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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, 2008              |  | 
| |  |      |  | 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)



|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|New York                                                       |  | 16-1276885                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (I.R.S. Employer Identification No.)
|                                                               | 
|120 Madison Street, Tower II, 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 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. [X]

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, 2008, the aggregate market value of the voting stock held by non-affiliates of the registrant was $89.3 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 January 22, 2009
was 4,578,910 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the 2009 annual shareholders meeting (the Proxy Statement) are incorporated by reference in Part III of this Annual Report on Form 10-K.

Exhibit index is located on page 77 of 79.



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TABLE OF CONTENTS

FORM 10-K ANNUAL REPORT

FOR THE YEAR ENDED

DECEMBER 31, 2008

ALLIANCE FINANCIAL
CORPORATION



|         |  |          |  |                                                                                                                  |  |     
|-------- |  | -------- |  | ---------------------------------------------------------------------------------------------------------------- |  | ----
|         |  |          |  |                                                                                                                  |  | Page
|PART I   |  |         
|         |  |          | 
|         |  | Item 1.  |  | Business                                                                                                         |  | 1   
|         |  | Item 1A. |  | Risk Factors                                                                                                     |  | 7   
|         |  | Item 1B. |  | Unresolved Staff Comments                                                                                        |  | 11  
|         |  | Item 2.  |  | Properties                                                                                                       |  | 11  
|         |  | Item 3.  |  | Legal Proceedings                                                                                                |  | 11  
|         |  | Item 4.  |  | Submission of Matters to a Vote of Security Holders                                                              |  | 11  
|         | 
|PART II  |  |         
|         |  |          | 
|         |  | Item 5.  |  | Market for the Registrants Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities |  | 12  
|         |  | Item 6.  |  | Selected Financial Data                                                                                          |  | 14  
|         |  | Item 7.  |  | Managements Discussion and Analysis of Financial Condition and Results of Operations                            |  | 17  
|         |  | Item 7A. |  | Quantitative and Qualitative Disclosures about Market Risk                                                       |  | 33  
|         |  | Item 8.  |  | Financial Statements and Supplementary Data                                                                      |  | 35  
|         |  | Item 9.  |  | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure                             |  | 75  
|         |  | Item 9A. |  | Controls and Procedures                                                                                          |  | 75  
|         |  | Item 9B. |  | Other Information                                                                                                |  | 75  
|         | 
|PART III |  |         
|         |  |          | 
|         |  | Item 10. |  | Directors and Executive Officers of the Registrant and Corporate Governance                                      |  | 76  
|         |  | Item 11. |  | Executive Compensation                                                                                           |  | 76  
|         |  | Item 12. |  | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters                   |  | 76  
|         |  | Item 13. |  | Certain Relationships, Related Transactions and Director Independence                                            |  | 76  
|         |  | Item 14. |  | Principal Accountant Fees and Services                                                                           |  | 76  
|         | 
|PART IV  |  |         
|         |  |          | 
|         |  | Item 15. |  | Exhibits and Financial Statement Schedules                                                                       |  | 77  



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PART I

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

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.

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 $726 million of related investment assets at December 31, 2008.

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.



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In December 2008, the Company entered into a Letter Agreement (the Purchase Agreement),
with the United States Department of the Treasury (Treasury Department) pursuant to which the Company has issued and sold to the Treasury Department: (i) 26,918 shares of the Companys Fixed Rate Cumulative Perpetual Preferred
Stock, Series A, (the Series A Preferred Stock), having a liquidation amount per share equal to $1,000, for a total price of $26,918,000 (ii) and a warrant (the Warrant) to purchase 173,069 shares of the
Companys common stock at an exercise price per share of $23.33.

In addition, under the Certificate of Designations, the
Companys ability to declare or pay dividends or repurchase its common stock or other equity or capital securities will be subject to restrictions in the event that it fails to declare and pay (or set aside for payment) full dividends on the
Series A Preferred Stock.

At December 31, 2008, the Company had 334 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 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. Trust and investment management 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 primarily is intended for the protection of depositors 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, state legislatures and regulatory agencies 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. As a participant in the Capital Purchase Program (CPP) under the United States Treasury Departments Troubled Asset Relief Program
(TARP), Alliance is subject to certain restrictions and reporting requirements relative to executive compensation and lending activities that do not apply to financial institutions which do not participate in the TARP.

The Company is a bank holding company registered under the Bank Holding Company Act of 1956, as amended, and elected to become a financial holding
company on June 21, 2006. As such, it is subject to supervision, regulation and examination by the Board of Governors of the Federal Reserve System (the Federal Reserve Board). The Bank Holding Company Act and other federal laws
subject bank and financial holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws
and regulations. A bank holding company that qualifies as a financial holding company can expand into a wide variety of services that are financial in nature, if its subsidiary depository institution is well-managed, well-capitalized and has
received at least a satisfactory rating on its last CRA examination. Services that have been deemed to be financial in nature include securities underwriting, dealing and market making, sponsoring mutual funds and investment companies,
insurance underwriting and agency activities and merchant banking. The Bank Holding Company Act requires every financial 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 financial
holding companies, the Federal Reserve Board is required to consider the financial and managerial resources and future prospects of the financial 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 financial 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



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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
Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess
civil money penalties for certain activities conducted on a knowing and reckless basis. 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.

Under Federal Reserve Board policy, a holding company is expected to act as a source of financial
strength to each of its banking subsidiaries and 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. Prior to December 19, 2011, unless the Company has redeemed the Series A Preferred Stock or the Treasury Department has
transferred the Series A Preferred Stock to a third party, the consent of the Treasury Department will be required for the Company to (1) declare or pay any dividend or make any distribution on its common stock (other than regular
quarterly cash dividends of not more than $0.26 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past
practice and certain other circumstances specified in the Purchase Agreement.

The Federal Reserve Board has established risk-based capital
guidelines that are applicable to financial holding companies. The guidelines established 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). Banking organizations 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, 2008 were 14.1% and 15.1%, 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 financial holding companies that meet certain specified criteria, including that they have the highest regulatory rating. All other financial holding companies are required to maintain a Tier
1 leverage ratio of 3.00% plus an additional layer of at least 100 to 200 basis points. The Companys Tier 1 leverage ratio as of December 31, 2008 was 9.6%, which exceeded its regulatory requirement of 4.00%. 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.

The Gramm-Leach-Bliley Act (Gramm-Leach) permits, subject to certain conditions, combinations among banks, securities firms and insurance
companies. Under Gramm-Leach, bank holding companies are permitted to offer their customers virtually any type of financial service including banking, securities underwriting, insurance (both underwriting and agency), and merchant banking. In order
to engage in these additional financial activities, a financial holding company must qualify and register with the Federal Reserve Board, as the Company has, as a financial holding company by meeting certain higher standards for capital
adequacy and management, with heavy penalties for noncompliance. Gramm-Leach establishes that the federal banking agencies will regulate the banking activities of financial holding companies and banks financial subsidiaries, the U.S.
Securities and Exchange Commission will regulate their securities activities and state insurance regulators will regulate their insurance activities. Bank holding companies that wish to engage in expanded activities but do not wish to become
financial holding companies may elect to establish financial subsidiaries, which are subsidiaries of national banks with expanded powers. Gramm-Leach permits financial subsidiaries to engage in the same types of activities permissible
for nonbank subsidiaries of financial holding companies, with the exception of merchant banking, insurance and annuity underwriting and real estate investment and development. Merchant banking may be permitted after a five-year waiting period under
certain regulatory circumstances. Gramm-Leach also provides new protections against the transfer and use by financial institutions of consumers nonpublic, personal information.

Transactions between the holding company and its subsidiary bank are subject to Section 23A of the Federal Reserve Act and to the requirements of Regulation W. In general, Section 23A
imposes limits on the amount of such transactions, and also requires certain levels of collateral for loans to affiliated parties. It also limits the amount of advances to third parties which are collateralized by the securities or obligations of
the Company or its subsidiaries. Affiliate transactions are also subject to Section 23B of the Federal Reserve Act and to the



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requirements of Regulation W, which generally require that certain transactions between the holding company and its affiliates be on terms substantially the
same, or at least as favorable to the banks, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons. The restrictions on loans to directors, executive officers, principal shareholders and their
related interests (collectively referred to herein as insiders) contained in the Federal Reserve Act and Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on
loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. Insiders are subject to enforcement actions for knowingly accepting
loans in violation of applicable restrictions.

As a national bank, the Bank is subject to primary supervision, regulation, and examination
by the Office of the Comptroller of the Currency (OCC) and secondary regulation by the FDIC and the Federal Reserve Board. The Bank is subject to federal statutes and regulations that significantly affect its business and activities. The
Bank must file reports with its regulators concerning its activities and financial condition and obtain regulatory approval to enter into certain transactions. Other applicable statutes and regulations relate to insurance of deposits, allowable
investments, loans, acceptance of deposits, trust activities, mergers, consolidations, payment of dividends, capital requirements, reserves against deposits, establishment of branches and certain other facilities, limitations on loans to one
borrower and loans to affiliated persons, and other aspects of the business of banks. In addition, federal legislation has instructed federal agencies to adopt standards or guidelines governing banks internal controls, information systems,
loan documentation, retail and commercial loan underwriting, interest rate exposure, asset growth, compensation and benefits, asset quality, earnings and capital, and other matters. Regulatory authorities have broad flexibility to initiate
proceedings designed to prohibit banks from engaging in unsafe and unsound banking practices.

The Federal Deposit Insurance Corporation
Improvement Act of 1991 (FDICIA) substantially revised the depository institution regulatory and funding provisions of the Federal Deposit Insurance Act and made revisions to several other federal banking statutes. Among other things,
federal banking regulators are required to take prompt corrective action in respect of depository institutions that do not meet minimum capital requirements. FDICIA identifies the following capital categories for financial institutions: well
capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. Rules adopted by the federal banking agencies under FDICIA provide that an institution is deemed to be well capitalized if the
institution 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
prompt corrective action directive to meet and maintain a specific level for any capital measure. FDICIA imposes progressively more restrictive constraints on operation, management, and capital distributions, depending on the capital category in
which an institution is classified. At December 31, 2008, the Company and the Bank were in the well-capitalized category, based on the ratios and guidelines noted above.

The Bank must pay assessments to the FDIC for federal deposit insurance protection. The FDIC has adopted a risk-based assessment system as required by FDICIA. Under this system, 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. 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.

The Federal Deposit Insurance Reform
Act of 2005 was signed into law on February 8, 2006, and 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; combines the BIF and SAIF to form a single Deposit
Insurance Fund; increase 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.

On February 27, 2009, the FDIC adopted an interim rule, with request for comment, which
would institute a one-time special assessment of 20 cents per $100 of domestic deposits on FDIC insured institutions. If approved, the Company estimates that the special assessment would total approximately $2 million for the Bank. The assessment
would be payable on September 30, 2009. In addition, the FDIC can levy an additional 10 cents per $100 assessment (approximately $1 million for the Bank) in any quarter in the future as needed to maintain the insurance fund at an appropriate
level.

The Community Reinvestment Act of 1977 (CRA) and the regulations issued thereunder are intended to encourage banks to
help meet the credit needs of their service area, including low and moderate income neighborhoods, consistent with the safe and sound operations of the banks. These regulations also provide 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. The Financial Institutions Reform, Recovery, and Enforcement Act of 1989 requires federal banking
agencies to make public a rating of a banks performance under the CRA. 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 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 Funds Transfer Act, the Expedited Funds Availability Act, 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 disclosure requirements and regulate the manner in



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which financial institutions must deal with customers when taking deposits or making loans to such customers. The bank must comply with the applicable
provisions of these consumer protection laws and regulations as part of their ongoing customer relations. The Check Clearing for the 21stCentury
Act (Check 21 Act or the Act), which became effective on October 28, 2004, creates a new negotiable instrument, called a substitute check, which banks are required to accept as the legal equivalent of a paper
check if it meets the requirements of the Act. The Act is designed to facilitate check truncation, to foster innovation in the check payment system, and to improve the payment system by shortening processing times and reducing the volume of paper
checks.

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.

Pursuant to Title V of Gramm-Leach, federal banking regulators adopted rules that limit the ability of banks and other financial institutions to disclose
nonpublic information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a
nonaffiliated third party. Under these rules, financial institutions must provide: initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated
third parties and affiliates, annual notices of their privacy policies to current customers, and a reasonable method for customers to opt out of disclosures to nonaffiliated third parties.

As part of the USA Patriot Act of 2001, signed into law on October 26, 2001, Congress adopted the International Money Laundering Abatement and
Financial Anti-Terrorism Act of 2001 (IMLAFATA). IMLAFATA authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to banks, bank holding companies, or
other financial institutions. Pursuant to this statute, the Department of the Treasury has issued a number of regulations relating to enhanced 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 institutions also
are barred from dealing with foreign shell banks. In addition, IMLAFATA expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to
requests for information from federal banking agencies within 120 hours. These regulations were also adopted during 2002 to implement minimum standards to verify customer identity, to encourage cooperation among financial institutions, federal
banking agencies, and law enforcement authorities regarding possible money laundering or terrorist activities, to prohibit the anonymous use of concentration accounts, and to require all covered financial institutions to have in place a
Bank Secrecy Act compliance program. IMLAFATA also amends the Bank Holding Company Act and the Bank Merger Act to require federal banking agencies to consider the effectiveness of a financial institutions anti-money laundering activities when
reviewing an application under these acts.

The Bank has in place a comprehensive Bank Secrecy Act compliance program. In 2008, 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.

On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 (the Act), implementing legislative reforms intended to address corporate and accounting fraud. In addition to the
establishment of a new accounting oversight board that enforces auditing, quality control and independence standards and is funded by fees from all publicly traded companies, the law restricts provision of both auditing and consulting services by
accounting firms. To ensure auditor independence, any non-audit services being provided to an audit client require pre-approval by the issuers audit committee members. In addition, the audit partners must be rotated. The Act requires chief
executive officers and chief financial officers, or their equivalent, to certify to 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 the Act, 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 its chief executive officer or its 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.

Longer prison terms and increased penalties are also applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers
has been extended, and bonuses issued to top executives prior to restatement of a companys financial statements are subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider
trading during retirement plan blackout periods, and loans to company executives are restricted. The Act accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their
financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a companys securities within two business days of the change.

The Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently
influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the companys financial statements for the purpose of rendering the financial statements materially misleading. The Act also
requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to stockholders. In addition, the Act requires that each financial report required to be prepared in accordance
with (or reconciled to) accounting principles



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generally accepted in the United States of America and filed with the SEC reflect all material correcting adjustments that are identified by a
registered public accounting firm in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the SEC.

As directed by Section 302(a) of the Act, the Companys chief executive officer and chief financial officer are each required to certify that the Companys quarterly and annual
reports do not contain any untrue statement of a material fact. The Act imposes several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the
Companys internal controls; they have made certain disclosures to the Companys auditors and the audit committee of the Board of Directors about the Companys internal controls; and they have included information in the
Companys quarterly and annual reports about their evaluation and whether there have been significant changes in the Companys internal controls or in other factors that could significantly affect internal controls during the last quarter.

In 1970, the U. S. Congress enacted the Fair Credit Reporting Act (the FCRA) in order to ensure the confidentiality, accuracy,
relevancy and proper utilization of consumer credit report information. Under the framework of the FCRA, the United States has developed a highly advanced and efficient credit reporting system. The information contained in that broad system is used
by financial institutions, retailers and other creditors of every size in making a wide variety of decisions regarding financial transactions. Employers and law enforcement agencies have also made wide use of the information collected and maintained
in databases made possible by the FCRA. The FCRA affirmatively preempts state law in a number of areas, including the ability of entities affiliated by common ownership to share and exchange information freely, and the requirements on credit bureaus
to reinvestigate the contents of reports in response to consumer complaints, among others. By its terms, the preemption provisions of the FCRA were to terminate as of December 31, 2003. With the enactment of the Fair and Accurate Transactions
Act (FACT Act) in late 2003, the preemption provisions of FCRA were extended, although the FACT Act imposes additional requirements on entities that gather and share consumer credit information. The FACT Act required the Federal Reserve Board and
the Federal Trade Commission to issue final regulations within nine months of the effective date of the Act. A series of regulations and announcements have been promulgated, including a joint FTC/FRB announcement of effective dates for FCRA
amendments, the FTCs Free Credit Report rule, revisions to the FTCs FACT Act Rules, the FTCs final rules on identity theft and proof of identity, the FTCs final regulation on consumer information and records
disposal, the FTCs final summaries and notices and a final rule on prescreen notices.

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, 2008, the Companys trust preferred securities comprised 20.0% of the sum of the Companys Tier 1 capital.

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
enables the federal government, under terms and conditions to be developed by the Secretary of the Treasury, to insure troubled assets, including mortgage-backed securities, and collect premiums from participating financial institutions. EESA
includes, among other provisions: (a) 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 (b) an increase in the amount of deposit insurance provided by the Federal Deposit Insurance Corporation
(FDIC).

Under the TARP, the Department of Treasury 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. 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 noninterest bearing transaction deposit accounts through
December 31, 2009. The limits are scheduled to return to $100,000 on January 1, 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. The U.S. Treasury Department has indicated more details regarding the FSP are to be announced on a
newly created government website, FinancialStability.gov, in the next several weeks.

On February 17, 2009, the American Recovery and
Reinvestment Act of 2009 (ARRA) was enacted. ARRA is intended 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. The new law also includes numerous non-economic recovery related items, including a limitation on
executive compensation in federally-aided banks.



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Under ARRA, an institution will be subject to the following restrictions and standards throughout the
period in which any obligation arising from financial assistance provided under TARP remains outstanding:



|¡ |  | Limits on compensation incentives for risk-taking by senior executive officers.
|- |  | -------------------------------------------------------------------------------

|¡ |  | Requirement of recovery of any compensation paid based on inaccurate financial information.
|- |  | -------------------------------------------------------------------------------------------

|¡ |  | Prohibition on Golden Parachute Payments.
|- |  | -------------------------------------------

|¡ |  | Prohibition on compensation plans that would encourage manipulation of reported earnings to enhance the compensation of employees.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------

|¡ |  | Publicly registered TARP recipients must establish a board compensation committee comprised entirely of independent directors, for the purpose of reviewing
employee compensation plans.
|- |  | ----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|¡ |  | Prohibition on bonus, retention award, or incentive compensation, except for payments of long term restricted stock.
|- |  | --------------------------------------------------------------------------------------------------------------------

|¡ |  | Limitation on luxury expenditures.
|- |  | ----------------------------------

|¡ |  | TARP recipients are required to permit a separate shareholder vote to approve the compensation of executives, as disclosed pursuant to the SECs
compensation disclosure rules.
|- |  | -------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|¡ |  | The chief executive officer and chief financial officer of each TARP recipient will be required to provide a written certification of compliance with these
standards to the SEC.
|- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

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 workers can continue to pay off their mortgages through the following elements:



|¡ |  | Provide access to low-cost refinancing for responsible homeowners suffering from falling home prices.
|- |  | -----------------------------------------------------------------------------------------------------

|¡ |  | A $75 billion homeowner stability initiative to prevent foreclosure and help responsible families stay in their homes.
|- |  | ----------------------------------------------------------------------------------------------------------------------

|¡ |  | Support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac.
|- |  | -------------------------------------------------------------------------------------

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.

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, 2008, 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



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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 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.



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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.

In December 2008, the Company entered into a Letter Agreement (the Purchase Agreement), with the United States Department of the Treasury (Treasury Department)
pursuant to which the Company has issued and sold to the Treasury Department: (i) 26,918 shares of the Companys Fixed Rate Cumulative Perpetual Preferred Stock, Series A, (ii) and a warrant (the Warrant) to purchase
173,069 shares of the Companys common stock. Section 5.3 of the Purchase Agreement grants the Treasury Department the ability to unilaterally amend any provision of the Purchase Agreement to the extent required to comply with any changes
after the date of the Purchase Agreement in applicable federal statutes. The ability of the Treasury Department to unilaterally amend any provision of the Purchase Agreement presents risks and uncertainties that the Company cannot predict.

The Company is Subject to Additional Government Oversight and Greater Regulatory Uncertainty Through its Participation in the Capital Purchase Program
than Financial Institutions Which Do Not Participate in the Program

For as long as the Company has any obligations outstanding under
the U.S. Treasurys CPP, Alliance is subject to certain restrictions and reporting requirements relative to executive compensation which are significantly more restrictive than financial institutions which do not participate in the CPP. The
most significant restriction, among others, prohibits the payment of incentive compensation and the vesting of equity securities to the Companys five highest paid officers. Currently, the restrictions apply to the Companys CEO, CFO,
Executive Vice-President, Executive Vice-President Credit Administration and Senior Vice President Retail Banking Sales and Service. The Companys inability to pay incentive compensation to its executive officers and other restrictions places
it at a significant competitive disadvantage to financial institutions which do not participate in the CPP, and exposes the Company to a heightened risk of an inability to retain or attract executive officers.

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 Insurance Premiums May Cause Our Earnings to Decrease

The EESA temporarily increased the limit on FDIC coverage to $250,000 for all accounts through December 31, 2009. In addition, we have enrolled in
the Temporary Liquidity Guarantee Program for non-interest bearing transaction deposit accounts. This, along with the full utilization or our assessment credit in early 2009 will cause the premiums assessed by the FDIC to increase. These actions
will significantly increase the Companys non-interest expense in 2009 and in future years as long as the increased premiums are in place.

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 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.



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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 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 people. 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.



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Severe Weather, Natural Disasters, Acts of War or Terrorism and Other External Events Could Significantly Impact the
Companys Business

Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a
significant impact on the Companys ability to conduct business. Such events could affect the stability of the Companys deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing
loans, cause significant property damage, result in loss of revenue and/or cause the Company to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a
material adverse effect on the Companys business, which, in turn, could have a material adverse effect on 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 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 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  Submission of Matters to a Vote of Security Holders

No matter was submitted to a vote of the
Companys security holders during the fourth quarter of the year ended December 31, 2008.



