periodic benefit cost was 5.77%, 6.38%, and 5.80%, for 2009, 2008, and 2007, respectively. The discount rate used to determine benefit obligations for the plans was based upon the Citibank pension liability index. The
Citibank pension liability index, less an adjustment of 10 basis points, was determined to appropriately reflect the rate at which the pension liabilities could be effectively settled based upon the expected duration of the plans. Salaries were
assumed to increase at an annual rate of 4.0% in 2009, 2008 and 2007.



62



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



12. Employee and Director Benefit Plans
(contd)



The following SRP payments, which reflect expected future service, as appropriate, are
expected to be paid (in thousands):



|                         |  |            
|------------------------ |  | -----------
|Year ending December 31:
|2010                     |  | $       261
|2011                     |  | 253        
|2012                     |  | 250        
|2013                     |  | 248        
|2014                     |  | 302        
|Years 2015-2019          |  | 1,831      

In 2010,
$22,000 in unrecognized prior service costs and $4,000 in unrecognized actuarial losses are estimated to be amortized from accumulated other comprehensive income into the net periodic cost for the SRPs.

The Company assumed a SRP for directors from Bridge Street, providing for extended compensation after retirement. The Company owns life
insurance policies on these individuals to provide for the estimated benefit obligations for the SRP. Cash surrender value of these policies approximated $3.5 million and $3.4 million at December 31, 2009 and 2008, respectively. At
December 31, 2009 and 2008 other liabilities include approximately $696,000 and $679,000, respectively, accrued under the directors SRP from Bridge Street. Deferred compensation expense related to the SRP from Bridge Street for the year
ended December 31, 2009, 2008 and 2007 approximated $107,000, $66,000 and $69,000, respectively.

The Company expects to
contribute $355,000 to its SRPs in 2010.

13. Directors Deferred Compensation

In March 2008, the Companys Board of Directors approved a stock-based deferral plan which provides directors and officers designated
by the Board of Directors the opportunity to defer receipt of cash compensation and, thereby, accumulate additional shares of the Companys common stock. The Company contributes the amount of compensation deferred to a trust, which purchases
shares of the Companys common stock, and distributions are made in shares of the Companys common stock upon such events as are elected by participants. Dividends paid on shares are also converted to common stock. Upon adoption of the
plan, certain directors transferred their balances from the prior deferred compensation plan to the stock-based deferral plan. The total amount transferred was $1.9 million which converted into 76,817 shares at an average share price of $24.57. At
December 31, 2009 and 2008, there were 103,512 and 85,510 shares held in trust with a cost basis of $2.5 million and $2.1 million, respectively.

The Company maintained an optional deferred compensation plan for its directors, whereby fees normally received were deferred and paid by the Company upon the retirement of the director. In March 2008,
active directors transferred their plan balances into the stock-based deferred compensation plan and the remaining liability consists of the retired directors balances. At December 31, 2009 and 2008, other liabilities included approximately
$533,000 and $580,000, respectively, relating to deferred compensation. Deferred compensation expense resulting from the earnings on deferred balances for the years ended December 31, 2009, 2008, and 2007 approximated $9,000, $76,000, and
$342,000, respectively.

The Company assumed a nonqualified deferred compensation plan for former directors of Bridge Street,
under which participants were eligible to elect to defer all or part of their annual director fees. The plan provides that deferred fees are to be invested in mutual funds, as selected by the individual directors. Deferrals under the plan were
discontinued effective with the acquisition of Bridge Street. At December 31, 2009 and 2008, deferred director fees included in other liabilities, and the corresponding assets included in other assets, aggregated approximately $372,000 and
$485,000, respectively.

14.  Stock Based Compensation Plans

The Company has a long-term incentive compensation plan (the Plan) authorizing the use of 550,000 shares of authorized but unissued common stock of the Company. The
purpose of the Plan is to promote the interests of the Company by providing current and future officers, directors and key employees with an equity or equity-based interest in the Company, so that the interests of such individuals will be closely
associated with the interests of shareholders. Pursuant to this Plan, eligible individuals may receive incentive stock options, non-qualified stock options, and/or restricted stock awards. The Plan expired in 2009 and no further awards will be
granted from this Plan.

There were 121,866 options outstanding at December 31, 2009, of which 111,866 of the options
were issued with a 10-year term, vesting one year after the issue date, and exercisable based on the Company achieving specified stock prices. 10,000 options were issued with a 10-year term and vest ratably over a three-year period. No options were
granted during 2009, 2008 and 2007.

Compensation expense recognized for stock options was $1,800 and $28,000 net of a tax
benefit of $1,200 and $18,000 during 2008 and 2007, respectively. As of December 31, 2008, there was no remaining unrecognized compensation cost related to non-vested stock option awards. The Company generally uses authorized but unissued
shares to satisfy stock option exercises.



63



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



14.  Stock Based Compensation Plans
(contd)



Stock option activity in the Plan for the years ended December 31 was as follows:



|                                 |  |                        |  |                               
|-------------------------------- |  | ---------------------- |  | ------------------------------
|                                 |  | 2009                  
|                                 |  |                       
|                                 |  | Options    Outstanding |  | Weighted AverageExercise
Price
|                                 |  |                       
|Outstanding at beginning of year |  | 182,555                |  | $    21.77                    
|Granted                          |  |                       |  |                              
|Exercised                        |  | (54,689)               |  | 24.75                         
|Forfeited                        |  | (6,000)                |  | 23.19                         
|                                 |  |                        |  |                               
|Outstanding at end of year       |  | 121,866                |  | $   20. 37                    
|                                 |  |                        |  |                               

The following table summarizes the Companys
stock options at December 31, 2009:



|                            |  |                        |  |                                 |  |                                          |  |                        |  |                              
|--------------------------- |  | ---------------------- |  | ------------------------------- |  | ---------------------------------------- |  | ---------------------- |  | -----------------------------
|                            |  | Options Outstanding    |  | Options Exercisable            
|Range of Exercise    Prices |  | Options    Outstanding |  | WeightedAverage  Exercise Price |  | WeightedAverage  Remaining Life  (Years) |  | Options    Exercisable |  | WeightedAverageExercise Price
|$17.75 - $19.00             |  | 75,500                 |  | $18.28                          |  | 0.7                                      |  | 75,500                 |  | $18.28                       
|$23.50 - $24.75             |  | 46,366                 |  | $23.78                          |  | 1.6                                      |  | 46,366                 |  | $23.78                       

The total intrinsic
value of options exercised during 2009 and 2007 was $170,000 and $66,000, respectively. The aggregate intrinsic value of shares outstanding and exercisable at December 31, 2009 was $782,000. Cash received from options exercised was $1.4 million
and $178,000 in 2009 and 2007, respectively. The tax benefit realized from stock options exercised was $48,000 and $26,000 in 2009 and 2007, respectively. No options were exercised in 2008.

Restricted stock awards are recorded as deferred compensation, a component of stockholders equity, at fair value at the date of the grant and amortized to compensation expense
over the specified vesting periods. These shares become vested at the end of a 7-year period. Furthermore, 50% of the shares awarded, to all grantees except the Companys Chief Executive Officer, become vested on the date, at least three years
after the award date, that the Companys stock price has closed at a price that is at least 160% of the award price for 15 consecutive days.

In 2009, the Companys Board of Directors approved a modification of the vesting schedule of restricted stock awards granted to all participating employees under the Plan. The modification provided
for the immediate vesting of all restricted shares which would have vested as of November 24, 2009 had the original cliff-vesting schedule instead been a pro-rata vesting schedule. The modification did not change the seven year cliff-vesting
schedule for the remaining unvested shares held by Plan participants.

Compensation expense associated with the amortization
of the cost of all restricted shares issued for the years ended December 31, 2009, 2008 and 2007 was $308,000, $359,000, and $241,000, respectively. The fair value of the vested restricted shares was $1.2 million in 2009. The unrecognized
compensation cost for restricted stock awards was $889,000 at December 31, 2009, which will be recognized as compensation expense over a weighted average period of 3.7 years.

The following is a summary of the Companys restricted stock activity for the year ended December 31, 2009:



|                                 |  |                    |  |                                        
|-------------------------------- |  | ------------------ |  | ---------------------------------------
|                                 |  | Non-vested  Shares |  | WeightedAverage  Grant Date  Fair Value
|                                 |  |                   
|Outstanding at beginning of year |  | 86,100             |  | $30.32                                 
|Granted                          |  | 11,850             |  | 20.21                                  
|Forfeited                        |  | (16,450)           |  | 23.21                                  
|Vested                           |  | (41,141)           |  | 30.73                                  
|                                 |  |                    |  |                                        
|Outstanding at end of year       |  | 40,359             |  | $29.76                                 
|                                 |  |                    |  |                                        



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



15.  Commitments and Contingent
Liabilities

The Company 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 statements of condition. The contract amount of those commitments and letters of credit reflects the extent of involvement the Company has in those particular classes of financial instruments. The Company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 Company 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 (in thousands):



|                                       |  |                 |  |            |  |           
|-------------------------------------- |  | --------------- |  | ---------- |  | ----------
|                                       |  | Contract Amount
|                                       |  | 2009            |  | 2008       |  | 2007      
|Commitments to extend credit, variable |  | $  134,540      |  | $  129,818 |  | $  122,099
|Commitments to extend credit, fixed    |  | 28,176          |  | 32,782     |  | 30,955    
|Standby letters of credit              |  | 4,371           |  | 1,572      |  | 1,289     

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
payments 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 Company 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 standby 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 standby letters of credit, the amount of collateral obtained, if deemed necessary by the Company 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
Company leases office space and certain branches under noncancelable operating lease agreements having initial terms which expire at various dates through 2025. Total rental expense was approximately $1.2 million in 2009, $1.2 million in 2008, and
$1.0 million in 2007.

Minimum rental payments under the initial terms of these leases are summarized as follows (in
thousands):



|                             |  |         
|---------------------------- |  | --------
|Year ending December 31:    
|2010                         |  | $  1,003
|2011                         |  | 972     
|2012                         |  | 576     
|2013                         |  | 484     
|2014                         |  | 390     
|Thereafter                   |  | 2,657   
|                             |  |         
|Total minimum lease payments |  | $ 6,082 
|                             |  |         

The Bank entered into an agreement in 2005 with
Onondaga County whereby the Bank obtained the naming rights to a sports stadium in Syracuse, NY for a 20-year term. Under the agreement, the Bank paid $152,000 in 2009 and 2008, and $120,000 in 2007, and will pay $152,000 annually from 2010 through
2024.

The Company is required to maintain a reserve balance as established by the Federal Reserve Bank of New York. The
required average total reserve for the 14-day maintenance period ended December 31, 2009 was $600,000.

The FASB
Accounting Standards Codification Topic on Asset Retirement Obligations refers to a legal obligation to perform an asset retirement activity in which the timing and (or) method of settlement are conditional on a future event that may or may not be
within the control of the Company. The Company is required to recognize a liability for the fair value of a conditional asset retirement obligation when it is incurred, generally upon acquisition, construction, or development and (or) through the
normal operation of the asset, and if the fair value of the liability can be reasonably estimated. The guidance acknowledges that in some cases sufficient information may not be available to reasonably estimate the fair value of an asset retirement
obligation. The Company acknowledges that some of its facilities were constructed years ago when asbestos was used for insulation and other construction purposes. Of our current 29 branches, nine are estimated to have been constructed when some use
of asbestos was common. Regulations are now in place that require the Company to handle and dispose of asbestos in a special manner if major renovations or demolition of a facility are to be completed. The Company does not believe that it has
sufficient information to estimate the fair value of the obligation at this time since no major renovations or demolition of any of its facilities have not been planned and if undertaken, would occur at an unknown future date. Accordingly, the
Company has not recognized a liability or a contingent liability in connection with potential future costs to remove and dispose of asbestos from its facilities.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



16. Dividends and Restrictions

The primary source of cash to pay dividends to the Companys shareholders is through dividends from its banking subsidiary. The Federal
Reserve Board and the Office of the Comptroller of the Currency are authorized to determine certain circumstances that the payment of dividends would be an unsafe or unsound practice and to prohibit payment of such dividends. The payment of
dividends that deplete a banks capital base could be deemed to constitute such an unsafe or unsound practice. Banking organizations may generally only pay dividends from the combined current year and prior two years net income less any
dividends previously paid during that period. At December 31, 2009, approximately $12.0 million was available for the declaration of dividends by the Bank. There were no loans or advances from the subsidiary Bank to the Company at
December 31, 2009.