11



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##### Table of Contents

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 961 shareholders of record as of
December 31, 2008. The following table presents stock prices for the Company for 2008 and 2007. Stock prices below are based on daily high and low closing prices for the quarter, as reported on the NASDAQ Global Market.



|            |  |        |  |  |  |        |  |                   |  |  |  |        |  |  |  |        |  |  |  |                  
|----------- |  | ------ |  |  |  | ------ |  | ----------------- |  |  |  | ------ |  |  |  | ------ |  |  |  | -----------------
|            |  | 2008   |  |  |  | 2007  
|            |  | High   |  |  |  | Low    |  | Dividend Declared |  |  |  | High   |  |  |  | Low    |  |  |  | Dividend Declared
|1st Quarter |  | $26.70 |  |  |  | $23.25 |  | $0.24             |  |  |  | $32.27 |  |  |  | $28.43 |  |  |  | $0.22            
|2nd Quarter |  | $27.27 |  |  |  | $21.03 |  | $0.24             |  |  |  | $30.55 |  |  |  | $26.30 |  |  |  | $0.22            
|3rd Quarter |  | $25.00 |  |  |  | $19.56 |  | $0.26             |  |  |  | $26.50 |  |  |  | $24.07 |  |  |  | $0.22            
|4th Quarter |  | $24.54 |  |  |  | $20.00 |  | $0.26             |  |  |  | $26.10 |  |  |  | $23.06 |  |  |  | $0.24            

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.

Prior to December 19, 2011, unless the Company has redeemed the Series A Preferred Stock or the Treasury Department has transferred the
Series A Preferred Stock to a third party, the consent of the Treasury Department will be required for the Company to (1) declare or pay any dividend or make any distribution on its common stock (other than regular quarterly cash dividends
of not more than $0.26 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain
other circumstances specified in the Purchase Agreement.

Stock Repurchases

On November 27, 2007, the Company announced that its Board of Directors had authorized the repurchase of up to 3% of the Companys outstanding common stock, or approximately 143,500
shares, over a 12-month period. The stock purchase plan was completed in the third quarter of 2008.



12



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##### Table of Contents

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 12/31/2003 to 12/31/2008.

LOGO



|                               |  |          |  |          |  |          |  |          |  |          |  |         
|------------------------------ |  | -------- |  | -------- |  | -------- |  | -------- |  | -------- |  | --------
|                               |  | 12/31/03 |  | 12/31/04 |  | 12/31/05 |  | 12/31/06 |  | 12/31/07 |  | 12/31/08
|                               |  |          |  |          |  |         
|Alliance Financial Corporation |  | 100.00   |  | 98.26    |  | 106.26   |  | 108.60   |  | 91.67    |  | 87.37   
|NASDAQ Composite               |  | 100.00   |  | 110.08   |  | 112.88   |  | 126.51   |  | 138.13   |  | 80.47   
|Russell 3000                   |  | 100.00   |  | 111.95   |  | 118.80   |  | 137.47   |  | 144.54   |  | 90.61   
|NASDAQ Bank                    |  | 100.00   |  | 111.11   |  | 108.64   |  | 123.74   |  | 97.71    |  | 74.73   



13



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##### Table of Contents

Item 6  Selected Financial Data

Five-Year Comparative Summary



|                                                                                |  |                                                 |  |             |  |                |  |              |  |             
|------------------------------------------------------------------------------- |  | ----------------------------------------------- |  | ----------- |  | -------------- |  | ------------ |  | ------------
|                                                                                |  | December 31,                                   
|                                                                                |  | 2008                                            |  | 2007        |  | 2006           |  | 2005         |  | 2004        
|Selected Financial Condition Data                                               |  | (In thousands)                                 
|Total assets                                                                    |  | $1,367,358                                      |  | $1,307,014  |  | $1,272,967     |  | $   983,256  |  | $   893,934 
|Loans & leases, net of unearned income                                          |  | 910,755                                         |  | 895,533     |  | 881,411        |  | 654,086      |  | 526,100     
|Allowance for credit losses                                                     |  | 9,161                                           |  | 8,426       |  | 7,029          |  | 4,960        |  | 5,267       
|Securities available-for-sale                                                   |  | 310,993                                         |  | 282,220     |  | 261,987        |  | 265,494      |  | 317,758     
|Goodwill                                                                        |  | 32,073                                          |  | 32,187      |  | 33,456         |  |             |  |            
|Intangible assets, net                                                          |  | 11,528                                          |  | 13,183      |  | 14,912         |  | 9,671        |  |            
|Deposits                                                                        |  | 937,882                                         |  | 945,230     |  | 936,671        |  | 739,118      |  | 623,121     
|Borrowings                                                                      |  | 238,972                                         |  | 200,757     |  | 178,575        |  | 150,429      |  | 181,854     
|Junior subordinated obligations                                                 |  | 25,774                                          |  | 25,774      |  | 25,774         |  | 10,310       |  | 10,310      
|Shareholders equity                                                            |  | 144,481                                         |  | 115,560     |  | 109,506        |  | 69,571       |  | 68,896      
|Common shareholders equity                                                     |  | 117,563                                         |  | 115,560     |  | 109,506        |  | 69,571       |  | 68,896      
|Investment assets under management (Market value, not included in total assets) |  | $   726,019                                     |  | $   971,078 |  | $   927,674    |  | $   862,504  |  | $   282,281 
|                                                                                | 
|                                                                                |  | Year ended December 31,                        
|                                                                                |  | 2008                                            |  | 2007        |  | 2006           |  | 2005         |  | 2004        
|                                                                                |  | (In thousands, except share and per share data)
|Selected Operating Data                                                         |  |                                                 |  |             |  |                |  |              |  |             
|Interest income                                                                 |  | $   67,964                                      |  | $  71,032   |  | $     57,673   |  | $   46,255   |  | $   40,757  
|Interest expense                                                                |  | 30,267                                          |  | 38,550      |  | 29,951         |  | 19,336       |  | 12,684      
|                                                                                |  |                                                 |  |             |  |                |  |              |  |             
|Net interest income                                                             |  | 37,697                                          |  | 32,482      |  | 27,722         |  | 26,919       |  | 28,073      
|Provision for credit losses                                                     |  | 5,502                                           |  | 3,790       |  | 2,477          |  | 144          |  | 984         
|                                                                                |  |                                                 |  |             |  |                |  |              |  |             
|Net interest income after provision for credit losses                           |  | 32,195                                          |  | 28,692      |  | 25,245         |  | 26,775       |  | 27,089      
|Non-interest income                                                             |  | 20,360                                          |  | 21,292      |  | 17,714         |  | 14,238       |  | 9,177       
|                                                                                |  |                                                 |  |             |  |                |  |              |  |             
|Total Operating income                                                          |  | 52,555                                          |  | 49,984      |  | 42,959         |  | 41,013       |  | 36,266      
|                                                                                |  |                                                 |  |             | 
|Non-interest expense                                                            |  | 39,378                                          |  | 37,638      |  | 33,886         |  | 31,352       |  | 27,085      
|                                                                                |  |                                                 |  |             |  |                |  |              |  |             
|Income before taxes                                                             |  | 13,177                                          |  | 12,346      |  | 9,073          |  | 9,661        |  | 9,181       
|Income tax expense                                                              |  | 2,820                                           |  | 2,869       |  | 1,762          |  | 2,154        |  | 1,926       
|                                                                                |  |                                                 |  |             |  |                |  |              |  |             
|Net Income                                                                      |  | $   10,357                                      |  | $    9,477  |  | $       7,311  |  | $     7,507  |  | $     7,255 
|                                                                                |  |                                                 |  |             |  |                |  |              |  |             
|Net income available to common shareholders                                     |  | $   10,310                                      |  | $    9,477  |  | $      7,311   |  | $    7,507   |  | $    7,255  
|                                                                                |  |                                                 |  |             | 
|Stock and Per Share Data                                                        |  |                                                 |  |             |  |                |  |              |  |             
|Basic earnings per common share                                                 |  | $       2.27                                    |  | $      2.01 |  | $         1.92 |  | $       2.09 |  | $       2.03
|Diluted earnings per common share                                               |  | $       2.24                                    |  | $      1.98 |  | $         1.88 |  | $       2.05 |  | $       2.00
|Basic weighted average common shares outstanding                                |  | 4,542,957                                       |  | 4,710,530   |  | 3,804,711      |  | 3,593,864    |  | 3,565,226   
|Diluted weighted average common shares outstanding                              |  | 4,597,624                                       |  | 4,775,883   |  | 3,874,484      |  | 3,664,684    |  | 3,631,806   
|Cash dividends declared                                                         |  | $       1.00                                    |  | $      0.90 |  | $         0.88 |  | $       0.84 |  | $       0.84
|Dividend payout ratio (1)                                                       |  | 44.6%                                           |  | 45.5%       |  | 46.8%          |  | 41.0%        |  | 42.0%       
|Common book value                                                               |  | $     25.67                                     |  | $    24.53  |  | $       22.81  |  | $     19.52  |  | $     19.29 
|Tangible common book value                                                      |  | $     16.15                                     |  | $    14.90  |  | $       12.74  |  | $     16.80  |  | $     19.29 

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



14



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##### Table of Contents

|                                        |  |                         |  |        |  |        |  |        |  |       
|--------------------------------------- |  | ----------------------- |  | ------ |  | ------ |  | ------ |  | ------
|                                        |  | Year ended December 31,
|Selected Financial and Other Data (1)   |  | 2008                    |  | 2007   |  | 2006   |  | 2005   |  | 2004  
|                                        |  |                         |  |        | 
|Performance Ratios:                     |  |                         |  |        |  |        |  |        |  |       
|Return on average assets                |  | 0.78%                   |  | 0.74%  |  | 0.69%  |  | 0.80%  |  | 0.84% 
|Return on average equity                |  | 8.73%                   |  | 8.48%  |  | 9.40%  |  | 10.75% |  | 10.75%
|Return on average common equity         |  | 8.80%                   |  | 8.48%  |  | 9.40%  |  | 10.75% |  | 10.75%
|Non-interest income to total income(2)  |  | 34.86%                  |  | 39.29% |  | 38.99% |  | 34.62% |  | 23.16%
|Efficiency Ratio(3)                     |  | 68.04%                  |  | 70.35% |  | 74.58% |  | 76.14% |  | 74.14%
|                                        |  |                         |  |        | 
|Rate/Yield Information:                 |  |                         |  |        |  |        |  |        |  |       
|Yield on earning assets                 |  | 5.88%                   |  | 6.36%  |  | 6.06%  |  | 5.47%  |  | 5.26% 
|Cost of funds                           |  | 2.87%                   |  | 3.78%  |  | 3.46%  |  | 2.48%  |  | 1.77% 
|Net interest rate spread                |  | 3.01%                   |  | 2.58%  |  | 2.60%  |  | 2.99%  |  | 3.49% 
|Net interest margin (tax equivalent)(4) |  | 3.35%                   |  | 3.02%  |  | 3.02%  |  | 3.28%  |  | 3.69% 

(1) Averages presented are daily averages

(2) 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)

(3) 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)

(4) Tax equivalent net interest income divided by average earning
assets



|                                                                  |  |                                       |  |        |  |        |  |        |  |       
|----------------------------------------------------------------- |  | ------------------------------------- |  | ------ |  | ------ |  | ------ |  | ------
|                                                                  |  | At or for the Year ended December 31,
|                                                                  |  | 2008                                  |  | 2007   |  | 2006   |  | 2005   |  | 2004  
|Asset Quality Ratios                                              |  |                                       |  |        |  |        |  |        |  |       
|Non-performing loans and leases to total loans and leases         |  | 0.49%                                 |  | 0.75%  |  | 0.30%  |  | 0.25%  |  | 0.53% 
|Non-performing assets to total assets                             |  | 0.38%                                 |  | 0.53%  |  | 0.21%  |  | 0.17%  |  | 0.31% 
|Allowance for credit losses to non-performing loans and leases    |  | 204.6%                                |  | 125.7% |  | 266.4% |  | 304.7% |  | 191.5%
|Allowance for credit losses to total loans and leases             |  | 1.01%                                 |  | 0.94%  |  | 0.80%  |  | 0.76%  |  | 1.00% 
|Net charge-offs to average loans and leases                       |  | 0.53%                                 |  | 0.27%  |  | 0.23%  |  | 0.08%  |  | 0.36% 
|                                                                  |  |                                       |  |        | 
|Equity Ratios                                                     |  |                                       |  |        |  |        |  |        |  |       
|Average total common shareholders equity to average total assets |  | 8.86%                                 |  | 8.74%  |  | 7.37%  |  | 7.43%  |  | 7.82% 
|Average tangible common equity to average tangible assets         |  | 5.69%                                 |  | 5.21%  |  | 6.22%  |  | 6.61%  |  | 7.82% 
|                                                                  |  |                                       |  |        | 
|Regulatory Ratios                                                 |  |                                       |  |        |  |        |  |        |  |       
|Consolidated:                                                     |  |                                       |  |        |  |        |  |        |  |       
|Tier 1 (core) capital                                             |  | 9.59%                                 |  | 7.53%  |  | 7.53%  |  | 7.42%  |  | 8.70% 
|Tier 1 risk-based capital                                         |  | 14.05%                                |  | 10.64% |  | 10.42% |  | 10.93% |  | 14.34%
|Total risk-based capital                                          |  | 15.08%                                |  | 11.59% |  | 11.26% |  | 11.72% |  | 15.34%
|Bank:                                                             |  |                                       |  |        |  |        |  |        |  |       
|Tier 1 (core) capital                                             |  | 8.97%                                 |  | 7.26%  |  | 7.00%  |  | 6.75%  |  | 7.79% 
|Tier 1 risk-based capital                                         |  | 13.15%                                |  | 10.34% |  | 9.65%  |  | 9.96%  |  | 12.89%
|Total risk-based capital                                          |  | 14.19%                                |  | 11.30% |  | 10.48% |  | 10.78% |  | 13.89%



15



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##### Table of Contents

Summarized quarterly financial information for the years ended December 31, 2008 and 2007 is as follows:



|                                            |  |                |  |                                                         |  |           |  |           |  |           |  | 
|------------------------------------------- |  | -------------- |  | ------------------------------------------------------- |  | --------- |  | --------- |  | --------- |  | 
|                                            |  | 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  |  | 
|                                            |  |                |  |                                                         |  |           |  |           |  |           |  | 
|                                            |  |                |  |                                                         |  |          
|Basic earnings per share                    |  | $         2.27 |  | $    0.52                                               |  | $    0.66 |  | $    0.63 |  | $    0.45 |  | 
|Diluted earnings per share                  |  | $         2.24 |  | $    0.51                                               |  | $    0.65 |  | $    0.63 |  | $    0.45 |  | 
|Basic weighted average shares outstanding   |  | 4,542,957      |  | 4,492,810                                               |  | 4,545,357 |  | 4,556,157 |  | 4,578,027 |  | 
|Diluted weighted average shares outstanding |  | 4,597,624      |  | 4,546,099                                               |  | 4,597,452 |  | 4,613,726 |  | 4,636,012 |  | 
|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%          |  | 0.70%                                                   |  | 0.92%     |  | 0.87%     |  | 0.63%     |  | 
|Return on average equity                    |  | 8.73%          |  | 7.52%                                                   |  | 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%    |  | 



|                                            |  |               |  |  |  |                                                         |  |           |  |           |  |          
|------------------------------------------- |  | ------------- |  |  |  | ------------------------------------------------------- |  | --------- |  | --------- |  | ---------
|                                            |  |               | 
|                                            |  | Year ended    |  |  |  | Three months ended                                     
|                                            |  | 12/31/07      |  |  |  | 12/31/07                                                |  | 9/30/07   |  | 6/30/07   |  | 3/31/07  
|                                            |  |               |  |  |  | (Dollars in thousands, except share and per share data)
|Total interest income                       |  | $    71,032   |  |  |  | $ 17,978                                                |  | $18,028   |  | $17,649   |  | $17,377  
|Total interest expense                      |  | 38,550        |  |  |  | 9,832                                                   |  | 9,822     |  | 9,600     |  | 9,296    
|                                            |  |               |  |  |  |                                                         |  |           |  |           |  |          
|Net interest income                         |  | 32,482        |  |  |  | 8,146                                                   |  | 8,206     |  | 8,049     |  | 8,081    
|Provision for credit losses                 |  | 3,790         |  |  |  | 1,200                                                   |  | 1,140     |  | 700       |  | 750      
|Non-interest income                         |  | 21,292        |  |  |  | 5,705                                                   |  | 5,432     |  | 5,136     |  | 5,019    
|Non-interest expense                        |  | 37,638        |  |  |  | 9,496                                                   |  | 9,350     |  | 9,541     |  | 9,251    
|                                            |  |               |  |  |  |                                                         |  |           |  |           |  |          
|Income before income taxes                  |  | 12,346        |  |  |  | 3,155                                                   |  | 3,148     |  | 2,944     |  | 3,099    
|Provision for income taxes                  |  | 2,869         |  |  |  | 715                                                     |  | 738       |  | 671       |  | 745      
|                                            |  |               |  |  |  |                                                         |  |           |  |           |  |          
|Net Income                                  |  | $9,477        |  |  |  | $  2,440                                                |  | $ 2,410   |  | $ 2,273   |  | $ 2,354  
|                                            |  |               |  |  |  |                                                         |  |           |  |           |  |          
|                                            |  |               |  |  |  |                                                        
|Basic earnings per share                    |  | $        2.01 |  |  |  | $    0.52                                               |  | $   0.51  |  | $   0.48  |  | $   0.50 
|Diluted earnings per share                  |  | $        1.98 |  |  |  | $    0.51                                               |  | $   0.51  |  | $   0.48  |  | $   0.49 
|Basic weighted average shares outstanding   |  | 4,710,530     |  |  |  | 4,699,106                                               |  | 4,709,334 |  | 4,709,334 |  | 4,724,638
|Diluted weighted average shares outstanding |  | 4,775,883     |  |  |  | 4,752,112                                               |  | 4,756,088 |  | 4,771,091 |  | 4,799,638
|Cash dividends declared per share           |  | $        0.90 |  |  |  | $    0.24                                               |  | $   0.22  |  | $   0.22  |  | $   0.22 
|Net interest margin (tax equivalent)        |  | 3.02%         |  |  |  | 2.98%                                                   |  | 3.04%     |  | 3.01%     |  | 3.04%    
|Return on average assets                    |  | 0.74%         |  |  |  | 0.75%                                                   |  | 0.75%     |  | 0.71%     |  | 0.75%    
|Return on average equity                    |  | 8.48%         |  |  |  | 8.49%                                                   |  | 8.64%     |  | 8.22%     |  | 8.58%    
|Return on average common equity             |  | 8.48%         |  |  |  | 8.49%                                                   |  | 8.64%     |  | 8.22%     |  | 8.58%    
|Non-interest income to total income         |  | 39.29%        |  |  |  | 40.01%                                                  |  | 39.83%    |  | 38.95%    |  | 38.31%   
|Efficiency ratio                            |  | 70.35%        |  |  |  | 69.93%                                                  |  | 68.56%    |  | 72.36%    |  | 70.62%   



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##### Table of Contents

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

The following section presents highlight information from management 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, 2008 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 Forward-Looking Statements and
Risk Factors in Items 1 and 1A, respectively of this Form 10-K.

2008 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.