17. Fair Value Measurements

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly
transaction between market participants on the measurement date. There are three levels of inputs that may be used to measure fair values:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or
liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entitys own assumptions about the assumptions that market participants would use in pricing an asset or liability.

Assets Measured on a Recurring Basis

The fair values of debt securities available-for-sale are determined by obtaining matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying
exclusively on quoted prices for the specific securities but rather by relying on the securities relationship to other benchmark quoted securities. The fair value of mutual fund and equity securities available-for-sale are determined by
obtaining quoted prices on nationally recognized securities exchanges when available.

Assets measured at fair value on a
recurring basis are summarized below:



|                                                      |  |               |  |                                                                      |  |                                                
|----------------------------------------------------- |  | ------------- |  | -------------------------------------------------------------------- |  | -----------------------------------------------
|                                                      |  |               |  | Fair Value Measurements at December 31, 2009 Using                  
|                                                      |  | Fair Value    |  | Quoted market prices in  active markets for identicalassets(Level 1) |  | Significant other    observable inputs(Level 2)
|Debt Securities:                                      |  |               |  |                                                                      |  |                                                
|U.S. Treasury obligations                             |  | $         101 |  | $                                                                   |  | $         101                                  
|Obligations of U.S. government-sponsored corporations |  | 6,129         |  |                                                                     |  | 6,129                                          
|Obligations of states and political subdivisions      |  | 77,147        |  |                                                                     |  | 77,147                                         
|Mortgage-backed securities - residential              |  | 275,680       |  |                                                                     |  | 275,680                                        
|                                                      |  |               |  |                                                                      |  |                                                
|Total debt securities                                 |  | 359,057       |  |                                                                     |  | 359,057                                        
|Stock Investments:                                    |  |               |  |                                                                      |  |                                                
|Equity securities                                     |  | 2,104         |  | 16                                                                   |  | 2,088                                          
|Mutual Funds                                          |  | 997           |  | 997                                                                  |  |                                               
|                                                      |  |               |  |                                                                      |  |                                                
|Total stock investments                               |  | 3,101         |  | 1,013                                                                |  | 2,088                                          
|                                                      |  |               |  |                                                                      |  |                                                
|Total available-for-sale                              |  | $  362,158    |  | $  1,013                                                             |  | $  361,145                                     
|                                                      |  |               |  |                                                                      |  |                                                
|                                                      |  |              
|                                                      |  |               |  | Fair Value Measurements at December 31, 2008 Using                  
|                                                      |  | Fair Value    |  | Quoted market prices inactive markets for identical  assets(Level 1) |  | Significant other    observable inputs(Level 2)
|Debt Securities:                                      |  |               |  |                                                                      |  |                                                
|U.S. Treasury obligations                             |  | $         102 |  | $                                                                   |  | $         102                                  
|Obligations of U.S. government-sponsored corporations |  | 35,143        |  |                                                                     |  | 35,143                                         
|Obligations of states and political subdivisions      |  | 91,033        |  |                                                                     |  | 91,033                                         
|Mortgage-backed securities - residential              |  | 169,960       |  |                                                                     |  | 169,960                                        
|                                                      |  |               |  |                                                                      |  |                                                
|Total debt securities                                 |  | 296,238       |  |                                                                     |  | 296,238                                        
|Stock Investments:                                    |  |               |  |                                                                      |  |                                                
|Equity securities                                     |  | 1,923         |  |                                                                     |  | 1,923                                          
|Mutual Funds                                          |  | 988           |  | 988                                                                  |  |                                               
|                                                      |  |               |  |                                                                      |  |                                                
|Total stock investments                               |  | 2,911         |  | 988                                                                  |  | 1,923                                          
|                                                      |  |               |  |                                                                      |  |                                                
|Total available-for-sale                              |  | $  299,149    |  | $    988                                                             |  | $  298,161                                     
|                                                      |  |               |  |                                                                      |  |                                                



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



17. Fair Value Measurements (contd)



Assets Measured on a Non-Recurring Basis

Loans held-for-sale  The fair value of loans held-for-sale is determined, when possible, using quoted secondary-market prices (Level 2), or if no such quoted price exists, the
fair value of a loan is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan (Level 2). There was no fair value allowance recorded on loans held-for-sale at December 31, 2009 and 2008.
Losses of $4,000 and $52,000 during 2009 and 2008, respectively, were recorded in other income related to fair value adjustments on loans held-for-sale.

Leases held-for-sale  The fair value of leases held-for-sale is primarily determined using an unadjusted quoted price for those leases, when available. If no such quoted price exists, the fair value
of a lease is determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that lease. There are no leases held for sale at December 31, 2009 and 2008. During 2008, a loss of $187,000 was recorded in
other income.

Loans are generally not recorded at fair value on a recurring basis. Periodically, the Company records
nonrecurring adjustment to the carrying value of loans based on fair value measurements for partial charge-offs of the uncollectible portions of those loans. Nonrecurring adjustments also include certain impairment amounts for
collateral-dependent loans calculated when establishing the allowance for credit losses. Such amounts are generally based on the fair value of the underlying collateral supporting the loan and, as a result, the carrying value of the loan less the
calculated valuation amount does not necessarily represent the fair value of the loan. Real estate collateral is typically valued using independent appraisals or other indications of value based on recent comparable sales of similar properties or
assumptions generally observable in the marketplace, adjusted based on non-observable inputs and the related nonrecurring fair value measurement adjustments and have generally been classified as Level 3. Estimates of fair value used for other
collateral supporting commercial loans generally are based on assumptions not observable in the marketplace and, therefore, such valuations have been classified as Level 3.

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral dependent loans, had a carrying amount of $908,000 with a valuation allowance
of $332,000 at December 31, 2009. At December 31, 2008, impaired loans had a carrying amount of $217,000, with a valuation allowance of $193,000. Changes in fair value recognized for partial charge-offs of loans and leases and impairment
reserves on loans and leases were $3.3 million and $2.0 million during 2009 and 2008, respectively.

The carrying amounts and
estimated fair values of financial instruments, not previously presented, at December 31 are as follows (in thousands):



|                                               |  |                        |  |                             |  |                |  |                    
|---------------------------------------------- |  | ---------------------- |  | --------------------------- |  | -------------- |  | -------------------
|                                               |  | 2009                   |  | 2008                       
|                                               |  | Carrying        Amount |  | Estimated        Fair
Value |  | CarryingAmount |  | EstimatedFair Value
|Financial Assets:                              |  |                       
|Cash and cash equivalents                      |  | $     26,696           |  | $         26,696            |  | $      21,172  |  | $        21,172    
|Fed funds sold                                 |  |                       |  |                            |  | 26,918         |  | 26,918             
|FHLB and FRB stock                             |  | 10,074                 |  | N/A                         |  | 11,844         |  | N/A                
|Loans held for sale                            |  | 1,023                  |  | 1,023                       |  | 875            |  | 875                
|Loans and leases, net of unearned income       |  | 914,162                |  | 943,818                     |  | 910,755        |  | 930,920            
|Allowance for credit losses                    |  | (9,414)                |  |                            |  | (9,161)        |  |                   
|                                               |  |                        |  |                             |  |                |  |                    
|Net loans and leases, including impaired loans |  | 904,748                |  | 943,818                     |  | 901,594        |  | 930,920            
|Accrued interest receivable                    |  | 4,167                  |  | 4,167                       |  | 4,218          |  | 4,218              
|                                               |  |                        |  |                            
|Financial Liabilities:                         |  |                        |  |                             |  |                |  |                    
|Deposits                                       |  | $  1,075,671           |  | $    1,080,083              |  | $    937,882   |  | $      943,182     
|Borrowings                                     |  | 172,707                |  | 175,914                     |  | 238,972        |  | 241,421            
|Junior subordinated obligations                |  | 25,774                 |  | 9,271                       |  | 25,774         |  | 14,131             
|Accrued interest payable                       |  | 1,745                  |  | 1,745                       |  | 3,037          |  | 3,037              

The fair value of
commitments to extend credit and standby letters of credit is not significant.

The Companys fair value estimates are
based on our existing on and off balance sheet financial instruments without attempting to estimate the value of any anticipated future business and the value of assets and liabilities that are not considered financial instruments. In addition, the
tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on our fair value estimates and have not been considered in these estimates.

The fair value estimates are made as of a specific point in time, based on relevant market information and information about the financial instruments, including our judgments
regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment
and therefore cannot be determined with precision. Changes in our assumptions could significantly affect the estimates.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



17. Fair Value Measurements (contd)



The following methods and assumptions were used by the Company in estimating its fair
value disclosures for financial instruments:

Cash and Cash Equivalents

The carrying amounts reported in the consolidated balance sheet for cash and short-term instruments approximate those assets fair value.

Fed Funds Sold

The carrying amount
reported in the consolidated balance sheet for Fed Funds Sold approximate the assets fair value.

FHLB and FRB Stock

It is not practicable to determine the fair value of FHLB and FRB stock due to restrictions placed on its transferability.

Loans and Leases

Variable-rate loans reprice as the associated rate index changes. Therefore, the carrying value of these loans approximates fair value. The fair value of our fixed-rate loans and leases were calculated by discounting scheduled cash flows
through the estimated maturity using current origination rates, credit adjusted for delinquent loans and leases. Our estimate of maturity is based on the contractual cash flows adjusted for prepayment estimates based on current economic and lending
conditions. 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 those currently being offered at the FHLB on similar terms. The fair value of accrued
interest approximates carrying value.

Borrowings

The fair value of borrowings are estimated using discounted cash flow analysis, based on interest rates approximating those currently being offered for borrowings with similar terms.

Junior Subordinated Obligations

The fair
value of trust preferred debentures has been estimated using a discounted cash flow analysis to maturity.

Off-balance-sheet Instruments

Off-balance-sheet financial instruments consist of commitments to extend credit and standby letters of credit, with fair
value based on fees currently charged to enter into agreements with similar terms and credit quality. Amounts are not significant.

18.
Capital and Regulatory Matters

Capital Requirements

The Company and its banking subsidiary are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate
certain mandatory and possibly discretionary 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 and its subsidiary bank to maintain minimum amounts and ratios (set forth in the table below) of total risk-based capital and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined). The leverage ratio (as
defined in the regulations) reflects Tier 1 capital divided by the average total assets for the period. Average assets used in the calculation exclude the Companys intangible assets.

The capital levels at the Companys subsidiary bank are maintained at or above the well-capitalized minimums of 10%, 6% and 5% for the total risk-based, Tier 1 capital, and
leverage ratio, respectively. As of December 31, 2009, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well-capitalized under the regulatory framework for prompt corrective
action. There are no conditions or events since that notification that management believes have changed the institutions category.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



18. Capital and Regulatory Matters (contd)



The Companys regulatory capital measures are presented in the following table
(dollars in thousands):



|                         |  |           |  |                              |  |                                                                |  |        |  |        |  |        
|------------------------ |  | --------- |  | ---------------------------- |  | -------------------------------------------------------------- |  | ------ |  | ------ |  | -------
|                         |  | Actual    |  | For CapitalAdequacy Purposes |  | To Be Well CapitalizedUnder Prompt CorrectiveAction
Provisions
|                         |  | Amount    |  | Ratio                        |  | Amount                                                         |  | Ratio  |  | Amount |  | Ratio  
|As of December 31, 2009  |  |           |  |                              |  |                                                                |  |        |  |        |  |        
|Total risk-based capital |  |           |  |                              |  |                                                                |  |        |  |        |  |        
|Company                  |  | $ 115,308 |  | 13.14%                       |  | $ 70,210                                                       |  | 38.00% |  | N/A    |  | N/A    
|Bank                     |  | 109,208   |  | 12.55%                       |  | 69,595                                                         |  | 38.00% |  | 86,994 |  | 310.00%
|Tier 1 capital           |  |           |  |                              |  |                                                                |  |        |  |        |  |        
|Company                  |  | 105,894   |  | 12.07%                       |  | 35,105                                                         |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  | 99,794    |  | 11.47%                       |  | 34,798                                                         |  | 34.00% |  | 52,196 |  | 36.00% 
|Leverage                 |  |           |  |                              |  |                                                                |  |        |  |        |  |        
|Company                  |  | 105,894   |  | 7.55%                        |  | 56,113                                                         |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  | 99,794    |  | 7.14%                        |  | 55,873                                                         |  | 34.00% |  | 69,841 |  | 35.00% 
|                         |  |           |  |                              |  |                                                               
|As of December 31, 2008  |  |           |  |                              |  |                                                                |  |        |  |        |  |        
|Total risk-based capital |  |           |  |                              |  |                                                                |  |        |  |        |  |        
|Company                  |  | $ 133,962 |  | 15.08%                       |  | $ 71,047                                                       |  | 38.00% |  | N/A    |  | N/A    
|Bank                     |  | 124,941   |  | 14.19%                       |  | 70,415                                                         |  | 38.00% |  | 88,019 |  | 310.00%
|Tier 1 capital           |  |           |  |                              |  |                                                                |  |        |  |        |  |        
|Company                  |  | 124,801   |  | 14.05%                       |  | 35,523                                                         |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  | 115,780   |  | 13.15%                       |  | 35,207                                                         |  | 34.00% |  | 52,811 |  | 36.00% 
|Leverage                 |  |           |  |                              |  |                                                                |  |        |  |        |  |        
|Company                  |  | 124,801   |  | 9.59%                        |  | 52,064                                                         |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  | 115,780   |  | 8.97%                        |  | 51,657                                                         |  | 34.00% |  | 64,571 |  | 35.00% 