17



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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,
|                                                                                                        |  |                          |           | 2008            |   |        |                |  |             |  | 2007            |           |  |                |        |             |  | 2006            |  |   |               
|                                                                                                        |  |                          |           |                 |   |        |                |  |            
|                                                                                                        |  | Avg.Balance              |           | Amt. ofInterest |   |        | Avg.Yield/Rate |  | Avg.Balance |  | Amt. ofInterest |           |  | Avg.Yield/Rate |        | Avg.Balance |  | Amt. ofInterest |  |   | Avg.Yield/Rate
|                                                                                                        |  | (Dollars in thousands)  
|Assets:                                                                                                 |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Interest-earning assets:                                                                                |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Federal funds sold                                                                                      |  | $                        | 4,856     |                 | $ | 100    |                |  | 2.06%       |  | $               | 362       |  | $              | 18     |             |  | 4.97%           |  | $ | 2,450          |  | $ | 136    |  |  | 5.55%
|Taxable investment securities                                                                           |  |                          | 189,164   |                 |   | 8,796  |                |  | 4.65%       |  |                 | 174,719   |  |                | 7,929  |             |  | 4.54%           |  |   | 177,027        |  |   | 7,311  |  |  | 4.13%
|Nontaxable investment securities                                                                        |  |                          | 88,667    |                 |   | 5,420  |                |  | 6.11%       |  |                 | 84,987    |  |                | 5,252  |             |  | 6.18%           |  |   | 75,384         |  |   | 4,683  |  |  | 6.21%
|FHLB and FRB stock                                                                                      |  |                          | 11,063    |                 |   | 634    |                |  | 5.73%       |  |                 | 8,741     |  |                | 628    |             |  | 7.18%           |  |   | 6,233          |  |   | 346    |  |  | 5.55%
|Residential real estate loans                                                                           |  |                          | 294,829   |                 |   | 17,442 |                |  | 5.92%       |  |                 | 263,180   |  |                | 15,914 |             |  | 6.05%           |  |   | 204,946        |  |   | 12,438 |  |  | 6.07%
|Commercial loans                                                                                        |  |                          | 207,931   |                 |   | 14,068 |                |  | 6.77%       |  |                 | 211,964   |  |                | 17,058 |             |  | 8.05%           |  |   | 170,919        |  |   | 13,459 |  |  | 7.87%
|Non-taxable commercial loans                                                                            |  |                          | 8,618     |                 |   | 565    |                |  | 6.56%       |  |                 | 8,527     |  |                | 606    |             |  | 7.11%           |  |   | 6,998          |  |   | 476    |  |  | 6.80%
|Taxable leases (net of unearned income)                                                                 |  |                          | 103,726   |                 |   | 6,436  |                |  | 6.20%       |  |                 | 111,182   |  |                | 7,559  |             |  | 6.80%           |  |   | 72,597         |  |   | 5,091  |  |  | 7.01%
|Nontaxable leases (net of unearned income)                                                              |  |                          | 16,284    |                 |   | 1,020  |                |  | 6.26%       |  |                 | 19,259    |  |                | 1,152  |             |  | 5.98%           |  |   | 17,907         |  |   | 1,038  |  |  | 5.80%
|Indirect auto loans                                                                                     |  |                          | 179,762   |                 |   | 10,180 |                |  | 5.66%       |  |                 | 180,688   |  |                | 9,983  |             |  | 5.52%           |  |   | 179,552        |  |   | 9,123  |  |  | 5.08%
|Consumer loans                                                                                          |  |                          | 90,675    |                 |   | 5,685  |                |  | 6.27%       |  |                 | 91,502    |  |                | 7,317  |             |  | 8.00%           |  |   | 72,450         |  |   | 5,680  |  |  | 7.84%
|                                                                                                        |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                
|Total interest-earning assets                                                                           |  |                          | 1,195,575 |                 |   | 70,346 |                |  | 5.88%       |  | $               | 1,155,111 |  | $              | 73,416 |             |  | 6.36%           |  | $ | 986,463        |  | $ | 59,781 |  |  | 6.06%
|Non-interest-earning assets:                                                                            |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Other assets                                                                                            |  |                          | 133,780   |                 |   |        |                |  |             |  |                 | 132,431   |  |                |        |             |  |                 |  |   | 77,155         |  |   |        |  |  |      
|Allowance for credit losses                                                                             |  |                          | (8,686)   |                 |   |        |                |  |             |  |                 | (7,656)   |  |                |        |             |  |                 |  |   | (5,518)        |  |   |        |  |  |      
|Net unrealized gains (losses) on available-for-sale securities                                          |  |                          | 1,867     |                 |   |        |                |  |             |  |                 | (1,712)   |  |                |        |             |  |                 |  |   | (3,227)        |  |   |        |  |  |      
|                                                                                                        |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Total                                                                                                   |  | $                        | 1,322,536 |                 |   |        |                |  |             |  | $               | 1,278,174 |  |                |        |             |  |                 |  | $ | 1,054,873      |  |   |        |  |  |      
|                                                                                                        |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|                                                                                                        |  |                          |           |                 |   |        |                |  |            
|Liabilities and Shareholders Equity:                                                                   |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Demand deposits                                                                                         |  | $                        | 107,204   |                 | $ | 733    |                |  | 0.68%       |  | $               | 97,740    |  | $              | 911    |             |  | 0.93%           |  | $ | 87,221         |  | $ | 519    |  |  | 0.60%
|Savings deposits                                                                                        |  |                          | 86,239    |                 |   | 492    |                |  | 0.57%       |  |                 | 84,764    |  |                | 474    |             |  | 0.56%           |  |   | 62,640         |  |   | 343    |  |  | 0.55%
|MMDA deposits                                                                                           |  |                          | 225,590   |                 |   | 4,732  |                |  | 2.10%       |  |                 | 197,079   |  |                | 6,322  |             |  | 3.21%           |  |   | 176,811        |  |   | 5,141  |  |  | 2.91%
|Time deposits                                                                                           |  |                          | 385,275   |                 |   | 15,277 |                |  | 3.97%       |  |                 | 432,652   |  |                | 20,547 |             |  | 4.75%           |  |   | 378,382        |  |   | 16,161 |  |  | 4.27%
|Borrowings                                                                                              |  |                          | 223,230   |                 |   | 7,634  |                |  | 3.42%       |  |                 | 182,051   |  |                | 8,336  |             |  | 4.58%           |  |   | 144,932        |  |   | 6,648  |  |  | 4.59%
|Junior subordinated obligations issued to unconsolidated subsidiary trusts                              |  |                          | 25,774    |                 |   | 1,399  |                |  | 5.43%       |  |                 | 25,774    |  |                | 1,960  |             |  | 7.60%           |  |   | 14,606         |  |   | 1,139  |  |  | 7.80%
|                                                                                                        |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                
|Total interest-bearing liabilities                                                                      |  | $                        | 1,053,312 |                 |   | 30,267 |                |  | 2.87%       |  | $               | 1,020,060 |  | $              | 38,550 |             |  | 3.78%           |  | $ | 864,592        |  | $ | 29,951 |  |  | 3.46%
|Non-interest-bearing liabilities:                                                                       |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Demand deposits                                                                                         |  |                          | 133,997   |                 |   |        |                |  |             |  |                 | 126,698   |  |                |        |             |  |                 |  |   | 101,266        |  |   |        |  |  |      
|Other liabilities                                                                                       |  |                          | 17,138    |                 |   |        |                |  |             |  |                 | 19,688    |  |                |        |             |  |                 |  |   | 11,239         |  |   |        |  |  |      
|Shareholders equity                                                                                    |  |                          | 118,089   |                 |   |        |                |  |             |  |                 | 111,728   |  |                |        |             |  |                 |  |   | 77,776         |  |   |        |  |  |      
|                                                                                                        |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Total                                                                                                   |  | $                        | 1,322,536 |                 |   |        |                |  |             |  | $               | 1,278,174 |  |                |        |             |  |                 |  | $ | 1,054,873      |  |   |        |  |  |      
|                                                                                                        |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Net interest income (tax equivalent)                                                                    |  |                          |           |                 | $ | 40,079 |                |  |             |  |                 |           |  | $              | 34,866 |             |  |                 |  |   |                |  | $ | 29,830 |  |  |      
|                                                                                                        |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Net interest rate spread                                                                                |  |                          |           |                 |   |        |                |  | 3.01%       |  |                 |           |  |                |        |             |  | 2.58%           |  |   |                |  |   |        |  |  | 2.60%
|Net interest margin (tax equivalent)                                                                    |  |                          |           |                 |   |        |                |  | 3.35%       |  |                 |           |  |                |        |             |  | 3.02%           |  |   |                |  |   |        |  |  | 3.02%
|Federal tax exemption on nontaxable investment securities, loans and leases included in interest income |  |                          |           |                 | $ | 2,382  |                |  |             |  |                 |           |  | $              | 2,384  |             |  |                 |  |   |                |  | $ | 2,108  |  |  |      
|                                                                                                        |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      
|Net interest income                                                                                     |  |                          |           |                 | $ | 37,697 |                |  |             |  |                 |           |  | $              | 32,482 |             |  |                 |  |   |                |  | $ | 27,722 |  |  |      
|                                                                                                        |  |                          |           |                 |   |        |                |  |             |  |                 |           |  |                |        |             |  |                 |  |   |                |  |   |        |  |  |      



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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.



|                                                                           |  |                            |         |      |                            |            |  |   |         |  |      |   |            |  |   |       |  |   |        | 
|-------------------------------------------------------------------------- |  | -------------------------- | ------- | ---- | -------------------------- | ---------- |  | - | ------- |  | ---- | - | ---------- |  | - | ----- |  | - | ------ | 
|                                                                           |  | 2008 Compared to 2007      |         |      | 2007 Compared to 2006      |           
|                                                                           |  | Increase (decrease) due to |         |      | Increase (decrease) due to |           
|                                                                           |  | Volume                     |         | Rate |                            | Net Change |  |   | Volume  |  | Rate |   | Net Change | 
|                                                                           |  |                            |         |     
|                                                                           |  | (In thousands)             |        
|Federal funds sold                                                         |  | $                          | 98      |      | $                          | (16)       |  | $ | 82      |  |      | $ | (105)      |  | $ | (13)  |  | $ | (118)  | 
|Taxable investment securities                                              |  |                            | 668     |      |                            | 199        |  |   | 867     |  |      |   | (96)       |  |   | 714   |  |   | 618    | 
|Non-taxable investment securities                                          |  |                            | 226     |      |                            | (58)       |  |   | 168     |  |      |   | 594        |  |   | (25)  |  |   | 569    | 
|FHLB and FRB stock                                                         |  |                            | 148     |      |                            | (142)      |  |   | 6       |  |      |   | 163        |  |   | 119   |  |   | 282    | 
|Residential real estate loans                                              |  |                            | 1,869   |      |                            | (341)      |  |   | 1,528   |  |      |   | 3,521      |  |   | (45)  |  |   | 3,476  | 
|Commercial loans                                                           |  |                            | (319)   |      |                            | (2,671)    |  |   | (2,990) |  |      |   | 3.297      |  |   | 302   |  |   | 3,599  | 
|Non-taxable commercial loans                                               |  |                            | 6       |      |                            | (47)       |  |   | (41)    |  |      |   | 108        |  |   | 22    |  |   | 130    | 
|Taxable leases, net of unearned income                                     |  |                            | (488)   |      |                            | (635)      |  |   | (1,123) |  |      |   | 2,628      |  |   | (160) |  |   | 2,468  | 
|Non-taxable leases, net of unearned income                                 |  |                            | (184)   |      |                            | 52         |  |   | (132)   |  |      |   | 81         |  |   | 33    |  |   | 114    | 
|Indirect loans                                                             |  |                            | (51)    |      |                            | 248        |  |   | 197     |  |      |   | 58         |  |   | 802   |  |   | 860    | 
|Consumer loans                                                             |  |                            | (66)    |      |                            | (1,566)    |  |   | (1,632) |  |      |   | 1,521      |  |   | 116   |  |   | 1,637  | 
|                                                                           |  |                            |         |      |                            |            |  |  
|Total interest-earning assets                                              |  | $                          | 1,907   |      | $                          | (4,977)    |  | $ | (3,070) |  |      | $ | 11,770     |  | $ | 1,865 |  | $ | 13,635 | 
|                                                                           |  |                            |         |      |                            |           
|Interest-bearing demand deposits                                           |  |                            | 82      |      |                            | (260)      |  |   | (178)   |  |      |   | 69         |  |   | 323   |  |   | 392    | 
|Savings deposits                                                           |  |                            | 9       |      |                            | 9          |  |   | 18      |  |      |   | 125        |  |   | 6     |  |   | 131    | 
|MMDA deposits                                                              |  |                            | 821     |      |                            | (2,411)    |  |   | (1,590) |  |      |   | 621        |  |   | 560   |  |   | 1,181  | 
|Time deposits                                                              |  |                            | (2,102) |      |                            | (3,168)    |  |   | (5,270) |  |      |   | 2,464      |  |   | 1,922 |  |   | 4,386  | 
|Borrowings                                                                 |  |                            | 1,662   |      |                            | (2,364)    |  |   | (702)   |  |      |   | 1,703      |  |   | (15)  |  |   | 1,688  | 
|Junior subordinated obligations issued to unconsolidated subsidiary trusts |  |                            |        |      |                            | (561)      |  |   | (561)   |  |      |   | 850        |  |   | (29)  |  |   | 821    | 
|                                                                           |  |                            |         |      |                            |            |  |  
|Total interest-bearing liabilities                                         |  | $                          | 472     |      | $                          | (8,755)    |  | $ | (8,283) |  |      | $ | 5,832      |  | $ | 2,767 |  | $ | 8,599  | 
|                                                                           |  |                            |         |      |                            |            |  |  
|                                                                           |  |                            |         |      |                            |           
|Net interest income (tax equivalent)                                       |  | $                          | 1,435   |      | $                          | 3,778      |  | $ | 5,213   |  |      | $ | 5,938      |  | $ | (902) |  | $ | 5,036  | 
|                                                                           |  |                            |         |      |                            |            |  |  

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

General

Net income available to common shareholders
for 2008 was $10.3 million, an increase of $833,000, or 8.8%, compared to net income of $9.5 million in 2007. Diluted earnings per share were $2.24 in 2008, an increase of 13.1%, or $0.26 per share, compared to $1.98 per 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 rate of
growth in the Companys net interest margin slowed in the second half of 2008 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.

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.

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. 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 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.



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##### Table of Contents

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 compared with 1.1 years at
December 31, 2007.

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 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,
|                                                        |  | 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. Despite this, the Companys account retention rates remain at levels consistent with our historical norms.

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)% 
|Other non-interest expense          |  |                         | 5,222  |      |   | 4,718  |  |   | 504   |  | 10.7%  
|                                    |  |                         |        |      |   |        |  |   |       |  |        
|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.

Comparison of
Operating Results for the Years Ended December 31, 2007 and 2006

General

Net income for 2007 was $9.5 million, an increase of $2.2 million, or 29.6%, compared to net income of $7.3 million in 2006. Diluted earnings per share were $1.98 in 2007, an increase of 5.3%, or
$0.10 per share, compared to $1.88 per share in 2006.

The increases in net income and diluted earnings per share are due largely to the
impact of the acquisition of Bridge Street in October 2006. The acquisition was also the primary factor behind increases in net interest income, non-interest income and non-interest expense. The provision for credit losses increased in 2007 due
primarily to increases in charge-offs, delinquencies and a general softening of economic and credit conditions in 2007.

Net Interest Income

Net interest income increased $4.8 million or 17.2% due primarily to a $168.6 million increase in average interest earning assets. The
increase in average earning assets resulted primarily from the Bridge Street acquisition and secondarily from organic growth, particularly in our lease portfolio.

The net interest margin on a tax-equivalent basis was 3.02% in 2007 and 2006, as an increase in the Companys cost of funds of 32 basis points in 2007 was substantially offset by a 30 basis point increase in
tax-equivalent earning asset yields.

Loans and leases comprised 76.7% of average earning assets in 2007, compared with 73.5% in 2006. The
higher proportion of earning assets in loans and leases, combined with general upward repricing of the Companys earning-assets in the higher interest rate environment of much of 2007, contributed to an increase in the Companys
tax-equivalent earning asset yield to 6.36% in 2007, compared with 6.06% in 2006.

The Companys cost of funds was 3.78% in 2007,
compared with 3.46% in 2006 due to generally higher market interest rates in 2007 and to the effect of significant competition for deposits in our market, which increased the cost of retaining existing deposits and attracting new deposits.

Reductions in the federal funds rate late in 2007 by the Federal Reserve along with a weakening of national economic conditions
contributed to a decline in short-term market interest rates late in 2007. Both the Companys earning-assets yields and its cost of funds began to decline in the fourth quarter of 2007 as a result.



21



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##### Table of Contents

Non-Interest Income

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



|                                                |  |                          |        |      |   |        |  |   |       |  |         
|----------------------------------------------- |  | ------------------------ | ------ | ---- | - | ------ |  | - | ----- |  | --------
|                                                |  | Years ended December 31,
|                                                |  | 2007                     |        | 2006 |   | Change
|                                                |  | (In thousands)          
|Investment management income                    |  | $                        | 9,180  |      | $ | 8,895  |  | $ | 285   |  | 3.2%    
|Service charges on deposit accounts             |  |                          | 5,296  |      |   | 4,316  |  |   | 980   |  | 22.7%   
|Card-related fees                               |  |                          | 1,942  |      |   | 1,291  |  |   | 651   |  | 50.4%   
|Insurance agency income                         |  |                          | 1,855  |      |   | 615    |  |   | 1,240 |  | 201.6%  
|Income from bank-owned life insurance           |  |                          | 635    |      |   | 455    |  |   | 180   |  | 39.6%   
|Gain on sale of loans                           |  |                          | 192    |      |   | 126    |  |   | 66    |  | 52.4%   
|Losses on sale of securities available-for-sale |  |                          | (12)   |      |   | (2)    |  |   | (10)  |  | (500.0)%
|Other operating income                          |  |                          | 2,204  |      |   | 2,018  |  |   | 186   |  | 9.2%    
|                                                |  |                          |        |      |   |        |  |   |       |  |         
|Total non-interest income                       |  | $                        | 21,292 |      | $ | 17,714 |  | $ | 3,578 |  | 20.2%   
|                                                |  |                          |        |      |   |        |  |   |       |  |         

Total non-interest income increased $3.6 million or 20.2% in 2007 due primarily to the effect of
the full-year impact in 2007 of the Bridge Street acquisition. In addition, organic growth in customer service charges and transaction fees, due in large part to increased customer transaction volumes and greater utilization of debit cards for
consumer purchases contributed to the increases in service charges on deposit accounts and card related fees.

Investment management income
increased in 2007 due to an increase in assets under management resulting from generally higher equity market returns in 2007 and the acquisition of new customers and related assets under management. Rental income from operating leases decreased due
to the Companys planned reduction of operating lease activity.

Approximately 60% of the increase in other non-interest income was
comprised of non-recurring items, including a $283,000 gain on a prepayment of certain equipment leases and an increase in other non-interest income resulted primarily from increases in mortgage servicing fees and miscellaneous customer fees. These
increases were partly offset by a decrease in rental income from operating leases.

Non-interest income comprised 39.3% of total revenue
(non-interest income, net of realized gains and losses on securities and lease prepayment, and net interest income) in 2007 compared with 39.0% in 2006.

Non-Interest Expenses

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



|                                    |  |                         |        |      |   |        |  |   |       |  |        
|----------------------------------- |  | ----------------------- | ------ | ---- | - | ------ |  | - | ----- |  | -------
|                                    |  | Years ended December 31
|                                    |  | 2007                    |        | 2006 |   | Change
|                                    |  | (In thousands)         
|Salaries and employee benefits      |  | $                       | 18,281 |      | $ | 16,607 |  | $ | 1,674 |  | 10.1%  
|Occupancy and equipment expenses    |  |                         | 6,765  |      |   | 6,460  |  |   | 305   |  | 4.7%   
|Communication expense               |  |                         | 827    |      |   | 744    |  |   | 83    |  | 11.2%  
|Office supplies and postage expense |  |                         | 1,236  |      |   | 1,079  |  |   | 157   |  | 14.6%  
|Marketing expense                   |  |                         | 1,237  |      |   | 1,128  |  |   | 109   |  | 9.7%   
|Amortization of intangible assets   |  |                         | 1,729  |      |   | 797    |  |   | 932   |  | 116.9% 
|Professional fees                   |  |                         | 2,845  |      |   | 3,239  |  |   | (394) |  | (12.2)%
|Other non-interest expense          |  |                         | 4,718  |      |   | 3,832  |  |   | 886   |  | 23.1%  
|                                    |  |                         |        |      |   |        |  |   |       |  |        
|Total non-interest expenses         |  | $                       | 37,638 |      | $ | 33,886 |  | $ | 3,752 |  | 11.1%  
|                                    |  |                         |        |      |   |        |  |   |       |  |        

Total non-interest expenses increased $3.8 million or 11.1% in 2007, with increases in all
categories, except marketing, resulting primarily from the incremental costs associated with the operation of the Bridge Street branches and the Ladds insurance agency, the costs associated with processing the increased volume of customer
transactions due to the Bridge Street acquisition and amortization of intangible assets recorded in connection with the acquisition.

Non-interest expenses in 2006 included integration and closing costs of the acquisition totaling approximately $1.1 million, including salaries and benefits of approximately $350,000, stationery expense of $130,000, and professional fees of
$585,000.

The Companys efficiency ratio was 70.4% in 2007, compared with 74.6% in 2006.

Income Tax Expense

The Companys effective tax
rate was 23.2% in 2007 and 19.4% in 2006. The increase in the effective tax rate in 2007 compared with 2006 is primarily attributable to lower non-taxable interest and life insurance income relative to total pre-tax income.



22



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##### Table of Contents

Comparison of Financial Condition at December 31, 2008 and December 31, 2007

General

Total assets increased $60.3 million or
4.6% in 2008, to $1.4 billion at December 31, 2008.

Federal funds sold increased $26.9 million in 2008 upon receipt of proceeds from
the issuance of preferred stock and common stock warrants in December 2008 in connection with the Companys voluntary participation in the Department of the Treasurys Capital Purchase Program (CPP). These funds will be used, along with
the Companys other funding sources and cash flows, to meet the financing needs of credit worthy retail and commercial borrowers in our markets. . The proceeds from the CPP will continue to be segregated from the Companys general
corporate funds during the time that they are drawn down to fund new loan originations.

Securities available-for-sale increased $26.4
million or 9.7%, and total loans and leases, net of unearned income, increased $15.2 million or 1.7% in 2008.

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:



|                                                               |  |                          |         |           |   |               |  |           |         |               |   |           |  |   |         |  |   |        
|-------------------------------------------------------------- |  | ------------------------ | ------- | --------- | - | ------------- |  | --------- | ------- | ------------- | - | --------- |  | - | ------- |  | - | -------
|                                                               |  | Years ended December 31,
|                                                               |  | 2008                     |         | 2007      |   | 2006         
|                                                               |  | AmortizedCost            |         | FairValue |   | AmortizedCost |  | FairValue |         | AmortizedCost |   | FairValue
|                                                               |  | (In thousands)          
|Securities available for sale:                                 |  |                          |         |           |   |               |  |           |         |               |   |           |  |   |         |  |   |        
|Debt securities:                                               |  |                          |         |           |   |               |  |           |         |               |   |           |  |   |         |  |   |        
|U.S. Treasury obligations                                      |  | $                        | 101     |           | $ | 102           |  | $         | 100     |               | $ | 101       |  | $ | 6,839   |  | $ | 6,420  
|Obligations of U.S. government-sponsored corporations          |  |                          | 34,489  |           |   | 35,143        |  |           | 60,902  |               |   | 60,942    |  |   | 62,178  |  |   | 61,452 
|Obligations of states and political subdivisions               |  |                          | 89,154  |           |   | 91,033        |  |           | 87,028  |               |   | 88,580    |  |   | 86,299  |  |   | 87,388 
|Mortgage-backed securities                                     |  |                          | 167,753 |           |   | 169,960       |  |           | 120,258 |               |   | 120,155   |  |   | 97,908  |  |   | 96,163 
|                                                               |  |                          |         |           |   |               |  |           |         |               |   |           |  |   |         |  |   |        
|Total debt securities                                          |  | $                        | 291,497 |           | $ | 296,238       |  | $         | 268,288 |               | $ | 269,778   |  | $ | 253,224 |  | $ | 251,423
|                                                               |  |                          |         |           |   |              
|Stock investments:                                             |  |                          |         |           |   |               |  |           |         |               |   |           |  |   |         |  |   |        
|Equity securities                                              |  |                          | 1,958   |           |   | 1,923         |  |           | 1,934   |               |   | 1,946     |  |   | 1,942   |  |   | 2,111  
|Mutual funds                                                   |  |                          | 1,000   |           |   | 988           |  |           | 1,000   |               |   | 989       |  |   | 500     |  |   | 468    
|                                                               |  |                          |         |           |   |               |  |           |         |               |   |           |  |   |         |  |   |        
|Total stock investments                                        |  |                          | 2,958   |           |   | 2,911         |  |           | 2,934   |               |   | 2,935     |  |   | 2,442   |  |   | 2,579  
|                                                               |  |                          |         |           |   |              
|Total available for sale                                       |  |                          | 294,455 |           |   | 299,149       |  |           | 271,222 |               |   | 272,713   |  |   | 255,666 |  |   | 254,002
|Net unrealized gains (losses) on available-for-sale securities |  |                          | 4,694   |           |   |               |  |           | 1,491   |               |   |           |  |   | (1,664) |  |   |        
|                                                               |  |                          |         |           |   |               |  |           |         |               |   |           |  |   |         |  |   |        
|Total carrying value                                           |  | $                        | 299,149 |           |   |               |  | $         | 272,713 |               |   |           |  | $ | 254,002 |  |   |        
|                                                               |  |                          |         |           |   |               |  |           |         |               |   |           |  |   |         |  |   |        

The Companys investment securities portfolio totaled $299.1 million at December 31,
2008, compared with $272.7 million at December 31, 2007. 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, 2008 is 57% guaranteed mortgage-backed securities, 30% municipal securities and 12% obligations of U.S. Government sponsored corporations. Mortgage-backed securities, which
totaled $170.0 million at December 31, 2008, 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 full faith and
credit of 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.

The Company had net unrealized gains of approximately $4.7 million in its securities portfolio at December 31,
2008, compared with net unrealized gains of $1.5 million at December 31, 2007. The increase in unrealized gains in 2008 resulted primarily from the changes in market interest rates and the levels of risk premiums sought by market participants
during 2008.



23



---

##### Table of Contents

The following table sets forth as of December 31, 2008, 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, 2008               
|                                                      |  | AmountMaturingWithinOne Yearor Less |        | AmountMaturing AfterOne Year butWithin FiveYears |   | AmountMaturing AfterFive Years butWithin Ten Years |  | AmountMaturing AfterTen Years |        | TotalCost
|                                                      |  | (In thousands)                     
|U.S. Treasury obligations                             |  | $                                   |       |                                                  | $ | 101                                                |  | $                             |       |           | $ |       |  | $ | 101    
|Obligations of U.S. government-sponsored corporations |  |                                     | 14,877 |                                                  |   | 19,612                                             |  |                               |       |           |   |       |  |   | 34,489 
|Obligations of states and political subdivisions      |  |                                     | 12,590 |                                                  |   | 48,216                                             |  |                               | 24,374 |           |   | 3,974  |  |   | 89,154 
|Mortgage-backed securities                            |  |                                     | 48,139 |                                                  |   | 82,965                                             |  |                               | 23,022 |           |   | 13,627 |  |   | 167,753
|                                                      |  |                                     |        |                                                  |   |                                                    |  |                               |        |           |   |        |  |   |        
|Total debt securities available-for-sale              |  | $                                   | 75,606 |                                                  | $ | 150,894                                            |  | $                             | 47,396 |           | $ | 17,601 |  | $ | 291,497
|                                                      |  |                                     |        |                                                  |   |                                                    |  |                               |        |           |   |        |  |   |        
|Weighted average yield at year end(1)                 |  |                                     | 4.32%  |                                                  |   | 4.72%                                              |  |                               | 5.30%  |           |   | 4.88%  |  |   | 4.72%  



|(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 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 $9 million per quarter over the next year.

Total loans and leases, net of unearned
income and deferred costs, increased $15.2 million or 1.7% in 2008.

Residential mortgages increased $40.6 million or 14.8% in 2008, and
reached an all-time high of $314.0 million at December 31, 2008. Residential mortgage origination volume increased $29.9 million or 40.8% in 2008 compared with 2007, reaching an all-time high for the Company of $103.2 million in 2008. Alliance
has increased its market share due largely to its focused expansion of and investment in the Companys mortgage business in Central New York over the past two years. 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 outstanding decreased $2.8 million or 1.3% in 2008, reflecting in part, the difficulty in expanding this portfolio in the perennially low-growth markets in which we operate. Until recently,
opportunities for growing our commercial loan portfolio were further limited by aggressive competition predominantly from the larger commercial banks and non-bank lenders operating in our markets, some of whom had offered credit terms (such as
non-recourse and high loan-to-values) against which we chose not to compete. As a result, Alliance declined many potential commercial lending opportunities due to underwriting concessions it was unwilling to make. The more 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. In 2008, originations of commercial loans (excluding lines of credit), totaled approximately $40 million, compared with approximately $43 million in 2007.

Leases (net of unearned income) decreased $26.6 million or 20.3% in 2008 due to the sale of a $10.8 million segment of the portfolio in the second quarter of 2008 and as a result of the Companys previously
announced decision to cease new lease originations in the third quarter of 2008. As noted above, the lease portfolio is expected to continue to run-off at the rate of approximately $9 million per quarter over the next year.

Indirect auto loans increased $6.7 million or 3.8% in 2008, though the portfolio growth was slightly negative in the fourth quarter due to normal
seasonal sales declines which have been exacerbated by the widespread drop in consumer automobile purchases. The Company originated $94.8 million of indirect auto loans in 2008, of which $55.7 million were new vehicles and $39.1 million were late
model pre-owned vehicles. 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 in its direct lending program.



24



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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:



|                               |  |                          |         |         |        |        |   |         |  |        |  |         |         |        |        |         |   |         |  |         |  |   |         |  |        | 
|------------------------------ |  | ------------------------ | ------- | ------- | ------ | ------ | - | ------- |  | ------ |  | ------- | ------- | ------ | ------ | ------- | - | ------- |  | ------- |  | - | ------- |  | ------ | 
|                               |  | Years ended December 31, |        
|                               |  | 2008                     |         | 2007    |        | 2006   |   | 2005    |  | 2004   | 
|                               |  | Amount                   |         | Percent |        | Amount |   | Percent |  | Amount |  | Percent |         | Amount |        | Percent |   | Amount  |  | Percent | 
|                               |  | (Dollars in thousands)   |        
|Residential real estate        |  | $                        | 314,039 |         | 34.6%  |        | $ | 273,465 |  | 30.6%  |  | $       | 252,134 |        | 28.7%  |         | $ | 185,760 |  | 28.5%   |  | $ | 175,851 |  | 33.6%  | 
|Commercial loans               |  |                          | 214,315 |         | 23.6%  |        |   | 217,136 |  | 24.4%  |  |         | 223,600 |        | 25.4%  |         |   | 162,408 |  | 24.8%   |  |   | 154,188 |  | 29.4%  | 
|Leases, net of unearned Income |  |                          | 104,655 |         | 11.6%  |        |   | 131,300 |  | 14.7%  |  |         | 131,048 |        | 14.9%  |         |   | 65,172  |  | 10.0%   |  |   | 13,762  |  | 2.6%   | 
|Indirect auto loans            |  |                          | 182,807 |         | 20.2%  |        |   | 176,115 |  | 19.7%  |  |         | 181,929 |        | 20.7%  |         |   | 172,113 |  | 26.4%   |  |   | 117,623 |  | 22.4%  | 
|Other consumer loans           |  |                          | 90,906  |         | 10.0%  |        |   | 94,246  |  | 10.6%  |  |         | 90,438  |        | 10.3%  |         |   | 66,981  |  | 10.3%   |  |   | 62,956  |  | 12.0%  | 
|                               |  |                          |         |        
|                               |  |                          | 906,722 |         | 100.0% |        |   | 892,262 |  | 100.0% |  |         | 879,149 |        | 100.0% |         |   | 652,434 |  | 100.0%  |  |   | 524,380 |  | 100.0% | 
|                               |  |                          |         |         |        |        |   |         |  |        |  |         |         |        |        |         |   |         |  |         |  |   |         |  |        | 
|Net deferred loan costs        |  |                          | 4,033   |         |        |        |   | 3,271   |  |        |  |         | 2,262   |        |        |         |   | 1,652   |  |         |  |   | 1,720   |  |        | 
|                               |  |                          |         |         |        |        |   |         |  |        |  |         |         |        |        |         |   |         |  |         |  |   |         |  |        | 
|Total loans and leases         |  |                          | 910,755 |         |        |        |   | 895,533 |  |        |  |         | 881,411 |        |        |         |   | 654,086 |  |         |  |   | 526,100 |  |        | 
|Allowance for credit losses    |  |                          | (9,161) |         |        |        |   | (8,426) |  |        |  |         | (7,029) |        |        |         |   | (4,960) |  |         |  |   | (5,267) |  |        | 
|                               |  |                          |         |         |        |        |   |         |  |        |  |         |         |        |        |         |   |         |  |         |  |   |         |  |        | 
|Net Loans and Leases           |  | $                        | 901,594 |         |        |        | $ | 887,107 |  |        |  | $       | 874,382 |        |        |         | $ | 649,126 |  |         |  | $ | 520,833 |  |        | 
|                               |  |                          |         |         |        |        |   |         |  |        |  |         |         |        |        |         |   |         |  |         |  |   |         |  |        | 

The following table shows the amount of loans and leases outstanding as of December 31, 2008,
which, based on remaining scheduled payments of principal, are due in the periods indicated:



|                                             |  |                                 |  |                                            |  |                                            |  |                            |  |           
|-------------------------------------------- |  | ------------------------------- |  | ------------------------------------------ |  | ------------------------------------------ |  | -------------------------- |  | ----------
|                                             |  | Maturing withinone year or less |  | Maturingafter one but    within five years |  | Maturing after    five butwithin ten years |  | Maturing    afterten years |  | Total     
|                                             |  | (In thousands)                 
|Residential real estate                      |  | $    15,550                     |  | $    59,217                                |  | $    83,420                                |  | $  155,852                 |  | $  314,039
|Commercial loans                             |  | 64,938                          |  | 74,305                                     |  | 39,898                                     |  | 35,174                     |  | 214,315   
|Leases, net of unearned income               |  | 31,072                          |  | 61,003                                     |  | 10,699                                     |  | 1,881                      |  | 104,655   
|Indirect auto loans                          |  | 59,569                          |  | 121,416                                    |  | 1,822                                      |  |                           |  | 182,807   
|Other consumer loans                         |  | 20,029                          |  | 42,632                                     |  | 22,359                                     |  | 5,886                      |  | 90,906    
|                                             |  |                                 |  |                                            |  |                                            |  |                            |  |           
|Total loans & leases, net of unearned income |  | $  191,158                      |  | $  358,573                                 |  | $  158,198                                 |  | $  198,793                 |  | $  906,722
|                                             |  |                                 |  |                                            |  |                                            |  |                            |  |           

The following table sets forth the sensitivity to changes in interest rates as of
December 31, 2008:



|                                          |  |                |         |               |   |         |  |   |        
|----------------------------------------- |  | -------------- | ------- | ------------- | - | ------- |  | - | -------
|                                          |  | Fixed Rate     |         | Variable Rate |   | Total  
|                                          |  | (In thousands)
|Due after one year, but within five years |  | $              | 280,810 |               | $ | 77,763  |  | $ | 358,573
|Due after five years                      |  |                | 175,100 |               |   | 181,891 |  |   | 356,991

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, 2008      |        |  | December 31, 2007 | 
|                                    |  | $                      |        |  | %(1)              |  |  | $ |        |  | %(1)  | 
|                                    |  | (Dollars in thousands) |       
|30 days past due                    |  | $                      | 11,124 |  | 1.22%             |  |  | $ | 8,633  |  | 0.97% | 
|60 days past due                    |  |                        | 4,736  |  | 0.52%             |  |  |   | 1,042  |  | 0.12% | 
|90 days past due and still accruing |  |                        | 126    |  | 0.01%             |  |  |   | 39     |  |      | 
|Non-accrual                         |  |                        | 4,352  |  | 0.48%             |  |  |   | 6,667  |  | 0.75% | 
|                                    |  |                        |        |  |                   |  |  |  
|Total                               |  | $                      | 20,338 |  | 2.23%             |  |  | $ | 16,381 |  | 1.84% | 
|                                    |  |                        |        |  |                   |  |  |  

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

Weaknesses in the local, state and national economies contributed, in part, to an increase in delinquent loans and leases in the fourth quarter and full
year of 2008. Loans and leases past due 30 days or more totaled $20.3 million or 2.23% of total loans and leases at December 31, 2008, compared with $10.9 million or 1.20% at September 30, 2008 and $16.4 million or 1.84% at
December 31, 2007. Approximately 55% of all delinquent loans and leases at the end of 2008 were past due for one payment, and 23% were two payments past due. The largest increase in delinquencies was in the Companys lease portfolio, with
$6.7 million past due 30 days or more at December 31, 2008, compared with $1.1 million at September 30, 2008 and $1.6 million at December 31, 2007. Residential mortgages past due 30 days or more totaled $6.7 million at
December 31, 2008, compared with $4.9 million at September 30, 2008 and $5.9 million at December 31, 2007. Commercial loans past due 30 days or more totaled $5.5 million at December 31, 2008, compared with $3.9 million at
September 30, 2008 and $7.0 million at December 31, 2007.



25



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##### Table of Contents

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



|                                                                |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       
|--------------------------------------------------------------- |  | -------------- | ------ | ---- | - | ------ |  | ---- | ------ | ---- | - | ------ |  | - | ------
|                                                                |  | December 31,  
|                                                                |  | 2008           |        | 2007 |   | 2006   |  | 2005 |        | 2004
|                                                                |  | (In thousands)
|Non-accrual loans and leases:                                   |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       
|Residential real estate                                         |  | $              | 1,506  |      | $ | 1,118  |  | $    | 298    |      | $ | 12     |  | $ | 168   
|Commercial                                                      |  |                | 1,997  |      |   | 4,988  |  |      | 1,248  |      |   | 1,103  |  |   | 2,116 
|Leases                                                          |  |                | 595    |      |   | 320    |  |      | 99     |      |   |       |  |   |      
|Indirect auto                                                   |  |                | 101    |      |   | 83     |  |      | 63     |      |   | 74     |  |   | 90    
|Consumer                                                        |  |                | 153    |      |   | 158    |  |      | 141    |      |   | 169    |  |   | 60    
|                                                                |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       
|Total non-accrual loans and leases                              |  |                | 4,352  |      |   | 6,667  |  |      | 1,849  |      |   | 1,358  |  |   | 2,434 
|                                                                |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       
|Accruing loans and leases past due 90 days or more              |  |                | 126    |      |   | 39     |  |      | 790    |      |   | 270    |  |   | 317   
|                                                                |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       
|Total non-performing loans                                      |  |                | 4,478  |      |   | 6,706  |  |      | 2,639  |      |   | 1,628  |  |   | 2,751 
|Other real estate owned and other repossessed assets            |  |                | 657    |      |   | 229    |  |      | -      |      |   | 6      |  |   | 53    
|                                                                |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       
|Total non-performing assets                                     |  | $              | 5,135  |      | $ | 6,935  |  | $    | 2,639  |      | $ | 1,634  |  | $ | 2,804 
|                                                                |  |                |        |      |   |        |  |      |        |      |   |        |  |   |       
|Total non-performing loans and leases to total loans and leases |  |                | 0.49%  |      |   | 0.75%  |  |      | 0.30%  |      |   | 0.25%  |  |   | 0.53% 
|Total non-performing assets to total assets                     |  |                | 0.38%  |      |   | 0.53%  |  |      | 0.21%  |      |   | 0.17%  |  |   | 0.31% 
|Allowance for credit losses to non-performing loans and leases  |  |                | 204.6% |      |   | 125.7% |  |      | 266.4% |      |   | 304.7% |  |   | 191.5%
|Allowance for credit losses to total loans and leases           |  |                | 1.01%  |      |   | 0.94%  |  |      | 0.80%  |      |   | 0.76%  |  |   | 1.00% 

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 $5.1 million or 0.38% of total assets at December 31, 2008, compared with $6.9 million or 0.53% of total assets at December 31, 2007. Conventional
residential mortgages comprised $1.5 million (22 loans) or 33.6% of nonperforming loans and leases at December 31, 2008. Commercial loans on nonaccrual status decreased $3.0 million in 2008, and totaled $2.0 million (16 loans) or 44.6% of
nonperforming loans and leases at the end of 2008. The decrease in nonaccrual commercial loans in 2008 is due primarily to principal pay downs (including $600,000 in cash collected in the fourth quarter of 2008), collateral liquidation and
charge-offs with respect to the two largest nonperforming loans (totaling $2.8 million) at the end of 2007.

As a recurring part of its
portfolio management program, the Company has identified approximately $13.3 million in potential problem loans at December 31, 2008, as compared to $5.4 million at December 31, 2007. The average balance of such potential problem loans was
$333,000 and $208,000 at December 31, 2008 and December 31, 2007, 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, 2008, 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 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 $264,000 in 2008, $202,000 in 2007, and $40,000
in 2006. 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, 2008, there was $1.1 million in impaired loans for which $193,000 in related allowance for credit losses was allocated. There was $4.2 million in impaired
loans for which $1.3 million in related allowance for credit losses was allocated as of December 31, 2007.

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 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.



26



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##### Table of Contents

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,
|                                                       |  | 2008                     |       | 2007 |   | 2006  |  | 2005 |       | 2004
|                                                       |  | (In thousands)          
|Balance at beginning of year                           |  | $                        | 8,426 |      | $ | 7,029 |  | $    | 4,960 |      | $ | 5,267 |  | $ | 6,069
|Loans and leases charged-off:                          |  |                          |       |      |   |       |  |      |       |      |   |       |  |   |      
|Residential real estate                                |  |                          | 276   |      |   | 103   |  |      | 33    |      |   | 39    |  |   | 123  
|Commercial loans                                       |  |                          | 1,940 |      |   | 545   |  |      | 689   |      |   | 393   |  |   | 1,271
|Leases                                                 |  |                          | 1,844 |      |   | 881   |  |      | 560   |      |   |      |  |   |     
|Indirect auto                                          |  |                          | 295   |      |   | 211   |  |      | 195   |      |   | 296   |  |   | 531  
|Consumer                                               |  |                          | 1,284 |      |   | 1,487 |  |      | 913   |      |   | 360   |  |   | 265  
|                                                       |  |                          |       |      |   |       |  |      |       |      |   |       |  |   |      
|Total loans and leases charged off                     |  |                          | 5,639 |      |   | 3,227 |  |      | 2,390 |      |   | 1,088 |  |   | 2,190
|Recoveries of loans and leases previously charged off: |  |                          |       |      |   |       |  |      |       |      |   |       |  |   |      
|Residential real estate                                |  |                          | 32    |      |   | 1     |  |      | 1     |      |   | 45    |  |   | 10   
|Commercial loans                                       |  |                          | 113   |      |   | 48    |  |      | 59    |      |   | 209   |  |   | 52   
|Leases                                                 |  |                          | 40    |      |   | 13    |  |      |      |      |   |      |  |   |     
|Indirect auto                                          |  |                          | 91    |      |   | 119   |  |      | 213   |      |   | 191   |  |   | 218  
|Consumer                                               |  |                          | 596   |      |   | 653   |  |      | 412   |      |   | 192   |  |   | 124  
|                                                       |  |                          |       |      |   |       |  |      |       |      |   |       |  |   |      
|Total recoveries                                       |  |                          | 872   |      |   | 834   |  |      | 685   |      |   | 637   |  |   | 404  
|                                                       |  |                          |       |      |   |       |  |      |       |      |   |       |  |   |      
|Net loans and leases charged off                       |  |                          | 4,767 |      |   | 2,393 |  |      | 1,705 |      |   | 451   |  |   | 1,786
|Provision for credit losses                            |  |                          | 5,502 |      |   | 3,790 |  |      | 2,477 |      |   | 144   |  |   | 984  
|Allowance acquired from Bridge Street Financial Inc.   |  |                          |      |      |   |      |  |      | 1,297 |      |   |      |  |   |     
|                                                       |  |                          |       |      |   |       |  |      |       |      |   |       |  |   |      
|Balance at end of year                                 |  | $                        | 9,161 |      | $ | 8,426 |  | $    | 7,029 |      | $ | 4,960 |  | $ | 5,267
|                                                       |  |                          |       |      |   |       |  |      |       |      |   |       |  |   |      

The provision for credit losses was $5.5 million in 2008, compared with $3.8 million in 2007. Net
charge-offs were $4.8 million in 2008, compared with $2.4 million in 2007. Total charge-offs in 2008 were impacted by comprehensive liquidation strategies implemented in the first quarter on the two largest non-performing commercial relationships at
that time, which resulted in charge-offs of $1.2 million or 65% of the first quarters total gross charge-offs. Net charge-offs in the fourth quarter of 2008 were $1.7 million compared with $637,000 in the fourth quarter of 2007. The increase
in charge-offs in the fourth quarter related largely to deterioration in specific segments of the Companys equipment lease portfolio. In the fourth quarter of 2008, the Company took aggressive action to address the challenges in these
segments, including charge downs and repossession of leased equipment. The net outstanding balance of the affected segments of the portfolio was approximately $10 million at December 31, 2008.

The Companys increased level of credit loss provisions in 2008 is a reflection of generally higher levels of loan delinquencies and charge-offs in
2008, a higher level of classified loans, and managements assessment of the potential impact on the Companys portfolio of macroeconomic factors and credit market conditions affecting the financial institutions sector generally.

Net charge-offs equaled 0.53% of average loans and leases in 2008 (0.74% annualized rate in the fourth quarter of 2008), compared with
0.27% in 2007 (0.29% annualized rate in the fourth quarter of 2007). The provision for credit losses as a percentage of net charge-offs was 115.4% in 2008, compared with 158.4% in 2007. The decrease in the ratio of the provision for credit losses to
net charge-offs in 2008 was largely the result of provision recorded by the Company in 2007 on impaired loans which were charged down to their estimated collectible amounts in the first quarter of 2008.

The allowance for credit losses was $9.2 million at December 31, 2008, compared with $8.4 million at December 31, 2007. The ratio of the
allowance for credit losses to total loans and leases was 1.01% at December 31, 2008, compared with 0.94% at December 31, 2007. The ratio of the allowance for credit losses to nonperforming loans and leases was 204.6% at December 31,
2008, compared with 125.7% at December 31, 2007.