Preferred Stock and Warrants under the U.S. Treasurys Capital Purchase Plan

In December 2008, the U.S. Department of Treasury (Treasury Department) purchased, in connection with the Capital Purchase Program (CPP) under the Troubled Asset Relief Program, 26,918 shares of the Companys
newly issued, non-voting senior cumulative preferred stock (Preferred Stock) valued at $26.9 million, with an initial annual dividend of 5% for five years and 9% thereafter. Dividends were accrued as earned. The Preferred Stock qualified
as Tier 1 capital for regulatory reporting purposes.

On May 13, 2009, the Company redeemed all 26,918 shares of its
Preferred Stock. The Company paid $27.2 million to the Treasury Department to redeem the Preferred Stock, which included the original investment amount of $26.9 million plus accrued dividends of approximately $329,000. The Company and Bank received
unconditional approvals from their respective regulators and from the Treasury Department to redeem the Preferred Stock. As a result of the redemption, the Company recorded a reduction in undivided profits of approximately $551,000 in the second
quarter of 2009 associated with the accelerated discount accretion related to the difference between the amount at which the Preferred Stock sale was initially recorded and the redemption price. The Preferred Stock dividend and the acceleration of
the accretion reduced the second quarters net income available to common shareholders and earnings per common share by $726,000 and $0.16, respectively.

In connection with the CPP, the Treasury Department was issued a warrant (Warrant) to purchase 173,069 shares of the Companys common stock with an exercise price of $23.33 per share
representing an aggregate market price of $4.0 million. On June 17, 2009, the Company repurchased the Warrant for $900,000. The repurchase of the Warrant was recorded as a reduction to shareholders equity and had no affect on the
Companys net income and earnings per share.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



19. Parent Company Financial Information

Condensed financial statement information of Alliance Financial Corporation for the years ended December 31 is
as follows (in thousands):



|                                                  |  |             |  |            
|------------------------------------------------- |  | ----------- |  | -----------
|Condensed Balance Sheets                          |  |             |  |            
|                                                  |  |            
|Assets:                                           |  | 2009        |  | 2008       
|Investment in subsidiaries                        |  | $  142,944  |  | $  160,770 
|Cash                                              |  | 2,146       |  | 4,927      
|Securities                                        |  | 1,694       |  | 1,512      
|Investment in limited partnerships                |  | 2,353       |  | 2,350      
|Other Assets                                      |  | 1,941       |  | 2,081      
|                                                  |  |             |  |            
|Total Assets                                      |  | $  151,078  |  | $  171,640 
|                                                  |  |             |  |            
|                                                  |  |            
|Liabilities:                                      |  |             |  |            
|Junior subordinated obligations                   |  | $    25,774 |  | $    25,774
|Dividends payable                                 |  | 1,292       |  | 1,232      
|Other liabilities                                 |  | 77          |  | 153        
|                                                  |  |             |  |            
|Total Liabilities                                 |  | 27,143      |  | 27,159     
|                                                  |  |            
|Shareholders Equity:                             |  |             |  |            
|Preferred stock                                   |  |            |  | 26,331     
|Common stock                                      |  | 4,937       |  | 4,901      
|Surplus                                           |  | 43,013      |  | 41,922     
|Undivided profits                                 |  | 86,194      |  | 81,110     
|Accumulated other comprehensive income            |  | 946         |  | 971        
|Directors stock-based deferred compensation plan |  | (2,499)     |  | (2,098)    
|Treasury stock                                    |  | (8,656)     |  | (8,656)    
|                                                  |  |             |  |            
|Total Shareholders Equity                        |  | 123,935     |  | 144,481    
|                                                  |  |             |  |            
|Total Liabilities and Shareholders Equity        |  | $  151,078  |  | $  171,640 
|                                                  |  |             |  |            



|                                                   |  |            |  |            |  |           
|-------------------------------------------------- |  | ---------- |  | ---------- |  | ----------
|Condensed Statements of Income                     |  |           
|                                                   |  | 2009       |  | 2008       |  | 2007      
|                                                   |  |            | 
|Dividend income from subsidiary Bank               |  | $    6,000 |  | $    9,500 |  | $    7,600
|Interest and dividends on securities               |  | 25         |  | 43         |  | 58        
|Income from limited partnerships                   |  | 75         |  | 202        |  | 230       
|Interest expense on junior subordinated debentures |  | (808)      |  | (1,399)    |  | (1,960)   
|Non-interest expenses                              |  | (72)       |  | (129)      |  | (101)     
|                                                   |  |            |  |            |  |           
|                                                   |  | 5,220      |  | 8,217      |  | 5,827     
|Equity in undistributed income of subsidiaries     |  | 6,228      |  | 2,140      |  | 3,650     
|                                                   |  |            |  |            |  |           
|Net Income                                         |  | $  11,448  |  | $  10,357  |  | $  9,477  
|                                                   |  |            |  |            |  |           