27



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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):



|                        |  |                    |  |                              |  |      |  |                    |  |                              |  |  |  |                    |  |                              |  |      |  |                    |  |                                |  |  |  |                    |  |                             
|----------------------- |  | ------------------ |  | ---------------------------- |  | ---- |  | ------------------ |  | ---------------------------- |  |  |  | ------------------ |  | ---------------------------- |  | ---- |  | ------------------ |  | ------------------------------ |  |  |  | ------------------ |  | ----------------------------
|                        |  | December 31,      
|                        |  | 2008               |  |                              |  | 2007 |  |                    |  | 2006                         |  |  |  | 2005               |  |                              |  | 2004
|                        |  | Amount ofAllowance |  | Percentof Loansto TotalLoans |  |      |  | Amount ofAllowance |  | Percentof Loansto TotalLoans |  |  |  | Amount ofAllowance |  | Percentof Loansto TotalLoans |  |      |  | Amount ofAllowance |  | Percent of Loans to TotalLoans |  |  |  | Amount ofAllowance |  | Percentof Loansto TotalLoans
|                        |  |                    |  |                              |  |      |  |                    |  |                              |  |  |  |                    |  |                              |  |     
|Residential real estate |  | $     850          |  | 34.6%                        |  |      |  | $     978          |  | 30.6%                        |  |  |  | $     969          |  | 28.7%                        |  |      |  | $     653          |  | 28.5%                          |  |  |  | $    689           |  | 33.6%                       
|Commercial              |  | 3,988              |  | 23.6%                        |  |      |  | 4,097              |  | 24.4%                        |  |  |  | 3,143              |  | 25.4%                        |  |      |  | 2,521              |  | 24.8%                          |  |  |  | 2,714              |  | 29.4%                       
|Leases                  |  | 2,673              |  | 11.6%                        |  |      |  | 1,951              |  | 14.7%                        |  |  |  | 1,468              |  | 14.9%                        |  |      |  | 385                |  | 10.0%                          |  |  |  | 51                 |  | 2.6%                        
|Indirect auto           |  | 879                |  | 20.2%                        |  |      |  | 685                |  | 19.7%                        |  |  |  | 785                |  | 20.7%                        |  |      |  | 1,099              |  | 26.4%                          |  |  |  | 1,447              |  | 22.4%                       
|Consumer                |  | 771                |  | 10.0%                        |  |      |  | 715                |  | 10.6%                        |  |  |  | 664                |  | 10.3%                        |  |      |  | 302                |  | 10.3%                          |  |  |  | 366                |  | 12.0%                       
|                        |  |                    |  |                              |  |      |  |                    |  |                              |  |  |  |                    |  |                              |  |      |  |                    |  |                                |  |  |  |                    |  |                             
|Total                   |  | $  9,161           |  | 100.0%                       |  |      |  | $  8,426           |  | 100.0%                       |  |  |  | $  7,029           |  | 100.0%                       |  |      |  | $  4,960           |  | 100.00%                        |  |  |  | $  5,267           |  | 100.00%                     
|                        |  |                    |  |                              |  |      |  |                    |  |                              |  |  |  |                    |  |                              |  |      |  |                    |  |                                |  |  |  |                    |  |                             

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, 2008 |         | December 31, 2007
|                      |  | Retail            |         | Commercial        |          | Municipal |          | Total |   | Percent |  | Retail |  | Commercial |         | Municipal |          | Total |             | Percent
|Non-interest checking |  | $                 | 35,685  |                   | $101,423 |           | $3,737   |       | $ | 140,845 |  | 15.0%  |  | $          | 35,133  |           | $100,598 |       | $     2,960 |         | $ | 138,691 |  | 14.6% 
|Interest checking     |  |                   | 82,096  |                   | 11,134   |           | 13,062   |       |   | 106,292 |  | 11.3%  |  |            | 77,368  |           | 9,636    |       | 14,789      |         |   | 101,793 |  | 10.8% 
|Total checking        |  |                   | 117,781 |                   | 112,557  |           | 16,799   |       |   | 247,137 |  | 26.3%  |  |            | 112,501 |           | 110,234  |       | 17,749      |         |   | 240,484 |  | 25.4% 
|                      |  |                   |         |                   |          |           |          |       |   |        
|Savings               |  |                   | 76,811  |                   | 8,049    |           | 3,382    |       |   | 88,242  |  | 9.4%   |  |            | 74,283  |           | 6,498    |       | 1,545       |         |   | 82,326  |  | 8.7%  
|Money market          |  |                   | 74,597  |                   | 45,471   |           | 127,324  |       |   | 247,392 |  | 26.4%  |  |            | 70,684  |           | 43,565   |       | 88,826      |         |   | 203,075 |  | 21.5% 
|Time deposits         |  |                   | 296,381 |                   | 20,189   |           | 38,541   |       |   | 355,111 |  | 37.9%  |  |            | 352,760 |           | 22,897   |       | 43,688      |         |   | 419,345 |  | 44.4% 
|                      |  |                   |         |                   |          |           |          |       |   |        
|Total deposits        |  | $                 | 565,570 |                   | $186,266 |           | $186,046 |       | $ | 937,882 |  | 100.0% |  | $          | 610,228 |           | $183,194 |       | $151,808    |         | $ | 945,230 |  | 100.0%
|                      |  |                   |         |                   |          |           |          |       |   |         |  |        |  |            |         |           |          |       |             |         |   |         |  |       

Total deposits decreased $7.3 million or 0.8% in 2008 as a decrease in high-rate, short-term time
accounts resulting from the Companys de-emphasis of these types of accounts was substantially offset by growth in lower rate checking, savings and money market accounts. The Companys liability mix changed favorably during 2008 as it
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. Transaction accounts increased $56.9 million in 2008 and
comprised 62.1% of total deposits at the end of 2008, compared with 55.6% at December 31, 2007. During 2008, the Company added a net 4,400 in new transaction accounts, due largely to business development efforts focusing on these lower cost
accounts and to a greater awareness of the Alliance brand in our markets. These increases largely offset decreases in time accounts of $64.2 million in 2008 as the Company actively managed its deposit pricing and promotional rate structure in order
to reduce its reliance on high-rate, short-term retail time accounts.

Time deposits in excess of $100,000, which tend to be more volatile
and sensitive to interest rates, totaled $102.0 million at December 31, 2008, representing 28.7% of total time deposits and 10.9% of total deposits. These deposits totaled $117.0 million, representing 27.9% of total time deposits and 12.4% of
total deposits at year-end 2007.

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, 2008 (in thousands):



|                           |  |   |        
|-------------------------- |  | - | -------
|Less than three months     |  | $ | 17,981 
|Three months to six months |  |   | 28,994 
|Six months to one year     |  |   | 33,949 
|Over one year              |  |   | 21,045 
|                           |  |   |        
|Total                      |  | $ | 101,969
|                           |  |   |        



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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, 2008, retail repurchase agreement balances amounted to $40.5 million compared to balances of $52.8 million at December 31,
2007.

During 2008, 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, 2008, the combination of repurchase agreements and FHLB advances were $198.5 million, compared to $148.0 million at December 31,
2007. Detailed information regarding the Companys borrowings is included in Note 7 in the consolidated financial statements section of this report.

Capital

Shareholders equity was $144.5 million at December 31, 2008, compared with $115.6 million at
December 31, 2007. In December 2008, the Company received $26.9 million from its voluntary participation in the CPP. In the transaction, the Treasury Department purchased 26,918 shares of newly issued, non-voting senior preferred stock for
$26.9 million, with an initial annual dividend rate of 5%. The U.S. Treasury also received a 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 or 15% of the preferred stock investment. In addition to this transaction, shareholders equity increased $5.8 million in 2008 from net income of $10.4 million which was partially offset by dividends declared of $4.6 million. In
2008 the Company purchased 143,900 shares of its stock for a total of $3.4 million, or an average price per share of $23.84 per share.

The
Companys Tier 1 leverage ratio was 9.6% and its total risk-based capital ratio was 15.1% 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, 2008, 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 and lease 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, 2008, 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, 2008, cash and cash equivalents increased by $17.4 million as net cash provided by operating activities and financing activities of $82.0 million exceeded the net cash used in investing activities of $64.7 million. Net cash
provided by financing activities reflects the $26.9 million in proceeds from the issuance of preferred stock and a net increase in borrowings of $38.2 million, partly offset by a $7.3 million net decrease in deposits, treasury stock purchases of
$3.4 million and cash dividends paid of $4.6 million. Net cash used in investing activities primarily results from a net increase in loans and leases of $31.5 million, a net increase in investment securities of $23.3 million, and a $7.0 million
purchase of bank-owned life insurance.

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, 2008, the Banks credit limit with the FHLB was $245.9 million with outstanding borrowings in the amount of $175.7
million.

The Company had a $151.8 million line of credit at December 31, 2008 with the Federal Reserve Bank of New York through its
Discount Window. The Company has pledged indirect loans and securities totaling $183.4 million and $5.2 million, respectively, at December 31, 2008. The Company did not draw any funds on this line of credit in 2008. At December 31, 2008
and 2007, the Company also had available $35.5 million of federal funds lines of credit with other financial institutions, none of which was in use at December 31, 2008 and 2007, 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



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securities have a variable annual coupon rate that resets quarterly based upon three-month LIBOR plus 285 basis points (6.32% at December 31, 2008). 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 (3.65% at December 31, 2008). The capital securities have a 30-year maturity and are redeemable at par in September 2011 and any time thereafter.

In December 2008, the Company entered into a Purchase Agreement with the Treasury Department pursuant to which the Company has issued and sold to the Treasury Department: (i) 26,918
shares of the Series A Preferred Stock, having a liquidation amount per share equal to $1,000, for a total price of $26,918,000 (ii) and a Warrant to purchase 173,069 shares of the Companys common stock at an exercise price per share
of $23.33.

The Series A Preferred Stock pays cumulative dividends at a rate of 5% per annum for the first five years and
thereafter at a rate of 9% per annum. The Company may not redeem the Series A Preferred Stock during the first three years except with the proceeds from a qualified equity offering. After three years, the Company may, at its
option, redeem the Series A Preferred Stock at the liquidation amount plus accrued and unpaid dividends. The Series A Preferred Stock is generally non-voting. The ARRA now provides an opportunity for TARP recipients to immediately repay a
TARP financing assistance without first needing to raise any funds, subject to the consultation by the Treasury Department with the appropriate federal banking agency. The nature of the consultation process is not defined under the ARRA, and banking
regulators might seek to require a withdrawing TARP recipient to raise additional funds from third parties if the regulators determine that there are not otherwise sufficient capital reserves. Under repayment, the Treasury Department is required to
liquidate any warrants it received from the Company.

Future federal statutes may contain retroactive restrictions which may adversely
affect our ability to comply with the terms of the Purchase Agreement or effectively manage our business, and therefore, we may choose to redeem the preferred shares issued under the CPP.

Prior to December 19, 2011, and unless the Company has redeemed all of the Series A Preferred Stock or the Treasury Department has transferred all of the Series A Preferred Stock
to a third party, the approval of the Treasury Department will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital securities, other than in certain circumstances specified in
the Purchase Agreement.

The Warrant has a ten year term and is immediately exercisable. The Warrant provides for the adjustment of the
exercise price and the number of shares of the Companys common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the
Companys common stock, and upon certain issuances of the Companys common stock at or below a specified price relative to the then current market price of the Companys common stock. If, on or prior to December 31, 2009, the
Company receives aggregate gross cash proceeds of not less than the purchase price of the Series A Preferred Stock from one or more qualified equity offerings, the number of shares of common stock issuable pursuant to the Warrant
will be reduced by one-half of the original number of shares, taking into account all adjustments. Pursuant to the Purchase Agreement, the Treasury Department has agreed not to exercise voting power with respect to any shares of common stock issued
upon exercise of the Warrant.

Both the Series A Preferred Stock and Warrant will be accounted for as components of the Companys
Tier 1 capital.

The Series A Preferred Stock and the Warrant were issued in a private placement exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933, as amended. The Company has agreed to register for resale the Series A Preferred Stock, the Warrant and the shares of common stock underlying the Warrant (the Warrant Shares), as soon
as practicable after the date of the issuance of the Series A Preferred Stock and the Warrant. Neither the Series A Preferred Stock nor the Warrant will be subject to any contractual restrictions on transfer, except that the Treasury
Department may only transfer or exercise an aggregate of one-half of the Warrant Shares prior to the earlier of the date on which the Company receives aggregate gross cash proceeds of not less than the purchase price of the Series A Preferred
Stock from one or more qualified equity offerings and December 31, 2009.

Prior to December 19, 2011, unless the
Company has redeemed the Series A Preferred Stock or the Treasury Department has transferred the Series A Preferred Stock to a third party, the consent of the Treasury Department will be required for the Company to (1) declare or pay
any dividend or make any distribution on its common stock (other than regular quarterly cash dividends of not more than $0.26 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or
capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Purchase Agreement.

In addition, under the Certificate of Designations, the Companys ability to declare or pay dividends or repurchase its common stock or other equity or capital securities will be subject to restrictions in the
event that it fails to declare and pay (or set aside for payment) full dividends on the Series A Preferred Stock.



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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, 2008, 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       
|                                                                       |  | NoteReference |  | One Yearor Less        |         | One toThree Years |   | Three toFive Years |  | Over FiveYears |        | Total
|                                                                       |  |               |  | (Dollars in thousands)
|Time deposits*                                                         |  | 6             |  | $                      | 255,645 |                   | $ | 69,148             |  | $              | 30,318 |       | $ |       |  | $ | 355,111
|Borrowings*                                                            |  | 7             |  |                        | 108,972 |                   |   | 65,000             |  |                | 25,000 |       |   | 40,000 |  |   | 238,972
|Junior subordinated obligations issued to unconsolidated subsidiaries* |  | 8             |  |                        |        |                   |   |                   |  |                |       |       |   | 25,774 |  |   | 25,774 
|Operating leases                                                       |  | 15            |  |                        | 1,113   |                   |   | 1,912              |  |                | 1,005  |       |   | 3,033  |  |   | 7,063  
|Purchase obligations                                                   |  | 15            |  |                        | 172     |                   |   | 344                |  |                | 344    |       |   | 1,708  |  |   | 2,568  
|                                                                       |  |               |  |                        |         |                   |   |                    |  |                |        |       |   |        |  |   |        
|Total                                                                  |  |               |  | $                      | 365,902 |                   | $ | 136,404            |  | $              | 56,667 |       | $ | 70,515 |  | $ | 629,488
|                                                                       |  |               |  |                        |         |                   |   |                    |  |                |        |       |   |        |  |   |        

*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, 2008, the liability for uncertain tax positions, excluding associated interest and penalties, was $180,000 pursuant to FASB
Interpretation No. 48. 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 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, 2008. 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 Yearor Less        |        | One toThree Years |   | Three toFive Years |  | OverFive Years |        | Total
|                              |  | (Dollars in thousands)
|Residential real estate       |  | $                      | 14,670 |                   | $ |                   |  | $              |       |       | $ |       |  | $ | 14,670 
|Commercial loans and leases   |  |                        | 26,197 |                   |   | 4,861              |  |                | 513    |       |   | 35,061 |  |   | 66,632 
|Revolving home equity lines   |  |                        | 2,867  |                   |   | 4,678              |  |                | 13,022 |       |   | 30,336 |  |   | 50,903 
|Consumer revolving credit     |  |                        | 30,395 |                   |   |                   |  |                |       |       |   |       |  |   | 30,395 
|Standby letters of credit     |  |                        | 1,572  |                   |   |                   |  |                |       |       |   |       |  |   | 1,572  
|                              |  |                        |        |                   |   |                    |  |                |        |       |   |        |  |   |        
|Total                         |  | $                      | 75,701 |                   | $ | 9,539              |  | $              | 13,535 |       | $ | 65,397 |  | $ | 164,172
|                              |  |                        |        |                   |   |                    |  |                |        |       |   |        |  |   |        

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



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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.

New Accounting Pronouncements

In September 2006,
the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that a liability be recorded
during the service period when a split-dollar life insurance agreement continues after participants employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for the continuing life
insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. The impact of adoption was a cumulative adjustment to
retained earnings of $462,000 to record the future death benefit obligation at January 1, 2008.

The FAS issued FASB Staff Position
(FSP) FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement
13, and FSP FAS 157-2, Effective Date of FASB Statement No. 157. FSP FAS 157-1 excludes certain leasing transactions accounted for under FASB Statement No. 13, Accounting for Leases, from the scope of
Statement 157. FSP FAS 157-2 defers the effective date in FASB Statement No. 157, Fair Value Measurements, 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 this will have on the Companys current practice of measuring fair value for these assets will not have a material
effect on the financial statements.

In December 2007, the FASB issued FASB Statement No. 141 (Revised 2007) Business
Combinations. Statement 141R will significantly change the accounting for business combinations. Under Statement 141R, an acquiring entity will be required to recognize all



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the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141R also includes a
substantial number of new disclosure requirements. The Company will be required to apply Statement 141R to any business acquisitions completed on or after January 1, 2009.

In October 2008, the FASB released Staff Position (FSP) 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active to clarify
the application of SFAS No. 157, Fair Value Measurements, in a market that is not active and to provide an example that illustrates key considerations in determining the fair value of a financial asset when the market for that asset
is not active. The impact of adoption was not material.

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 present 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.

Earnings Simulation Modeling

Net interest income is affected by changes in the amounts and composition of the Companys interest earning assets and non-interest and interest bearing funding and by changes in the
absolute level of interest rates and by changes in the shape of the yield curve. In general, a flattening of the yield curve would result in a decline in earnings due to the compression of earning asset yields and funding rates, while a steepening
of the yield curve would result in increased earnings as investment margins widen. The model requires management to make assumptions about how the balance sheet is likely to evolve through time in different interest rate environments. Loan and
deposit growth rate assumptions are derived from historical analysis and managements outlook, as are the assumptions used to project yields and rates for new loans and deposits. Securities portfolio maturities and prepayments are assumed to be
reinvested in similar instruments. Mortgage loan prepayment assumptions are developed from industry median estimates of prepayment speeds in conjunction with the historical prepayment performance of the Banks loans. Non-contractual deposit
growth rates and pricing are modeled on historical patterns. Interest rates of the various assets and liabilities on the balance sheet are assumed to change proportionally, based on their historic relationship to short-term rates. The Banks
guidelines for risk management call for preventative measures to be taken if the simulation modeling demonstrates that a gradual increase or decrease in short-term rates of no more than 2% over the next 12 months would adversely affect net interest
income over the same period by more than 15% when compared to the stable rate scenario.

The following table sets forth the results of our
net interest income simulation model assuming that management does not take action to alter the outcome as of December 31:



|                                         |  |  |  |                                                     |  |  |  |      
|---------------------------------------- |  |  |  | --------------------------------------------------- |  |  |  | -----
|Change in interest rates in basis points |  |  |  | First year percentage change in net interest income
|                                         |  |  |  | 2008                                                |  |  |  | 2007 
|-200                                     |  |  |  | N/A                                                 |  |  |  | 6.3% 
|-100                                     |  |  |  | -2.1%                                               |  |  |  | N/A  
|+200                                     |  |  |  | -2.1%                                               |  |  |  | 13.3%

The Company periodically changes the interest rate environment assumptions used in its earnings
simulation modeling based on the absolute levels of interest rates and the Companys perceived probability of a hypothetical interest rate environment occurring. At December 31, 2008, the Company suspended the modeling of an interest
rate environment which assumed rates dropped by 200 basis points because the historically low level of interest rates at that time rendered this scenario not meaningful.

Net interest income is estimated to decrease 2.1% over twelve months in both interest rate scenarios modeled at December 31, 2008 due to the effect of interest rate floors on certain interest-bearing
liabilities. If interest rates decrease 100 basis points, the rates on many of our deposit accounts cannot or are not likely to drop the full 100 basis points because of their already low rates. As a result, the expected decrease in the
Companys asset yields could exceed the decrease in our cost of funds in such a rate scenario. If interest rates were to increase 200 basis points, the Companys net interest income would also be expected to decrease 2.1% as a result
of our slightly liability-sensitive position, which would result in the rates on our interest-bearing liabilities adjusting upward more quickly than our interest-earning assets.

The large change in the expected net interest income from 2007 to 2008 in the up 200 basis point scenario is due primarily to a combination of changes in the asset/liability mix, the level
of absolute interest rates and the change in the period of time over which the change in rates are assumed to occur.



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##### Table of Contents

Net Present Value Estimation

The Net Present Value of Equity (NPV) measure is used for discerning levels of risk present in the balance sheet that might not be taken into account in the earnings simulation model due to the shorter time horizon
used by the earnings simulation model. The NPV of the balance sheet, at a point in time, is defined as the discounted present value of the asset cash flows minus the discounted value of liability cash flows. Interest rate risk analysis using NPV
involves changing the interest rates used in determining the cash flows and in discounting the cash flows. The Companys NPV analysis models both an instantaneous 2% increasing and 2% decreasing interest rate scenario comparing the NPV in each
scenario to the NPV in the current rate scenario. The resulting percentage change in NPV is an indication of the longer-term repricing risk and options risk embedded in the balance sheet. The NPV measure assumes a static balance sheet versus the
growth assumptions that are incorporated into the earnings simulation measure, and an unlimited time horizon instead of the one-year horizon applied in the earnings simulation model. As with earnings simulation modeling, assumptions about the timing
and the variability of balance sheet cash flows are critical in NPV analysis. Particularly important are assumptions driving mortgage prepayments in both the loan and investment portfolios, and changes in the non-contractual deposit portfolios.
These assumptions are applied consistently in both models The Companys policy guidelines limit the amount of the estimated decrease or increase in NPV to 25% in a 2% rate change scenario.

The following table sets forth the results of NPV simulation model assuming that management does not take action to alter the outcome as of
December 31:



|                                         |  |                             |  |     
|---------------------------------------- |  | --------------------------- |  | ----
|Change in interest rates in basis points |  | Change in net present value
|                                         |  | 2008                        |  | 2007
|-200                                     |  | -0.7%                       |  | 7.3%
|+200                                     |  | 0.0%                        |  | 1.4%

The variances in the NPV simulation results from 2007 to 2008 are attributable to the same factors
affecting the net interest income simulation model identified above.



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##### Table of Contents

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, 2008. 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 internal control over financial reporting as of December 31, 2008 has been audited by Crowe Horwath LLP, an independent
registered public accounting firm, as stated in their report appearing herein, which expresses an unqualified opinion on the effectiveness of the Companys internal control over financial reporting as of December 31, 2008.



|                          |  |  |  |                                     |  | 
|------------------------- |  |  |  | ----------------------------------- |  | 
|/s/ Jack H. Webb          |  |  |  | /s/ J. Daniel Mohr                  |  | 
|Jack H. Webb              |  |  |  | J. Daniel Mohr                      |  | 
|Chairman, President & CEO |  |  |  | Chief Financial Officer & Treasurer |  | 
|                          |  |  | 
|Syracuse, New York        |  |  |  |                                     |  | 
|March 13, 2009            |  |  |  |                                     |  | 



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##### Table of Contents

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, 2008, 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, 2008, 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 sheet of Alliance Financial Corporation as of December 31, 2008 and 2007 and the related consolidated statements of income, changes in shareholders equity, comprehensive income and cash flows for the years then ended
and our report dated March 12, 2009 expressed an unqualified opinion on those consolidated financial statements.



/s/ Crowe Horwath LLPCrowe Horwath LLP


|                      
|----------------------
|Livingston, New Jersey
|March 12, 2009        



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##### Table of Contents

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, 2008 and 2007
and the related consolidated statements of income, changes in shareholders equity, comprehensive income and cash flows for each of the two years in the period ended December 31, 2008. 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 audits 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, 2008 and 2007 and the
results of its operations and its cash flows for each of the two years in the period ended December 31, 2008 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, 2008, 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, 2009 expressed an unqualified opinion thereon.



/s/ Crowe Horwath LLPCrowe Horwath LLP


|                      
|----------------------
|Livingston, New Jersey
|March 12, 2009        



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##### Table of Contents

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

To the Board of Directors and Shareholders of Alliance Financial Corporation:

In our opinion, the accompanying consolidated statements of income, changes in shareholders equity, comprehensive income and cash flows for the year ended December 31, 2006 present
fairly, in all material respects, the results of operations and cash flows of Alliance Financial Corporation and its subsidiaries for the year ended December 31, 2006 in conformity with accounting principles generally accepted in the United
States of America. 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 audit. We conducted our audit of these statements 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, assessing the accounting principles used and significant estimates made by management, and evaluating the
overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion.



|                              
|------------------------------
|/s/ PricewaterhouseCoopers LLP
|Boston, Massachusetts         
|March 13, 2007                



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Balance Sheets

December 31, 2008 and 2007





|                                                                                                                                                                                                              |  |                        |           |      |   |          
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---------------------- | --------- | ---- | - | ---------
|                                                                                                                                                                                                              |  | 2008                   |           | 2007
|Assets                                                                                                                                                                                                        |  | (Dollars in thousands)
|Cash and due from banks                                                                                                                                                                                       |  | $                      | 21,172    |      | $ | 30,704   
|Federal funds sold                                                                                                                                                                                            |  |                        | 26,918    |      |   |         
|Securities available-for-sale                                                                                                                                                                                 |  |                        | 299,149   |      |   | 272,713  
|Federal Home Loan Bank of NY(FHLB) and Federal Reserve Bank (FRB) Stock                                                                                                                                   |  |                        | 11,844    |      |   | 9,507    
|Loans held for sale                                                                                                                                                                                           |  |                        | 875       |      |   | 3,163    
|                                                                                                                                                                                                              |  |                       
|Loans and leases, net of unearned income                                                                                                                                                                      |  |                        | 910,755   |      |   | 895,533  
|Less allowance for credit losses                                                                                                                                                                              |  |                        | 9,161     |      |   | 8,426    
|                                                                                                                                                                                                              |  |                        |           |      |   |          
|Net loans and leases                                                                                                                                                                                          |  |                        | 901,594   |      |   | 887,107  
|                                                                                                                                                                                                              |  |                       
|Premises and equipment, net                                                                                                                                                                                   |  |                        | 21,202    |      |   | 21,560   
|Accrued interest receivable                                                                                                                                                                                   |  |                        | 4,218     |      |   | 4,501    
|Bank-owned life insurance                                                                                                                                                                                     |  |                        | 24,940    |      |   | 17,084   
|Goodwill                                                                                                                                                                                                      |  |                        | 32,073    |      |   | 32,187   
|Intangible assets, net                                                                                                                                                                                        |  |                        | 11,528    |      |   | 13,183   
|Other assets                                                                                                                                                                                                  |  |                        | 11,845    |      |   | 15,305   
|                                                                                                                                                                                                              |  |                        |           |      |   |          
|Total assets                                                                                                                                                                                                  |  | $                      | 1,367,358 |      | $ | 1,307,014
|                                                                                                                                                                                                              |  |                        |           |      |   |          
|                                                                                                                                                                                                              |  |                       
|Liabilities and shareholders equity                                                                                                                                                                          |  |                        |           |      |   |          
|Liabilities:                                                                                                                                                                                                  |  |                        |           |      |   |          
|Deposits                                                                                                                                                                                                      |  |                        |           |      |   |          
|Non-interest bearing                                                                                                                                                                                          |  | $                      | 140,845   |      | $ | 138,691  
|Interest bearing                                                                                                                                                                                              |  |                        | 797,037   |      |   | 806,539  
|                                                                                                                                                                                                              |  |                        |           |      |   |          
|Total deposits                                                                                                                                                                                                |  |                        | 937,882   |      |   | 945,230  
|                                                                                                                                                                                                              |  |                       
|Borrowings                                                                                                                                                                                                    |  |                        | 238,972   |      |   | 200,757  
|Accrued interest payable                                                                                                                                                                                      |  |                        | 3,037     |      |   | 3,903    
|Other liabilities                                                                                                                                                                                             |  |                        | 17,212    |      |   | 15,790   
|Junior subordinated obligations issued to unconsolidated subsidiary trusts                                                                                                                                    |  |                        | 25,774    |      |   | 25,774   
|                                                                                                                                                                                                              |  |                        |           |      |   |          
|Total liabilities                                                                                                                                                                                             |  |                        | 1,222,877 |      |   | 1,191,454
|                                                                                                                                                                                                              |  |                       
|Commitments and contingent liabilities (Note 16)                                                                                                                                                              |  |                        |          |      |   |         
|                                                                                                                                                                                                              |  |                       
|Shareholders equity: Preferred stock  par value $1.00 a share; 1,000,000 shares authorized, Series A, cumulative perpetual preferred stock,
$1,000 liquidation value, 26,918 issued and outstanding in 2008 |  |                        | 26,331    |      |   |         
|Common stock  par value $1.00 a share; 10,000,000 shares authorized, 4,901,222 and 4,889,297 shares issued, and 4,578,910 and 4,710,885
shares outstanding for 2008 and 2007, respectively                   |  |                        | 4,901     |      |   | 4,889    
|Surplus                                                                                                                                                                                                       |  |                        | 41,922    |      |   | 38,847   
|Undivided profits                                                                                                                                                                                             |  |                        | 81,110    |      |   | 75,844   
|Accumulated other comprehensive income                                                                                                                                                                        |  |                        | 971       |      |   | 1,205    
|Directors stock-based deferred compensation plan: 85,510 shares                                                                                                                                              |  |                        | (2,098)   |      |   |         
|Treasury stock, at cost: 322,312 and 178,412 shares, respectively                                                                                                                                             |  |                        | (8,656)   |      |   | (5,225)  
|                                                                                                                                                                                                              |  |                        |           |      |   |          
|Total Shareholders Equity                                                                                                                                                                                    |  |                        | 144,481   |      |   | 115,560  
|                                                                                                                                                                                                              |  |                        |           |      |   |          
|Total Liabilities and Shareholders Equity                                                                                                                                                                    |  | $                      | 1,367,358 |      | $ | 1,307,014
|                                                                                                                                                                                                              |  |                        |           |      |   |          

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



39



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Income

Years Ended December 31, 2008, 2007 and 2006





|                                                       |  |                                       |        |      |   |        |  |   |       
|------------------------------------------------------ |  | ------------------------------------- | ------ | ---- | - | ------ |  | - | ------
|                                                       |  | 2008                                  |        | 2007 |   | 2006  
|Interest Income                                        |  | (In thousands, except per share data)
|Interest and fees on loans and leases                  |  | $                                     | 54,857 |      | $ | 58,992 |  | $ | 46,790
|Federal funds sold and interest bearing deposits       |  |                                       | 100    |      |   | 28     |  |   | 148   
|Interest and dividends on taxable securities           |  |                                       | 9,430  |      |   | 8,546  |  |   | 7,644 
|Interest and dividends on nontaxable securities        |  |                                       | 3,577  |      |   | 3,466  |  |   | 3,091 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total Interest Income                                  |  |                                       | 67,964 |      |   | 71,032 |  |   | 57,673
|Interest Expense                                       |  |                                       |        |      |   |        |  |   |       
|Deposits:                                              |  |                                       |        |      |   |        |  |   |       
|Savings accounts                                       |  |                                       | 492    |      |   | 474    |  |   | 343   
|Money market accounts                                  |  |                                       | 4,732  |      |   | 6,322  |  |   | 5,141 
|Time accounts                                          |  |                                       | 15,277 |      |   | 20,547 |  |   | 16,161
|NOW accounts                                           |  |                                       | 733    |      |   | 911    |  |   | 519   
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total                                                  |  |                                       | 21,234 |      |   | 28,254 |  |   | 22,164
|Borrowings:                                            |  |                                       |        |      |   |        |  |   |       
|Repurchase agreements                                  |  |                                       | 1,584  |      |   | 2,790  |  |   | 2,596 
|FHLB advances                                          |  |                                       | 6,050  |      |   | 5,546  |  |   | 4,052 
|Junior subordinated obligations                        |  |                                       | 1,399  |      |   | 1,960  |  |   | 1,139 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total interest expense                                 |  |                                       | 30,267 |      |   | 38,550 |  |   | 29,951
|                                                       |  |                                       |        |      |   |        |  |   |       
|Net interest income                                    |  |                                       | 37,697 |      |   | 32,482 |  |   | 27,722
|Provision for credit losses                            |  |                                       | 5,502  |      |   | 3,790  |  |   | 2,477 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Net interest income after provision for credit losses  |  |                                       | 32,195 |      |   | 28,692 |  |   | 25,245
|Non-interest income:                                   |  |                                       |        |      |   |        |  |   |       
|Investment management income                           |  |                                       | 8,670  |      |   | 9,180  |  |   | 8,895 
|Service charges on deposit accounts                    |  |                                       | 5,164  |      |   | 5,296  |  |   | 4,316 
|Card-related fees                                      |  |                                       | 2,106  |      |   | 1,942  |  |   | 1,291 
|Insurance agency income                                |  |                                       | 1,583  |      |   | 1,855  |  |   | 615   
|Income from bank-owned life insurance                  |  |                                       | 856    |      |   | 635    |  |   | 455   
|Gain on the sale of loans                              |  |                                       | 252    |      |   | 192    |  |   | 126   
|Gain (loss) on sale of securities available-for-sale   |  |                                       | 137    |      |   | (12)   |  |   | (2)   
|Other non-interest income                              |  |                                       | 1,592  |      |   | 2,204  |  |   | 2,018 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total non-interest income                              |  |                                       | 20,360 |      |   | 21,292 |  |   | 17,714
|Non-interest expense:                                  |  |                                       |        |      |   |        |  |   |       
|Salaries and employee benefits                         |  |                                       | 19,823 |      |   | 18,281 |  |   | 16,607
|Occupancy and equipment expense                        |  |                                       | 7,032  |      |   | 6,765  |  |   | 6,460 
|Communication expense                                  |  |                                       | 791    |      |   | 827    |  |   | 744   
|Office supplies and postage expense                    |  |                                       | 1,137  |      |   | 1,236  |  |   | 1,079 
|Marketing expense                                      |  |                                       | 1,090  |      |   | 1,237  |  |   | 1,128 
|Amortization of intangible assets                      |  |                                       | 1,622  |      |   | 1,729  |  |   | 797   
|Professional fees                                      |  |                                       | 2,661  |      |   | 2,845  |  |   | 3,239 
|Other non-interest expense                             |  |                                       | 5,222  |      |   | 4,718  |  |   | 3,832 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Total non-interest expenses                            |  |                                       | 39,378 |      |   | 37,638 |  |   | 33,886
|                                                       |  |                                       |       
|Income before income tax expense                       |  |                                       | 13,177 |      |   | 12,346 |  |   | 9,073 
|Income tax expense                                     |  |                                       | 2,820  |      |   | 2,869  |  |   | 1,762 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Net income                                             |  | $                                     | 10,357 |      | $ | 9,477  |  | $ | 7,311 
|                                                       |  |                                       |        |      |   |        |  |   |       
|Dividends and accretion of discount on preferred stock |  |                                       | 47     |      |   |       |  |   |      
|                                                       |  |                                       |        |      |   |        |  |   |       
|Net income available to common shareholders            |  | $                                     | 10,310 |      | $ | 9,477  |  | $ | 7,311 
|Earnings Per Common Share                              |  |                                       |        |      |   |        |  |   |       
|Basic                                                  |  | $                                     | 2.27   |      | $ | 2.01   |  | $ | 1.92  
|Diluted                                                |  | $                                     | 2.24   |      | $ | 1.98   |  | $ | 1.88  

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



40



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders Equity

Years Ended December 31, 2008, 2007 and 2006





|                                                                                                                 |  |                                       |  |                 |  |              |  |             |  |                                       |  |                   |  |                                               |  |                |  |                           |  |          
|---------------------------------------------------------------------------------------------------------------- |  | ------------------------------------- |  | --------------- |  | ------------ |  | ----------- |  | ------------------------------------- |  | ----------------- |  | --------------------------------------------- |  | -------------- |  | ------------------------- |  | ---------
|                                                                                                                 |  | Issued and Outstanding Common Shares  |  | Preferred Stock |  | Common Stock |  | Surplus     |  | Unamortized Value of Restricted Stock |  | Undivided Profits |  | Accumulated Other Comprehensive Income (Loss) |  | Treasury Stock |  | Directors Deferred Stock |  | Total    
|                                                                                                                 |  | (In thousands, except per share data)
|Balance at December 31, 2005                                                                                     |  | 3,565,012                             |  | $              |  | $  3,979     |  | $    11,185 |  | $  (1,453)                            |  | $  66,740         |  | $  (1,700)                                    |  | $  (9,180)     |  | $                        |  | $  69,571
|Comprehensive income:                                                                                            |  |                                       |  |                 |  |              |  |             |  |                                       |  |                   |  |                                               |  |                |  |                           |  |          
|Net income                                                                                                       |  |                                      |  |                |  |             |  |            |  |                                      |  | 7,311             |  |                                              |  |               |  |                          |  | 7,311    
|Other comprehensive income, net of taxes                                                                         |  |                                      |  |                |  |             |  |            |  |                                      |  |                  |  | 572                                           |  |               |  |                          |  | 572      
|Total comprehensive income                                                                                       |  |                                      |  |                |  |             |  |            |  |                                      |  |                  |  |                                              |  |               |  |                          |  | 7,883    
|Cumulative effect of change in accounting for adoption of SFAS No. 158                                           |  |                                      |  |                |  |             |  |            |  |                                      |  |                  |  | (994)                                         |  |               |  |                          |  | (994)    
|Shares issued in purchase of Bridge Street Financial Inc.                                                        |  | 1,291,812                             |  |                |  | 863          |  | 27,518      |  |                                      |  |                  |  |                                              |  | 9,676          |  |                          |  | 38,057   
|Issuance of restricted stock                                                                                     |  | 26,500                                |  |                |  | 27           |  | 789         |  | (816)                                 |  |                  |  |                                              |  |               |  |                          |  |         
|Forfeiture of restricted stock                                                                                   |  | (19,995)                              |  |                |  | (21)         |  | (594)       |  | 503                                   |  |                  |  |                                              |  |               |  |                          |  | (112)    
|Amortization of restricted stock                                                                                 |  |                                      |  |                |  |             |  |            |  | 332                                   |  |                  |  |                                              |  |               |  |                          |  | 332      
|Stock options exercised                                                                                          |  | 47,032                                |  |                |  | 47           |  | 1,080       |  |                                      |  |                  |  |                                              |  |               |  |                          |  | 1,127    
|Tax benefit of stock-based compensation                                                                          |  |                                      |  |                |  |             |  | 442         |  |                                      |  | 22                |  |                                              |  |               |  |                          |  | 464      
|Cash dividends $0.88 per share                                                                                   |  |                                      |  |                |  |             |  |            |  |                                      |  | (3,415)           |  |                                              |  |               |  |                          |  | (3,415)  
|Treasury stock purchased                                                                                         |  | (109,849)                             |  |                |  |             |  |            |  |                                      |  |                  |  |                                              |  | (3,407)        |  |                          |  | (3,407)  
|Reclassification of unearned restricted stock awards to surplus in accordance with SFAS No. 123R (67,375 shares) |  |                                      |  |                |  |             |  | (1,434)     |  | 1,434                                 |  |                  |  |                                              |  |               |  |                          |  |         
|Balance at December 31, 2006                                                                                     |  | 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)     



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Alliance Financial Corporation and Subsidiaries

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

Years Ended December 31, 2008,
2007 and 2006





|                                        |  |                                      |  |                 |  |              |  |           |  |                                       |  |                   |  |                                               |  |                |  |                           |  |           
|--------------------------------------- |  | ------------------------------------ |  | --------------- |  | ------------ |  | --------- |  | ------------------------------------- |  | ----------------- |  | --------------------------------------------- |  | -------------- |  | ------------------------- |  | ----------
|                                        |  | Issued and Outstanding Common Shares |  | Preferred Stock |  | Common Stock |  | Surplus   |  | Unamortized Value of Restricted Stock |  | Undivided Profits |  | Accumulated Other Comprehensive Income (Loss) |  | Treasury Stock |  | Directors Deferred Stock |  | Total     
|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

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



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Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Comprehensive Income

Years Ended December 31, 2008, 2007 and 2006





|                                                                                                                                                                                 |  |                |  |            |  |         
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | -------------- |  | ---------- |  | --------
|                                                                                                                                                                                 |  | 2008           |  | 2007       |  | 2006    
|                                                                                                                                                                                 |  | (In thousands)
|Net income                                                                                                                                                                       |  | $  10,357      |  | $    9,477 |  | $  7,311
|Other comprehensive income (loss) net of tax:                                                                                                                                    |  |                |  |            |  |         
|Net unrealized gains for the period, net of tax expense of $1,275 in 2008, $1,222 in 2007, and $445 in 2006                                                                      |  | 2,021          |  | 1,924      |  | 645     
|Reclassification adjustment for (gains) losses included in net income, net of tax expense (benefit) of $53 in 2008, $(5) in 2007, and $(1) in
2006                               |  | (84)           |  | 7          |  | 1       
|Change in minimum pension liability                                                                                                                                              |  |               |  |           |  | (74)    
|Change in accumulated unrealized loss and prior service costs for pension and other post- retirement benefits, net of tax (benefit) expense of
$(1,371) in 2008 and $310 in 2007 |  | (2,132)        |  | 569        |  |        
|Post-retirement plan amendment net of tax benefit of $(521)                                                                                                                      |  |               |  | 827        |  |        
|                                                                                                                                                                                 |  |                |  |            |  |         
|Total other comprehensive income (loss)                                                                                                                                          |  | (195)          |  | 3,327      |  | 572     
|                                                                                                                                                                                 |  |                |  |            |  |         
|Comprehensive income                                                                                                                                                             |  | $  10,162      |  | $  12,804  |  | $  7,883
|                                                                                                                                                                                 |  |                |  |            |  |         

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



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Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows