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



19.  Parent Company Financial Information
(contd)



|                                                                                  |  |              |  |              |  |            
|--------------------------------------------------------------------------------- |  | ------------ |  | ------------ |  | -----------
|Condensed Statements of Cash Flows                                                |  |             
|                                                                                  |  | 2009         |  | 2008         |  | 2007       
|Operating Activities:                                                             |  |             
|Net Income                                                                        |  | $     11,448 |  | $     10,357 |  | $     9,477
|Adjustments to reconcile net income to net cash provided by operating activities: |  |              |  |              |  |            
|Equity in undistributed net income of subsidiary                                  |  | (6,228)      |  | (2,140)      |  | (3,650)    
|Depreciation expense                                                              |  | 57           |  | 116          |  | 89         
|Net change in other assets and liabilities                                        |  | 321          |  | 114          |  | 270        
|                                                                                  |  |              |  |              |  |            
|Net cash provided by operating activities                                         |  | 5,598        |  | 8,447        |  | 6,186      
|                                                                                  |  |              | 
|Investing Activities:                                                             |  |              |  |              |  |            
|Purchase of securities available-for-sale                                         |  |             |  | (23)         |  |           
|                                                                                  |  |              |  |              |  |            
|Net cash used in investing activities                                             |  |             |  | (23)         |  |           
|                                                                                  |  |              | 
|Financing Activities:                                                             |  |              |  |              |  |            
|Treasury stock purchased                                                          |  |             |  | (3.431)      |  | (2,314)    
|Proceeds from the exercise of stock options                                       |  | 1,352        |  |             |  | 178        
|Retirement of common stock                                                        |  | (421)        |  |             |  |           
|Issuance of preferred stock                                                       |  |             |  | 26,918       |  |           
|Redemption of preferred stock                                                     |  | (26,918)     |  |             |  |           
|Repurchase of warrant                                                             |  | (900)        |  |             |  |           
|Capital contribution to subsidiary                                                |  |             |  | (23,918)     |  | (660)      
|Return of capital from subsidiary                                                 |  | 23,918       |  |             |  |           
|Cash dividends paid to common shareholders                                        |  | (4,872)      |  | (4,570)      |  | (4,213)    
|Cash dividends paid to preferred shareholders                                     |  | (538)        |  |             |  |           
|                                                                                  |  |              |  |              |  |            
|Net cash used in financing activities                                             |  | (8,379)      |  | (5,001)      |  | (7,009)    
|Increase (decrease) in cash and cash equivalents                                  |  | (2,781)      |  | 3,423        |  | (823)      
|Cash and cash equivalents at beginning of year                                    |  | 4,927        |  | 1,504        |  | 2,327      
|                                                                                  |  |              |  |              |  |            
|Cash and cash equivalents at end of year                                          |  | $    2,146   |  | $    4,927   |  | $    1,504 
|                                                                                  |  |              |  |              |  |            
|                                                                                  |  |              | 
|Supplemental Disclosures of Cash Flow Information:                                |  |              |  |              |  |            
|Non-cash financing activities:                                                    |  |              |  |              |  |            
|Dividend declared and unpaid                                                      |  | $    1,292   |  | $    1,191   |  | $    1,135 

In October 2001, the Companys Board of Directors adopted a shareholders rights plan. Under the plan, Series A Junior Participating Preferred Stock Purchase Rights were distributed at the close
of business on October 29, 2001 to shareholders of record as of that date. The Rights trade with the Common Stock, and are exercisable and trade separately from the Common Stock only if a person or group acquires or announces a tender or
exchange offer that would result in such person or group owning 20% or more of the Common Stock of the Company. In the event the person or group acquires a 20% Common Stock position, the Rights allow other holders to purchase stock of the Company at
a discount to market value. The Company is generally entitled to redeem the Rights at $.001 per Right at any time prior to the 10th day after a person or group has acquired a 20% Common Stock position. The Rights will expire on October 29, 2011
unless the plan is extended or the Rights are earlier redeemed or exchanged.



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Item 9  Changes in and Disagreements with Accountants on
Accounting and Financial Disclosure

Not applicable

Item 9A  Controls and Procedures

REPORT OF MANAGEMENTS RESPONSIBILITY

Management is responsible for preparation of the consolidated
financial statements and related financial information contained in all sections of this Annual Report on Form 10-K, including the determination of amounts that must necessarily be based on judgments and estimates. It is the belief of management
that effective internal controls over financial reporting have been designed to produce reliable financial statements that have been prepared in conformity, in all material respects, with generally accepted accounting principles appropriate in the
circumstances, and that the financial information appearing throughout this annual report is consistent, in all material respects, with the consolidated financial statements.

The Audit Committee of the Board of Directors, composed solely of independent directors, meets periodically with the Companys management, internal auditors and independent
registered public accounting firm, Crowe Horwath LLP to review matters relating to the quality of financial reporting, internal accounting control, and the nature, extent, and results of audit efforts. The internal auditors and independent public
accounting firm have unlimited access to the Audit Committee to discuss all such matters.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

The Companys principal executive officer and principal financial officer evaluated, as of December 31, 2009,
the effectiveness of the Companys disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on that evaluation, the Companys principal executive officer
and principal financial officer concluded that the Companys disclosure controls and procedures as of December 31, 2009 were effective.

MANAGEMENTS ANNUAL REPORT ON INTERNAL CONTROL OVER FINANCIAL REPORTING

Managements
responsibilities related to establishing and maintaining effective disclosure controls and procedures include maintaining effective internal controls over financial reporting that are designed to produce reliable financial statements in accordance
with accounting principles generally accepted in the United States. As disclosed in the Report on Managements Assessment of Internal Control Over Financial Reporting which is set forth in Item 8 - Financial Statements and
Supplementary Data on page 32 and is incorporated herein by reference, management assessed the Corporations system of internal control over financial reporting as of December 31, 2009, in relation to criteria for effective
internal control over financial reporting as described in Internal Control  Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management believes
that, as of December 31, 2009, its system of internal control over financial reporting met those criteria and is effective.

ATTESTATION REPORT OF THE REGISTERED PUBLIC ACCOUNTING FIRM

The effectiveness of the Companys internal
control over financial reporting as of December 31, 2009 has been audited by Crowe Horwath LLP, an independent registered public accounting firm, as stated in its report, which is set forth in Item 8  Financial Statements and
Supplementary Data on page 33 and is incorporated herein by reference.

CHANGES IN INTERNAL CONTROL OVER FINANCIAL REPORTING

The Company regularly assesses the adequacy of its internal control over financial reporting and enhances its controls in
response to internal control assessments and internal and external audit and regulatory recommendations. There has been no change in the Companys internal control over financial reporting during the quarter ended December 31, 2009 that
has materially affected, or is reasonably likely to materially affect, the Companys internal control over financial reporting.