Years Ended December 31, 2008, 2007 and 2006





|                                                                                                                   |  |                |  |              |  |             
|------------------------------------------------------------------------------------------------------------------ |  | -------------- |  | ------------ |  | ------------
|                                                                                                                   |  | 2008           |  | 2007         |  | 2006        
|Operating Activities:                                                                                              |  | (In thousands)
|Net income                                                                                                         |  | $    10,357    |  | $      9,477 |  | $      7,311
|Adjustments to reconcile net income to net cash provided by operating activities:                                  |  |                |  |              |  |             
|Provision for credit losses                                                                                        |  | 5,502          |  | 3,790        |  | 2,477       
|Depreciation expense                                                                                               |  | 2,516          |  | 2,456        |  | 2,837       
|Increase in surrender value of life insurance                                                                      |  | (856)          |  | (635)        |  | (455)       
|Deferred income tax benefit (expense)                                                                              |  | 37             |  | 534          |  | (1,353)     
|Amortization (accretion) of investment security discounts and premiums, net                                        |  | 189            |  | (38)         |  | (195)       
|Net (gain) loss on sale of securities available-for-sale                                                           |  | (137)          |  | 12           |  | 2           
|Net (gain) loss on sale of premises and equipment                                                                  |  |               |  | (10)         |  | 22          
|Impairment write-down on premises                                                                                  |  |               |  |             |  | 174         
|Proceeds from the sale of loans and leases held-for-sale                                                           |  | 25,281         |  | 13,043       |  | 7,889       
|Origination of loans held-for-sale                                                                                 |  | (12,223)       |  | (14,973)     |  | (8,918)     
|Net gains on sale of loans and leases                                                                              |  | (252)          |  | (192)        |  | (126)       
|Write-down of leases transferred to held-for-sale                                                                  |  | 160            |  |             |  |            
|Gain on lease prepayment                                                                                           |  |               |  | (286)        |  |            
|Gain on sale of assets held-for-sale                                                                               |  | (99)           |  |             |  |            
|(Gain) loss on foreclosed real estate-owned                                                                        |  | (71)           |  | 43           |  |            
|Amortization of capitalized servicing rights                                                                       |  | 272            |  | 296          |  | 104         
|Amortization of intangible assets                                                                                  |  | 1,622          |  | 1,729        |  | 797         
|Restricted stock expense                                                                                           |  | 359            |  | 240          |  | 220         
|Change in other assets and liabilities                                                                             |  | 1,665          |  | (787)        |  | 11,728      
|                                                                                                                   |  |                |  |              |  |             
|Net cash provided by operating activities                                                                          |  | 34,322         |  | 14,699       |  | 22,514      
|                                                                                                                   |  |                | 
|Investing Activities:                                                                                              |  |                |  |              |  |             
|Proceeds from maturities, redemptions, calls and principal repayments of investment securities, available-for-sale |  | 84,456         |  | 79,347       |  | 60,725      
|Proceeds from sales of investment securities available-for-sale                                                    |  | 6,299          |  | 6,975        |  | 9,718       
|Purchase of investment securities available-for-sale                                                               |  | (114,040)      |  | (101,852)    |  | (27,128)    
|Purchase of FRB and FHLB stock                                                                                     |  | (22,466)       |  | (26,197)     |  | (14,579)    
|Redemption of FRB and FHLB stock                                                                                   |  | 20,129         |  | 24,675       |  | 14,845      
|Net increase in loans and leases                                                                                   |  | (31,468)       |  | (16,670)     |  | (86,403)    
|Purchases of premises and equipment                                                                                |  | (1,553)        |  | (2,596)      |  | (1,994)     
|Proceeds from the sale of premises and equipment                                                                   |  | 119            |  | 174          |  | 16          
|Proceeds from disposition of assets held-for-sale                                                                  |  | 176            |  | 107          |  |            
|Proceeds from disposition of foreclosed assets                                                                     |  | 689            |  |             |  |            
|Purchase of bank-owned life insurance                                                                              |  | (7,000)        |  |             |  |            
|Acquisitions                                                                                                       |  |               |  |             |  | (13,171)    
|                                                                                                                   |  |                |  |              |  |             
|Net cash used in investing activities                                                                              |  | (64,659)       |  | (36,037)     |  | (57,971)    
|                                                                                                                   |  |                | 
|Financing Activities:                                                                                              |  |                |  |              |  |             
|Net increase (decrease) in demand deposits, NOW, money market and savings accounts                                 |  | 56,886         |  | 26,306       |  | (20,530)    
|Net (decrease) increase in time deposits                                                                           |  | (64,234)       |  | (17,689)     |  | 44,456      
|Net increase (decrease) in short-term borrowings                                                                   |  | 5,215          |  | (12,021)     |  | 27,264      
|Payments on long-term borrowings                                                                                   |  | (17,000)       |  | (15,700)     |  | (46,750)    
|Proceeds from long-term borrowings                                                                                 |  | 50,000         |  | 50,000       |  | 25,000      
|Net increase in junior subordinated obligations                                                                    |  |               |  |             |  | 15,464      
|Proceeds from the exercise of stock options                                                                        |  |               |  | 178          |  | 1,127       
|Treasury stock purchased                                                                                           |  | (3,431)        |  | (2,314)      |  | (3,407)     
|Purchase of shares for directors deferred stock-based plan                                                        |  | (2,098)        |  |             |  |            
|Tax benefit of stock-based compensation                                                                            |  | 37             |  | 97           |  | 464         
|Issuance of preferred stock and warrants                                                                           |  | 26,918         |  |             |  |            
|Cash dividends                                                                                                     |  | (4,570)        |  | (4,213)      |  | (3,111)     
|                                                                                                                   |  |                |  |              |  |             
|Net cash provided by financing activities                                                                          |  | 47,723         |  | 24,644       |  | 39,977      
|                                                                                                                   |  |                |  |              |  |             
|Net increase in cash and cash equivalents                                                                          |  | 17,386         |  | 3,306        |  | 4,520       
|Cash and cash equivalents at beginning of year                                                                     |  | 30,704         |  | 27,398       |  | 22,878      
|                                                                                                                   |  |                |  |              |  |             
|Cash and cash equivalents at end of year                                                                           |  | $    48,090    |  | $    30,704  |  | $    27,398 
|                                                                                                                   |  |                |  |              |  |             



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Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Cash Flows (contd)

Years Ended December 31, 2008, 2007 and 2006





|                                                                 |  |             |  |             |  |              
|---------------------------------------------------------------- |  | ----------- |  | ----------- |  | -------------
|                                                                 |  | 2008        |  | 2007        |  | 2006         
|Supplemental Disclosures of Cash Flow Information:               |  |             |  |             |  |              
|Interest received during the year                                |  | $    68,336 |  | $    71,136 |  | $      57,083
|Interest paid during the year                                    |  | 31,113      |  | 37,300      |  | 29,561       
|Income taxes paid                                                |  | 1,377       |  | 2,971       |  | 2,455        
|Non-cash investing activities:                                   |  |             |  |             |  |              
|Change in unrealized loss on securities available-for-sale       |  | 3,203       |  | 3,155       |  | 1,090        
|Fair value of assets acquired in acquisition                     |  |            |  |            |  | 252,182      
|Fair value of liabilities assumed in acquisition                 |  |            |  |            |  | 200,954      
|Transfer between premises and equipment and assets held-for-sale |  | 724         |  | (1,459)     |  | 118          
|Transfer of loans to foreclosed real estate                      |  | 660         |  | 441         |  |             
|Transfer of leases to held-for-sale                              |  | 10,819      |  |            |  |             
|Non-cash financing activities:                                   |  |             |  |             |  |              
|Dividends declared and unpaid                                    |  | 1,232       |  | 1,135       |  | 1,057        
|Common stock issued in acquisition                               |  |            |  |            |  | 38,057       

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. 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.

In December 2008, the Company entered into a Letter Agreement (the Purchase Agreement), with the United States Department
of the Treasury (Treasury Department) pursuant to which the Company has issued and sold to the Treasury Department: (i) 26,918 shares of the Companys Fixed Rate Cumulative Perpetual Preferred Stock, Series A,
(ii) and a warrant (the Warrant) to purchase 173,069 shares of the Companys common stock. Section 5.3 of the Purchase Agreement grants the Treasury Department the ability to unilaterally amend any provision of the
Purchase Agreement to the extent required to comply with any changes after the date of the Purchase Agreement in applicable federal statutes. The ability of the Treasury Department to unilaterally amend any provision of the Purchase Agreement
presents risks and uncertainties that the Company cannot predict.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and highly liquid investments with original
maturities less than ninety days.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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



Securities

The Company classifies securities as held-to-maturity or available-for-sale at the time of purchase. Held-to-maturity 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. 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 securities have been classified as trading securities or held-to-maturity.

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. Securities are reviewed regularly for other than temporary impairment. In estimating other-than-temporary losses, management considers: the length of time and extent that fair value has been less than cost, the
financial condition and near term prospects of the issuer, and the Companys ability and intent to hold the security for a period sufficient to allow for any anticipated recovery in fair value. The cost basis of individual securities is written
down to estimated fair value through a charge to earnings when declines in value below amortized cost are considered to be other than temporary. Purchases and sales of securities are recognized on a trade-date basis.

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

As a member of the Federal Home Loan Bank of New York (FHLB) and Federal Reserve Bank (FRB), the Company is required to hold stock in based on ultimate recovery of par value.

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 market, 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.



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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



Loans and Leases

Loans and leases 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 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, 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. 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.

Loans 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.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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



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. 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.

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 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. In accordance with Emerging Issues Task Force (EITF) No. 06-5, Company 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 EITF Number 97-14, as affected by FAS 123R the stock held in the trust is classified in equity
similar to the manner in which treasury stock is classified.



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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



Earnings Per Common Share

Basic earnings per common share are net income available to common shareholders divided by the weighted average number of common shares outstanding during the period. Diluted earnings per common share include the
dilutive effect of additional potential common shares issuable under stock options, restricted stock awards and warrants.

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.

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 FASB Interpretation 48, Accounting for Uncertainty in Income Taxes (FIN 48), 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.

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. The Company received capital in the form of preferred stock from the U.S. Treasury Department under the Capital Purchase Program. Until the earlier of
December 19, 2011 and the date the Treasury no longer holds any preferred stock, without U.S. Treasurys consent, the Company is restricted from increasing the quarterly common dividend above $0.26 per share.

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 conducts 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.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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



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.

New Accounting Pronouncements

In September 2006, the FASB Emerging Issues Task Force finalized Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements. This issue requires that
a liability be recorded during the service period when a split-dollar life insurance agreement continues after participants employment or retirement. The required accrued liability will be based on either the post-employment benefit cost for
the continuing life insurance or based on the future death benefit depending on the contractual terms of the underlying agreement. This issue is effective for fiscal years beginning after December 15, 2007. The impact of adoption was a
cumulative adjustment to retained earnings of $462,000 to record the future death benefit obligation at January 1, 2008.

The FAS
issued FASB Staff Position (FSP) FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or
Measurement under Statement 13, and FSP FAS 157-2, Effective Date of FASB Statement No. 157. FSP FAS 157-1 excludes certain leasing transactions accounted for under FASB Statement No. 13, Accounting for
Leases, from the scope of Statement 157. FSP FAS 157-2 defers the effective date in FASB Statement No. 157, Fair Value Measurements, 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 Company is currently evaluating the impact this will have on the Companys current
practice of measuring fair value for these assets and does not anticipate a material effect on the financial statements.

In December 2007,
the FASB issued FASB Statement No. 141 (Revised 2007) Business Combinations. Statement 141R will significantly change the accounting for business combinations. Under Statement 141R, an acquiring entity will be required to recognize
all the assets acquired and liabilities assumed in a transaction at the acquisition-date fair value with limited exceptions. Statement 141R also includes a substantial number of new disclosure requirements. The Company will be required to apply
Statement 141R to any business acquisitions completed on or after January 1, 2009.

In October 2008, the FASB released Staff
Position (FSP) 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset is Not Active to clarify the application of SFAS No. 157, Fair Value Measurements, in a market that is not
active and to provide an example that illustrates key considerations in determining the fair value of a financial asset when the market for that asset is not active. The impact of adoption was not material.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





2. Securities

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



|                                                      |  |                   |         |                      |   |                       |  |                     |     |  |   |        
|----------------------------------------------------- |  | ----------------- | ------- | -------------------- | - | --------------------- |  | ------------------- | --- |  | - | -------
|                                                      |  | December 31, 2008
|                                                      |  | Amortized Cost    |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedFair 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                            |  |                   | 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
|                                                      |  |                   |         |                      |   |                       |  |                     |     |  |   |        

Mortgage-backed securities, which totaled $170.0 million at December 31, 2008, 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 full faith and credit of 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, 2007
|                                                      |  | Amortized Cost    |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedFair Value
|Debt Securities:                                      |  |                   |         |                      |   |                       |  |                     |       |  |   |        
|U.S. Treasury obligations                             |  | $                 | 100     |                      | $ | 1                     |  | $                   |      |  | $ | 101    
|Obligations of U.S. government-sponsored corporations |  |                   | 60,902  |                      |   | 162                   |  |                     | 122   |  |   | 60,942 
|Obligations of states and political subdivisions      |  |                   | 87,028  |                      |   | 1,657                 |  |                     | 105   |  |   | 88,580 
|Mortgage-backed securities                            |  |                   | 120,258 |                      |   | 675                   |  |                     | 778   |  |   | 120,155
|                                                      |  |                   |         |                      |   |                       |  |                     |       |  |   |        
|Total debt securities                                 |  |                   | 268,288 |                      |   | 2,495                 |  |                     | 1,005 |  |   | 269,778
|Stock Investments:                                    |  |                   |         |                      |   |                       |  |                     |       |  |   |        
|Equity securities                                     |  |                   | 1,934   |                      |   | 12                    |  |                     |      |  |   | 1,946  
|Mutual Funds                                          |  |                   | 1,000   |                      |   | 15                    |  |                     | 26    |  |   | 989    
|                                                      |  |                   |         |                      |   |                       |  |                     |       |  |   |        
|Total stock investments                               |  |                   | 2,934   |                      |   | 27                    |  |                     | 26    |  |   | 2,935  
|                                                      |  |                   |         |                      |   |                       |  |                     |       |  |   |        
|Total available-for-sale                              |  | $                 | 271,222 |                      | $ | 2,522                 |  | $                   | 1,031 |  | $ | 272,713
|                                                      |  |                   |         |                      |   |                       |  |                     |       |  |   |        

The carrying value and estimated fair value of debt securities at December 31, 2008, by
contractual maturity, are shown below (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.



|                                       |  |                |         |                      |   |        
|-------------------------------------- |  | -------------- | ------- | -------------------- | - | -------
|                                       |  | 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, 2008 and 2007, securities with a carrying value of $293.1 million and $262.3
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 $137,000, $0, and $8,000, for 2008, 2007, and 2006, respectively, and gross losses of $0, $12,000, and $10,000, for 2008, 2007, and 2006, respectively. The tax provision (benefit) related to these net
realized gains and losses was $53,000, $(5,000) and $(1,000), respectively.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





2.  Securities (contd.)



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, 2008  
|                                                      |  | Less than 12 Months |        | 12 Months or Longer |   | Total              
|Type of Security                                      |  | EstimatedFair Value |        | UnrealizedLosses    |   | EstimatedFair Value |  | UnrealizedLosses |        | EstimatedFair Value |   | UnrealizedLosses
|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  
|                                                      |  |                     |        |                     |   |                     |  |                  |        |                     |   |                  |  |   |         |  |   |      
|                                                      | 
|                                                      |  | December 31, 2007  
|                                                      |  | Less than 12 Months |        | 12 Months or Longer |   | Total              
|Type of Security                                      |  | EstimatedFair Value |        | UnrealizedLosses    |   | EstimatedFair Value |  | UnrealizedLosses |        | EstimatedFair Value |   | UnrealizedLosses
|Obligations of U.S. government-sponsored corporations |  | $                   | 7,063  |                     | $ | 4                   |  | $                | 24,332 |                     | $ | 118              |  | $ | 31,395  |  | $ | 122  
|Obligations of states and political subdivisions      |  |                     | 2,147  |                     |   | 33                  |  |                  | 10,387 |                     |   | 72               |  |   | 12,534  |  |   | 105  
|Mortgage-backed securities                            |  |                     | 8,436  |                     |   | 56                  |  |                  | 49,589 |                     |   | 722              |  |   | 58,025  |  |   | 778  
|                                                      |  |                     |        |                     |   |                     |  |                  |        |                     |   |                  |  |   |         |  |   |      
|Subtotal, debt securities                             |  |                     | 17,646 |                     |   | 93                  |  |                  | 84,308 |                     |   | 912              |  |   | 101,954 |  |   | 1,005
|Mutual Funds                                          |  |                     |       |                     |   |                    |  |                  | 474    |                     |   | 26               |  |   | 474     |  |   | 26   
|                                                      |  |                     |        |                     |   |                     |  |                  |        |                     |   |                  |  |   |         |  |   |      
|Total temporarily impaired Securities                 |  | $                   | 17,646 |                     | $ | 93                  |  | $                | 84,782 |                     | $ | 938              |  | $ | 102,428 |  | $ | 1,031
|                                                      |  |                     |        |                     |   |                     |  |                  |        |                     |   |                  |  |   |         |  |   |      

Management does not believe any individual unrealized loss as of December 31, 2008 represents
an other-than-temporary impairment. A total of 82 available-for-sale securities were in a continuous unrealized loss position for less than 12 months and 8 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 individually were 10% or less
of their respective amortized cost basis. The Company has both the intent and ability to hold the securities contained in the previous table for a time necessary to recover the amortized cost.

3. Loans and Leases

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



|                            |  |      |          |      |   |         
|--------------------------- |  | ---- | -------- | ---- | - | --------
|                            |  | 2008 |          | 2007
|Residential real estate     |  | $    | 314,039  |      | $ | 273,465 
|Commercial loans            |  |      | 214,315  |      |   | 217,136 
|Leases                      |  |      | 117,691  |      |   | 150,933 
|Indirect auto loans         |  |      | 182,807  |      |   | 176,115 
|Other consumer loans        |  |      | 90,906   |      |   | 94,246  
|                            |  |      |          |      |   |         
|Total                       |  |      | 919,758  |      |   | 911,895 
|                            |  |     
|Unearned income             |  |      | (13,036) |      |   | (19,633)
|Net deferred loan costs     |  |      | 4,033    |      |   | 3,271   
|                            |  |      |          |      |   |         
|Total loans and leases      |  |      | 910,755  |      |   | 895,533 
|Allowance for credit losses |  |      | (9,161)  |      |   | (8,426) 
|                            |  |      |          |      |   |         
|Net loans & leases          |  | $    | 901,594  |      | $ | 887,107 
|                            |  |      |          |      |   |         



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





3. Loans and Leases (contd.)



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 $135.3 million and $139.5 million at December 31, 2008 and 2007, respectively. Servicing fee income, net of mortgage servicing rights amortization, totaled $82,000,
$75,000 and $51,000 for the years ended December 31, 2008, 2007 and 2006.

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



|                                            |  |      |       |                                                   |   |       |  |   |      
|------------------------------------------- |  | ---- | ----- | ------------------------------------------------- | - | ----- |  | - | -----
|                                            |  | 2008 |       | 2007                                       
 2006
|Balance at January 1                        |  | $    | 976   |                                                   | $ | 1,158 |  | $ | 304  
|Additions                                   |  |      | 141   |                                                   |   | 114   |  |   | 65   
|Amortization                                |  |      | (272) |                                                   |   | (296) |  |   | (104)
|Acquired from Bridge Street Financial, Inc. |  |      |      |                                                   |   |      |  |   | 893  
|                                            |  |      |       |                                                   |   |       |  |   |      
|Balance at December 31                      |  | $    | 845   |                                                   | $ | 976   |  | $ | 1,158
|                                            |  |      |       |                                                   |   |       |  |   |      

The fair value of mortgage servicing rights was $1.0 million at December 31, 2008. 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 $581,000 and $1.3 million at December 31, 2008 and 2007, respectively.

At December 31, 2008, the minimum future lease payments to be received from lease financings were as follows (in thousands):



|                         |  |   |       
|------------------------ |  | - | ------
|Year ending December 31:
|2009                     |  | $ | 38,898
|2010                     |  |   | 28,223
|2011                     |  |   | 20,064
|2012                     |  |   | 13,722
|2013                     |  |   | 5,813 
|Thereafter               |  |   | 10,971

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



|                                                     |  |      |       |      |   |      
|---------------------------------------------------- |  | ---- | ----- | ---- | - | -----
|                                                     |  | 2008 |       | 2007
|Loans and leases 90 days past due and still accruing |  | $    | 126   |      | $ | 39   
|Non-accrual loans and leases                         |  |      | 4,352 |      |   | 6,667
|                                                     |  |      |       |      |   |      
|Total nonperforming loans and leases                 |  | $    | 4,478 |      | $ | 6,706
|                                                     |  |      |       |      |   |      

As of December 31, 2008 and 2007, impaired loans and leases totaled approximately $1.4
million and $4.2 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 $217,000 and $193,000, respectively, at December 31, 2008 and $4.2 million and $1.3 million, respectively, at December 31, 2007. The recorded investment in loans considered impaired for which there was no related valuation allowance
for impairment was $1.2 million at December 31, 2008. The average recorded investment in impaired loans for 2008 and 2007 totaled $2.1 million and $4.7 million, respectively. During 2008 and 2007, there was no interest recognized on impaired
loans while they were considered to be impaired. There were no loans that were considered to be impaired in 2006.

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



|                                                      |  |      |         |      |   |         |  |   |        
|----------------------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                                      |  | 2008 |         | 2007 |   | 2006   
|Balance at beginning of year                          |  | $    | 8,426   |      | $ | 7,029   |  | $ | 4,960  
|Loans and leases charged off                          |  |      | (5,639) |      |   | (3,227) |  |   | (2,390)
|Recoveries                                            |  |      | 872     |      |   | 834     |  |   | 685    
|Provision for credit losses                           |  |      | 5,502   |      |   | 3,790   |  |   | 2,477  
|Allowance acquired from Bridge Street Financial, Inc. |  |      |        |      |   |        |  |   | 1,297  
|                                                      |  |      |         |      |   |         |  |   |        
|Balance at end of year                                |  | $    | 9,161   |      | $ | 8,426   |  | $ | 7,029  
|                                                      |  |      |         |      |   |         |  |   |        

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 2008. Loan transactions with related parties are summarized as follows (in thousands):



|                             |  |      |        
|---------------------------- |  | ---- | -------
|                             |  | 2008
|Balance at beginning of year |  | $    | 3,935  
|New loans and advances       |  |      | 851    
|Loan payments                |  |      | (1,202)
|                             |  |      |        
|Balance at end of year       |  | $    | 3,584  
|                             |  |      |        



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





4. Bank Premises, Furniture, and Equipment

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



|                               |  |      |        |      |   |       
|------------------------------ |  | ---- | ------ | ---- | - | ------
|                               |  | 2008 |        | 2007
|Land                           |  | $    | 3,168  |      | $ | 2,911 
|Bank premises                  |  |      | 19,804 |      |   | 19,151
|Furniture and equipment        |  |      | 24,218 |      |   | 26,184
|                               |  |      |        |      |   |       
|Total cost                     |  |      | 47,190 |      |   | 48,246
|Less: Accumulated depreciation |  |      | 25,988 |      |   | 26,686
|                               |  |      |        |      |   |       
|                               |  | $    | 21,202 |      | $ | 21,560
|                               |  |      |        |      |   |       

At December 31, 2008 and 2007, furniture and equipment included $1.3 million and $1.4
million, respectively, in equipment leased to others under operating leases and the related accumulated depreciation of $351,000 and $137,000 at December 31, 2008 and 2007, respectively. Depreciation expense on equipment leased to others
totaled $226,000, $93,000 and $832,000 in 2008, 2007 and 2006, respectively.

At December 31, 2008, the minimum future lease payments
to be received from equipment leased to others were as follows (in thousands):



|                         |  |   |    
|------------------------ |  | - | ---
|Year ending December 31:
|2009                     |  | $ | 248
|2010                     |  |   | 205
|2011                     |  |   | 255
|2012                     |  |   | 229
|2013                     |  |   | 245
|Thereafter               |  |   | 51 

5. Goodwill and Other Intangible Assets

The carrying value of goodwill was $32.1 million and $32.2 million at December 31, 2008 and 2007, respectively. The change in the carrying amount of goodwill is associated with
purchase accounting adjustments. No goodwill impairment adjustments were recognized in 2008 or 2007. The carrying value of intangible assets decreased by $33,000 in 2008 due to the sale of a segment of the insurance agency customer list.