Item 9B  Other Information

Not applicable



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PART III

Item 10  Directors and Executive Officers of the Registrant and Corporate Governance

The information required by this Item 10 is incorporated herein by reference to the sections entitled Information About Our Board of Directors and Information
About Our Executive Officers, Committees of the Board of DirectorsAudit Committee, Report of the Audit Committee of the Board of Directors, Committees of the Board of DirectorsCorporate Governance
Committee and Section 16 (a) Beneficial Ownership Reporting Compliance in the Companys Proxy Statement issued in connection with its 2010 Annual Meeting of Shareholders (Proxy Statement). The Company has
adopted a Code of Ethics applicable to its Chief Executive Officer, Chief Financial Officer, Controller and senior financial management. The Companys Code of Ethics for Senior Officers is available at the Companys website at
www.alliancebankna.com.

Item 11  Executive Compensation

The information required by this Item 11 is incorporated herein by reference to the sections entitled Compensation Discussion and
Analysis, Executive and Director Compensation Tables and Committees of the Board of DirectorsCompensation Committee in the Companys Proxy Statement.

Item 12  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information required by this item 12 is incorporated herein by reference to the sections entitled
Securities Authorized for Issuance Under Equity Compensation Plans, Information About Our Executive Officers and Security Ownership of Certain Beneficial Owners and Management in the Companys Proxy
Statement.

Item 13  Certain Relationships, Related Transactions and Director Independence

The information required by this Item 13 is incorporated herein by reference to the sections entitled
Board of Directors Independence and Transactions With Related Persons in the Companys Proxy Statement.

Item 14  Principal Accountant Fees and Services

The
information required by this Item 14 is incorporated herein by reference to the section entitled Independent Registered Public Accounting Firm Fees and Services in the Companys Proxy Statement.



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PART IV

Item 15  Exhibits and Financial Statement Schedules

The financial statement schedules and exhibits filed as part of this form 10-K are as follows:



|        |  |                                                                                                                                                                      
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------
|(a) (1) |  | The following consolidated financial statements are included in Part II, Item 8 hereof:                                                                              
|        |  | Consolidated Balance Sheets at December 31, 2009 and 2008.                                                                                                           
|        |  | Consolidated Statements of Income for the years ended December 31, 2009, 2008 and 2007.                                                                              
|        |  | Consolidated Statements of Comprehensive Income for the years ended December 31, 2009, 2008 and 2007.                                                                
|        |  | Consolidated Statements of Shareholders Equity for each of the years ended December 31, 2009, 2008 and 2007.                                                        
|        |  | Consolidated Statements of Cash Flows for the years ended December 31, 2009, 2008 and 2007.                                                                          
|        |  | Notes to Consolidated Financial Statements.                                                                                                                          
|        | 
|(a) (2) |  | Financial statement schedules are omitted from this Form 10-K since the required information is not applicable to the Company.                                       
|        | 
|(a) (3) |  | The exhibits required to be filed as part of the Annual Report on Form 10-K are listed in the Exhibit Index attached hereto and are incorporated herein by
reference.



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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.



|                   |  |                                                                                            
|------------------ |  | -------------------------------------------------------------------------------------------
|                   |  | ALLIANCE FINANCIAL CORPORATION                                                             
|                   |  | (Registrant)                                                                               
|                   | 
|DateMarch 12, 2010 |  | By /s/Jack H. Webb                                                                         
|                   |  | Jack H. Webb, Chairman, President & CEO (Principal Executive Officer)                      
|                   | 
|DateMarch 12, 2010 |  | By /s/J. Daniel Mohr                                                                       
|                   |  | J. Daniel Mohr, Executive Vice President & CFO (Principal Financial and Accounting Officer)

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



|                                                                                   |  |  |  |                     |  | 
|---------------------------------------------------------------------------------- |  |  |  | ------------------- |  | 
|/s/Mary Pat Adams                                                                  |  |  |  | DateMarch 10,
2010 
|Mary Pat Adams, Director                                                           |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/Donald S. Ames                                                                  |  |  |  | DateMarch 10,
2010 
|Donald S. Ames, Director                                                           |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/Donald H. Dew                                                                   |  |  |  | DateMarch 10,
2010 
|Donald H. Dew, Director                                                            |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/John M. Endries                                                                 |  |  |  | DateMarch 10,
2010 
|John M. Endries, Director                                                          |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/Samuel J. Lanzafame                                                             |  |  |  | DateMarch 10,
2010 
|Samuel J. Lanzafame, Director                                                      |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/Margaret G. Ogden                                                               |  |  |  | DateMarch 10,
2010 
|Margaret G. Ogden, Director                                                        |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/Lowell A. Seifter                                                               |  |  |  | DateMarch 10,
2010 
|Lowell A. Seifter, Director                                                        |  |  |  |                     |  | 
|                                                                                   |  | 
|                                                                                   |  |  |  | Date               
|Charles E. Shafer, Director                                                        |  |  |  |                     |  | 
|                                                                                   |  | 
|                                                                                   |  |  |  | Date               
|Charles H. Spaulding, Director                                                     |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/Paul M. Solomon                                                                 |  |  |  | DateMarch 10,
2010 
|Paul M. Solomon, Director                                                          |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/Deborah F. Stanley                                                              |  |  |  | DateMarch 10,
2010 
|Deborah F. Stanley, Director                                                       |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/John H. Watt, Jr.                                                               |  |  |  | DateMarch 10 , 2010
|John H. Watt, Jr., Executive Vice President & Director                             |  |  |  |                     |  | 
|                                                                                   |  | 
|/s/Jack H. Webb                                                                    |  |  |  | DateMarch 10,
2010 
|Jack H. Webb, Chairman, President & CEO and Director (Principal Executive Officer) |  |  |  |                     |  | 



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EXHIBIT INDEX



|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|              | 
|3.1           |  | Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to exhibit 3.1 to the Companys Registration Statement on Form S-4
(Registration No. 333-62623) filed with the Commission on August 27, 2009)                                                                                                                                                                                                              
|              | 
|3.2           |  | Amended and Restated Bylaws of the Company (incorporated herein by reference to exhibit 3.2 to the Companys Current Report on Form 8-K filed with the Commission on September
3, 2004)                                                                                                                                                                                                                                                                       
|              | 
|3.3           |  | Amendment to the Amended and Restated Bylaws of the Company (incorporated herein by reference to exhibit 3.3 to the Companys Current Report on Form 8-K filed with the
Commission on November 27, 2007)                                                                                                                                                                                                                                                      
|              | 
|4.1           |  | Rights Agreement dated October 19, 2001 between Alliance Financial Corporation and American Stock Transfer & Trust Company, including the Certificate of Amendment to the
companys Certificate of Incorporation, the form of Rights Certificate and the Summary of Rights attached thereto as Exhibits A, B, and C, respectively (incorporated herein by reference to exhibit 4.1 to the Companys Form 8-A12G
filed with the Commission on October 25, 2001)
|              | 
|10.1 *        |  | Alliance Financial Corporation 1998 Long Term Incentive Compensation Plan (incorporated herein by reference to exhibit 10.1 to the Companys Registration Statement on Form S-4,
Registration No. 333-62623, filed with the Commission on August 31, 1998, as amended)                                                                                                                                                                                        
|              | 
|10.2 *        |  | Employment Agreement dated January 26, 2010 by and between the Company and Jack H. Webb (incorporated herein by reference to exhibit 10.1 of the Companys Current Report on
Form 8-K filed with the Commission on February 1, 2010)                                                                                                                                                                                                                          
|              | 
|10.3 *        |  | Amended and Restated Supplemental Retirement Agreement, dated as of November 28, 2006, by and among the Company, Alliance Bank, N.A. and Jack H. Webb (incorporated herein by
reference to exhibit 10.5 to the Companys Current Report on Form 8-K filed with the Commission on February 1, 2010)                                                                                                                                                            
|              | 
|10.4 *        |  | First Amendment to the Amended and Restated Supplemental Retirement Agreement between the Company, the Bank and Jack H. Webb (incorporated herein by reference to exhibit 10.6 to the
Companys Current Report on Form 8-K filed with the Commission on February 1, 2010)                                                                                                                                                                                     
|              | 
|10.5 *        |  | Split Dollar Agreement between the Bank and Jack H. Webb (incorporated herein by reference to exhibit 10.4 to the Companys Current Report on Form 8-K filed with the Commission
on February 1, 2010)                                                                                                                                                                                                                                                         
|              | 
|10.6 *        |  | Employment Agreement dated January 26, 2010 by and among the Company and John H. Watt Jr. (incorporated herein by reference to exhibit 10.2 to the Companys Current Report on
Form 8-K filed with the Commission on February 1, 2010)                                                                                                                                                                                                                        
|              | 
|10.7 *        |  | Employment Agreement, dated January 26, 2010 by and between the Company and J. Daniel Mohr (incorporated by reference to exhibit 10.3 to the Companys Current Report on Form
8-K filed with the Commission on February 1, 2010)                                                                                                                                                                                                                              
|              | 
|10.8 *        |  | Form of Change of Control Agreement, dated January 27, 2009, by and between the Company, Alliance Financial Corporation, and James W. Getman and Steven G. Cacchio (incorporated
herein by reference to exhibit 10.11 of the Companys annual report on Form 10-K filed with the Commission on March 13, 2009)                                                                                                                                                
|              | 
|10.9 *        |  | Director Supplemental Retirement Benefit Plan of Oswego County Savings Bank, dated as of March 15, 2000 (incorporated by reference to exhibit 10.10 to the Companys Annual
Report on Form 10-K filed with the Commission on March 13, 2007)                                                                                                                                                                                                                  
|              | 
|10.10 *       |  | Oswego County National Bank Voluntary Deferred Compensation Plan for Directors, Amended and Restated effective January 1, 2005 (incorporated by reference to exhibit 10.11 to the
Companys Annual Report on Form 10-K filed with the Commission on March 13, 2007)                                                                                                                                                                                           
|              | 
|10.11 *       |  | Directors Compensation Deferral Plan of the Company (incorporated herein by reference to exhibit 10.1 to the Companys Quarterly Report on Form 10-Q filed with the Commission
on August 13, 1999)                                                                                                                                                                                                                                                            
|              | 
|10.12 *       |  | Alliance Financial Corporation Director Retirement Plan dated March 11, 2008 (incorporated herein by reference to exhibit 10.1 to the Companys Current Report on Form 8-K filed
with the Commission on March 14, 2008)                                                                                                                                                                                                                                       
|              | 
|10.13 *       |  | Alliance Financial Corporation Stock-Based Deferral Plan dated March 11, 2008 (incorporated herein by reference to exhibit 10.3 to the Companys Current Report on Form 8-K
filed with the Commission on March 14, 2008)                                                                                                                                                                                                                                      
|              | 
|10.14 *       |  | Alliance Bank Executive Incentive Retirement Plan dated March 11, 2008 (incorporated herein by reference to exhibit 10.2 to the Companys Current Report on Form 8-K filed with
the Commission on March 14, 2008)                                                                                                                                                                                                                                             



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|        |  |                                                                                                                                                                                                                                                                                  
|------- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.15 * |  | First National Bank of Cortland Excess Benefit Plan for David R. Alvord, dated December 31, 1991, and all amendments thereto (incorporated herein by reference to exhibit 10.13 to
the Companys Annual Report on Form 10-K filed with the Commission on March 30, 2001)         
|        | 
|10.16 * |  | Oneida Valley National Bank Supplemental Retirement Income Plan for John C. Mott, dated September 1, 1997, and all amendments thereto (incorporated herein by reference to exhibit
10.14 to the Companys Annual Report on Form 10-K filed with the Commission on March 29, 2002)
|        | 
|21.1   |  | List of the Companys Subsidiaries                                                                                                                                                                                                                                               
|        | 
|23.1   |  | Consent of Crowe Horwath LLP                                                                                                                                                                                                                                                     
|        | 
|31.1   |  | Certification of Jack H. Webb, Chairman of the Board, President and Chief Executive Officer of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act of
2002                                                                                                         
|        | 
|31.2   |  | Certification of J. Daniel Mohr, Executive Vice President and Chief Financial Officer of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002                                                                                                               
|        | 
|32.1   |  | Certification of Jack H. Webb, Chairman of the Board, President and Chief Executive Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906
of the Sarbanes-Oxley Act of 2002                                                          
|        | 
|32.2   |  | Certification of J. Daniel Mohr, Executive Vice President and Chief Financial Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of
the Sarbanes-Oxley Act of 2002                                                                



| | Filed herewith.
|- | ---------------

|* | Management contract or compensatory plan or arrangement.
|- | --------------------------------------------------------



77