The following table summarizes the companys intangible assets that are subject to amortization (in thousands):



|                                     |  |                       |        |                          |   |                     |  |   |       
|------------------------------------ |  | --------------------- | ------ | ------------------------ | - | ------------------- |  | - | ------
|                                     |  | 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
|                                     |  |                       |        |                          |   |                     |  |   |       
|                                     | 
|                                     |  | December 31, 2007    
|                                     |  | Gross Carrying Amount |        | Accumulated Amortization |   | Net Carrying Amount
|Intangible Assets                    |  |                       |        |                          |   |                     |  |   |       
|Core deposit intangible              |  | $                     | 4,202  |                          | $ | 936                 |  | $ | 3,266 
|Non-compete covenant                 |  |                       | 894    |                          |   | 372                 |  |   | 522   
|Investment management intangible     |  |                       | 10,089 |                          |   | 1,427               |  |   | 8,662 
|Insurance agency customer intangible |  |                       | 942    |                          |   | 209                 |  |   | 733   
|                                     |  |                       |        |                          |   |                     |  |   |       
|Total                                |  | $                     | 16,127 |                          | $ | 2,944               |  | $ | 13,183
|                                     |  |                       |        |                          |   |                     |  |   |       



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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 DepositIntangible |     | Non-competeCovenant |   | InvestmentManagementIntangible |  | Insurance AgencyCustomer Intangible |       | Total
|2009       |  | $                      | 592 |                     | $ | 224                            |  | $                                   | 504   |       | $    133 |  | $ | 1,453
|2010       |  |                        | 516 |                     |   |                               |  |                                     | 504   |       | 116      |  |   | 1,136
|2011       |  |                        | 439 |                     |   |                               |  |                                     | 504   |       | 99       |  |   | 1,042
|2012       |  |                        | 363 |                     |   |                               |  |                                     | 504   |       | 81       |  |   | 948  
|2013       |  |                        | 287 |                     |   |                               |  |                                     | 504   |       | 64       |  |   | 855  
|Thereafter |  |                        | 401 |                     |   |                               |  |                                     | 5,637 |       | 56       |  |   | 6,094

6. Deposits

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



|                              |  |      |         |      |   |        
|----------------------------- |  | ---- | ------- | ---- | - | -------
|                              |  | 2008 |         | 2007
|Non-interest-bearing checking |  | $    | 140,845 |      | $ | 138,691
|Interest-bearing checking     |  |      | 106,292 |      |   | 101,793
|Savings accounts              |  |      | 88,242  |      |   | 82,326 
|Money market accounts         |  |      | 247,392 |      |   | 203,075
|Time deposits                 |  |      | 355,111 |      |   | 419,345
|                              |  |      |         |      |   |        
|Total deposits                |  | $    | 937,882 |      | $ | 945,230
|                              |  |      |         |      |   |        

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



|                          |  |      |         |      |   |        
|------------------------- |  | ---- | ------- | ---- | - | -------
|                          |  | 2008 |         | 2007
|Due in one year           |  | $    | 255,645 |      | $ | 314,436
|Due in two years          |  |      | 59,391  |      |   | 76,093 
|Due in three years        |  |      | 9,757   |      |   | 19,653 
|Due in four years         |  |      | 18,082  |      |   | 3,120  
|Due in five years or more |  |      | 12,236  |      |   | 6,044  
|                          |  |      |         |      |   |        
|Total time deposits       |  | $    | 355,111 |      | $ | 419,346
|                          |  |      |         |      |   |        

Total time deposits in excess of $100,000 as of December 31, 2008 and 2007 were $102.0
million and $117.0 million, respectively. Time deposits include $67.9 million and $89.2 million in accounts acquired through third party brokers at December 31, 2008 and 2007, respectively.

7. Borrowings

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



|                                                   |  |      |         |      |   |        
|-------------------------------------------------- |  | ---- | ------- | ---- | - | -------
|                                                   |  | 2008 |         | 2007
|Short-term:                                        |  |      |         |      |   |        
|Federal Home Loan Bank (FHLB) overnight advances |  | $    | 34,700  |      | $ | 15,500 
|FHLB advances                                      |  |      |        |      |   |       
|Repurchase agreements                              |  |      | 40,495  |      |   | 52,780 
|                                                   |  |      |         |      |   |        
|Total short-term borrowings                        |  |      | 75,195  |      |   | 68,280 
|Long-term:                                         |  |      |         |      |   |        
|FHLB advances                                      |  |      | 141,000 |      |   | 107,700
|Repurchase agreements                              |  |      | 22,777  |      |   | 24,777 
|                                                   |  |      |         |      |   |        
|Total long-term borrowings                         |  |      | 163,777 |      |   | 132,477
|                                                   |  |      |         |      |   |        
|Total borrowings                                   |  | $    | 238,972 |      | $ | 200,757
|                                                   |  |      |         |      |   |        



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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):



|                                                 |  |      |        |      |   |        |  |   |       
|------------------------------------------------ |  | ---- | ------ | ---- | - | ------ |  | - | ------
|                                                 |  | 2008 |        | 2007 |   | 2006  
|FHLB overnight advances and short-term advances: |  |      |        |      |   |        |  |   |       
|Maximum month-end balance                        |  | $    | 48,900 |      | $ | 49,700 |  | $ | 38,300
|Balance at end of year                           |  |      | 34,700 |      |   | 15,500 |  |   | 38,300
|Average balance during the year                  |  |      | 19,284 |      |   | 29,459 |  |   | 11,040
|Weighted average interest rate at end of year    |  |      | 0.44%  |      |   | 4.11%  |  |   | 5.44% 
|Weighted average interest rate during the year   |  |      | 2.02%  |      |   | 5.26%  |  |   | 5.46% 
|                                                 |  |      |       
|Repurchase agreements:                           |  |      |        |      |   |        |  |   |       
|Maximum month-end balance                        |  | $    | 45,667 |      | $ | 58,617 |  | $ | 46,152
|Balance at end of year                           |  |      | 40,495 |      |   | 52,780 |  |   | 41,998
|Average balance during the year                  |  |      | 43,400 |      |   | 49,456 |  |   | 38,898
|Weighted average interest rate at end of year    |  |      | 0.15%  |      |   | 2.74%  |  |   | 3.95% 
|Weighted average interest rate during the year   |  |      | 1.34%  |      |   | 3.84%  |  |   | 4.47% 

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



|                         |  |                   |         |                      |       |        |   |                      |  |      
|------------------------ |  | ----------------- | ------- | -------------------- | ----- | ------ | - | -------------------- |  | -----
|                         |  | December 31, 2008 |         | December 31, 2007   
|Maturing                 |  | Amount            |         | WeightedAverage Rate |       | Amount |   | WeightedAverage Rate
|2008                     |  | $                 |        |                      |      |        | $ | 16,700               |  | 4.72%
|2009                     |  |                   | 31,000  |                      | 4.10% |        |   | 31,000               |  | 5.07%
|2010                     |  |                   | 50,000  |                      | 4.18% |        |   | 40,000               |  | 4.53%
|2011                     |  |                   | 15,000  |                      | 3.47% |        |   |                     |  |     
|2012                     |  |                   | 10,000  |                      | 3.54% |        |   |                     |  |     
|2013                     |  |                   | 15,000  |                      | 4.08% |        |   |                     |  |     
|Thereafter               |  |                   | 20,000  |                      | 3.75% |        |   | 20,000               |  | 3.75%
|                         |  |                   |         |                      |       |        |   |                      |  |      
|Total FHLB term advances |  | $                 | 141,000 |                      | 3.97% |        | $ | 107,700              |  | 4.57%
|                         |  |                   |         |                      |       |        |   |                      |  |      

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



|                            |  |                   |        |                      |       |        |   |                      |  |      
|--------------------------- |  | ----------------- | ------ | -------------------- | ----- | ------ | - | -------------------- |  | -----
|                            |  | December 31, 2008 |        | December 31, 2007   
|Maturing                    |  | Amount            |        | WeightedAverage Rate |       | Amount |   | WeightedAverage Rate
|2008                        |  | $                 |       |                      |      |        | $ | 2,000                |  | 3.80%
|2009                        |  |                   | 2,777  |                      | 3.99% |        |   | 2,777                |  | 3.99%
|2010                        |  |                   |       |                      |      |        |   |                     |  |     
|2011                        |  |                   |       |                      |      |        |   |                     |  |     
|2012                        |  |                   |       |                      |      |        |   |                     |  |     
|2013                        |  |                   |       |                      |      |        |   |                     |  |     
|Thereafter                  |  |                   | 20,000 |                      | 4.01% |        |   | 20,000               |  | 4.01%
|                            |  |                   |        |                      |       |        |   |                      |  |      
|Total repurchase agreements |  | $                 | 22,777 |                      | 4.01% |        | $ | 24,777               |  | 3.99%
|                            |  |                   |        |                      |       |        |   |                      |  |      

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 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, 2008 of $245.9 million. At December 31, 2008, the Company had borrowed $175.7 million
against the pledged mortgages. At December 31, 2008, the Company had $70.2 million available under its various credit facilities with the FHLB.

The Company had a $151.8 million line of credit at December 31, 2008 with the Federal Reserve Bank of New York through its Discount Window. The Company has pledged indirect loans and securities totaling $183.4
million and $5.2 million, respectively, at December 31, 2008. At December 31, 2008 and 2007, the Company also had available $35.5 million of federal funds lines of credit with other financial institutions, none of which was in use at
December 31, 2008 and 2007, respectively.

The Company offers retail repurchase agreements primarily to its larger 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, 2008, the Company had securities with a market value of $53.1 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, 2008, securities with a market value of $22.9 million were pledged against repurchase agreements in the amount of $22.8 million. All of these repurchase agreements at
December 31, 2008 were transacted with the FHLB.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





8. Junior Subordinated Obligations

On September 21, 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% (3.65% at December 31, 2008). The Company guarantees all of the securities.

On December 19, 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% (6.32% at December 31, 2008). The Company guarantees all of the securities.

The Company had a $310,000 investment in Trust I at December 31, 2008 and 2007 and a $464,000 investment in Trust II at December 31, 2008 and
2007.

The trusts are variable interest entities (VIEs) as defined by FASB Interpretation No. 46 (FIN 46
R). 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 FIN 46R. Liabilities owed to the trusts, totaling $25.8 million, were
reflected as liabilities in the consolidated balance sheets at December 31, 2008 and 2007, respectively.

9. Earnings Per Common Share

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):



|                                                                                 |  |      |           |      |   |           |  |   |          
|-------------------------------------------------------------------------------- |  | ---- | --------- | ---- | - | --------- |  | - | ---------
|                                                                                 |  | 2008 |           | 2007 |   | 2006     
|Basic                                                                            |  |      |           |      |   |           |  |   |          
|Net income                                                                       |  | $    | 10,357    |      | $ | 9,477     |  | $ | 7,311    
|                                                                                 |  |      |           |      |   |           |  |   |          
|Less: Preferred stock dividends and discount accretion                           |  |      | 47        |      |   |          |  |   |         
|                                                                                 |  |      |           |      |   |           |  |   |          
|Net income available to common shareholders                                      |  |      | 10,310    |      |   | 9,477     |  |   | 7,311    
|                                                                                 |  |      |           |      |   |           |  |   |          
|Average common shares outstanding                                                |  |      | 4,542,957 |      |   | 4,710,530 |  |   | 3,804,711
|Earnings per common share  basic                                                |  | $    | 2.27      |      | $ | 2.01      |  | $ | 1.92     
|                                                                                 |  |      |           |      |   |           |  |   |          
|                                                                                 |  |      |          
|Diluted                                                                          |  |      |           |      |   |           |  |   |          
|Net income                                                                       |  | $    | 10,357    |      | $ | 9,477     |  | $ | 7,311    
|                                                                                 |  |      |           |      |   |           |  |   |          
|Less: Preferred stock dividends and discount accretion                           |  |      | 47        |      |   |          |  |   |         
|                                                                                 |  |      |           |      |   |           |  |   |          
|Net income available to common shareholders                                      |  |      | 10,310    |      |   | 9,477     |  |   | 7,311    
|                                                                                 |  |      |           |      |   |           |  |   |          
|Average common shares outstanding                                                |  |      | 4,542,957 |      |   | 4,710,530 |  |   | 3,804,711
|                                                                                 |  |      |           |      |   |           |  |   |          
|Incremental shares from assumed conversion of stock options and restricted stock |  |      | 54,667    |      |   | 65,353    |  |   | 69,773   
|                                                                                 |  |      |           |      |   |           |  |   |          
|Average common shares outstanding  diluted                                      |  |      | 4,597,624 |      |   | 4,775,883 |  |   | 3,874,484
|                                                                                 |  |      |           |      |   |           |  |   |          
|Earnings per common share  diluted                                              |  | $    | 2.24      |      | $ | 1.98      |  | $ | 1.88     
|                                                                                 |  |      |           |      |   |           |  |   |          

Basic earnings per share, after giving effect to preferred stock dividends and discount accretion,
are computed by dividing net income available to common shareholders by the weighted average number of common shares outstanding throughout each year. Diluted earnings per share gives the effect to weighted average shares which would be outstanding
assuming the exercise of options and warrants using the treasury stock method. For the years ended December 31, 2008 and 2007, 66,055 and 1,000, respectively, anti-dilutive stock options were excluded from the diluted weighted average common
share calculations.



58



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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):



|                                                                                                                                        |  |      |         |      |   |         |  |   |        
|--------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                                                                                                                        |  | 2008 |         | 2007 |   | 2006   
|Current tax expense                                                                                                                     |  |      |         |      |   |         |  |   |        
|Federal                                                                                                                                 |  | $    | 2,236   |      | $ | 2,882   |  | $ | 977    
|State                                                                                                                                   |  |      | 145     |      |   | 475     |  |   | 51     
|                                                                                                                                        |  |      |         |      |   |         |  |   |        
|                                                                                                                                        |  |      | 2,381   |      |   | 3,357   |  |   | 1,028  
|                                                                                                                                        |  |      |        
|Deferred tax (benefit) provision                                                                                                        |  |      |         |      |   |         |  |   |        
|Federal                                                                                                                                 |  |      | 422     |      |   | (373)   |  |   | 491    
|State                                                                                                                                   |  |      | 17      |      |   | (115)   |  |   | 243    
|                                                                                                                                        |  |      |         |      |   |         |  |   |        
|                                                                                                                                        |  |      | 439     |      |   | (488)   |  |   | 734    
|                                                                                                                                        |  |      |         |      |   |         |  |   |        
|Total                                                                                                                                   |  | $    | 2,820   |      | $ | 2,869   |  | $ | 1,762  
|                                                                                                                                        |  |      |         |      |   |         |  |   |        
|                                                                                                                                       
|A reconciliation between the statutory federal income tax rate and the effective income tax rate for the years indicated is as follows:
|                                                                                                                                        |  |      |        
|                                                                                                                                        |  | 2008 |         | 2007 |   | 2006   
|Statutory federal income tax rate                                                                                                       |  |      | 34.0%   |      |   | 34.0%   |  |   | 34.0%  
|State franchise tax, net of federal tax benefit                                                                                         |  |      | 0.8%    |      |   | 1.9%    |  |   | 2.1%   
|Tax exempt interest income                                                                                                              |  |      | (11.3%) |      |   | (11.4%) |  |   | (13.2%)
|Tax exempt insurance income                                                                                                             |  |      | (2.2%)  |      |   | (1.8%)  |  |   | (1.7%) 
|Other, net                                                                                                                              |  |      | 0.1%    |      |   | 0.5%    |  |   | (1.8%) 
|                                                                                                                                        |  |      |         |      |   |         |  |   |        
|Total                                                                                                                                   |  |      | 21.4%   |      |   | 23.2%   |  |   | 19.4%  
|                                                                                                                                        |  |      |         |      |   |         |  |   |        

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



|                                                      |  |      |        |      |   |      
|----------------------------------------------------- |  | ---- | ------ | ---- | - | -----
|                                                      |  | 2008 |        | 2007
|Assets:                                               |  |      |        |      |   |      
|Loans                                                 |  | $    | 445    |      | $ | 606  
|Allowance for credit losses                           |  |      | 3,509  |      |   | 3,260
|Retirement benefits                                   |  |      | 1,336  |      |   | 1,468
|Deferred compensation                                 |  |      | 2,616  |      |   | 2,317
|Pension costs                                         |  |      | 1,200  |      |   |     
|Tax attribute carry-forwards                          |  |      | 672    |      |   | 1,249
|Incentive compensation plans                          |  |      | 487    |      |   | 348  
|Covenant not to compete                               |  |      | 255    |      |   | 275  
|Other                                                 |  |      | 559    |      |   | 350  
|                                                      |  |      |        |      |   |      
|Total deferred tax assets                             |  |      | 11,079 |      |   | 9,873
|Liabilities:                                          |  |      |        |      |   |      
|Securities                                            |  |      | 87     |      |   | 178  
|Premises, furniture and equipment                     |  |      | 510    |      |   | 521  
|Depreciation and leasing                              |  |      | 3,319  |      |   | 3,169
|Deferred fees                                         |  |      | 1,045  |      |   | 916  
|Intangible assets                                     |  |      | 1,326  |      |   | 1,804
|Net unrealized gains on available-for-sale securities |  |      | 1,813  |      |   | 577  
|Pension costs                                         |  |      |       |      |   | 170  
|Other                                                 |  |      | 412    |      |   | 68   
|                                                      |  |      |        |      |   |      
|Total deferred tax liabilities                        |  |      | 8,512  |      |   | 7,403
|                                                      |  |      |        |      |   |      
|Net deferred tax asset at year-end                    |  | $    | 2,567  |      | $ | 2,470
|                                                      |  |      |        |      |   |      

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.



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements



10.  Income Taxes (contd.)



The Company has the following tax attribute carry-forward benefits available as of December 31 (dollars in
thousands)



|                                     |  |      |     |                      |     
|------------------------------------ |  | ---- | --- | -------------------- | ----
|                                     |  | 2008 |     | Year(s) ofExpiration
|Federal:                             |  |      |     |                      |     
|Alternative Minimum Tax (AMT) Credit |  | $    | 672 |                      | None

The utilization of $480,000 of the AMT credit carry-forward is subject to annual limitations
imposed by the Internal Revenue Code. The Company believes these limitations will not prevent the tax attribute from being utilized.

The
Company has adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48) effective January 1, 2007. There was no cumulative effect of adoption of FIN 48. At
December 31, 2007 and 2008, the Company had approximately $163,000 and $173,000, respectively, of net unrecognized tax benefits and interest.

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):



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

Included in the amount at December 31, 2008 and 2007, is $101,000 and $90,000, respectively,
of unrecognized tax benefits and interest which would impact the Companys effective tax rate, if recognized or reversed. As of December 31, 2008 and 2007, accrued interest related to uncertain tax positions was $27,000 and $17,000,
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 examination for
tax years prior to 2005. The Company is no longer subject to State examination for tax years prior to 2004. The Companys 2004-2006 New York income tax returns are currently under examination. Management does not anticipate the New York state
examination will result in an unfavorable material change to its financial position. The Company does anticipate that a reduction in the unrecognized tax benefits of up to $60,000 may occur over the next twelve months from the settlement of
examinations.



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





11. Accumulated Other Comprehensive Income (Loss)

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



|                                                                                                                                                   |  |      |         |      |   |         |  |   |        
|-------------------------------------------------------------------------------------------------------------------------------------------------- |  | ---- | ------- | ---- | - | ------- |  | - | -------
|                                                                                                                                                   |  | 2008 |         | 2007 |   | 2006   
|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                                                    |  | $    | 933     |      | $ | (998)   |  | $ | (1,644)
|Net unrealized gains for the period, net of tax expense of $1,275 in 2008, $1,222 in 2007, and $445 in 2006                                        |  |      | 2,021   |      |   | 1,924   |  |   | 645    
|Reclassification adjustment for (gains) losses included in net income, net of tax expense (benefit) of $53 in 2008, $(5) in 2007, and $(1) in
2006 |  |      | (84)    |      |   | 7       |  |   | 1      
|                                                                                                                                                   |  |      |         |      |   |         |  |   |        
|Effect on other comprehensive income for the period                                                                                                |  |      | 1,937   |      |   | 1,931   |  |   | 646    
|Accumulated unrealized gains (losses) on securities available-for-sale at December 31, net of tax                                                  |  | $    | 2,870   |      | $ | 933     |  | $ | (998)  
|                                                                                                                                                   |  |      |         |      |   |         |  |   |        
|                                                                                                                                                   |  |      |        
|Effect from retirement benefit plans                                                                                                               |  |      |         |      |   |         |  |   |        
|Accumulated unrealized gains (losses) for retirement benefit plans at January 1, net of tax                                                        |  | $    | 272     |      | $ | (1,124) |  | $ | (56)   
|                                                                                                                                                   |  |      |        
|Change in minimum pension liability                                                                                                                |  |      |        |      |   |        |  |   | (74)   
|Amortization of prior service costs, net of tax benefit of $(4) in 2008 and $(6) in 2007                                                           |  |      | 6       |      |   | 10      |  |   |       
|Amortization of net (gain) loss, net of tax expense (benefit) of $3 in 2008 and $(12) in 2007                                                      |  |      | (7)     |      |   | 18      |  |   |       
|Change in accumulated unrealized net (losses) gains for plan benefits, net of tax (benefit) expense of $(1,185) in 2008 and $292 in
2007           |  |      | (1,839) |      |   | 541     |  |   |       
|Change in unrecognized prior service cost, net of tax benefit $(185)                                                                               |  |      | (292)   |      |   |        |  |   |       
|Post-retirement plan amendment, net of tax benefit $(521)                                                                                          |  |      |        |      |   | 827     |  |   |       
|                                                                                                                                                   |  |      |         |      |   |         |  |   |        
|Effect on other comprehensive income for the period                                                                                                |  |      | (2,132) |      |   | 1,396   |  |   | (74)   
|                                                                                                                                                   |  |      |        
|Cumulative effect of change in accounting for pension obligations                                                                                  |  |      |         |      |   |         |  |   |        
|Prior service costs, net of tax expense of $126 in 2006                                                                                            |  |      |        |      |   |        |  |   | (190)  
|Net loss, net of tax benefit of $25 in 2008 and $536 in 2006                                                                                       |  |      | (39)    |      |   |        |  |   | (804)  
|                                                                                                                                                   |  |      |         |      |   |         |  |   |        
|                                                                                                                                                   |  |      |        |      |   |        |  |   | (994)  
|                                                                                                                                                   |  |      |        
|Accumulated unrealized (losses) gains for benefit obligations at December 31, net of tax                                                           |  | $    | (1,899) |      | $ | 272     |  | $ | (1,124)
|                                                                                                                                                   |  |      |         |      |   |         |  |   |        
|                                                                                                                                                   |  |      |        
|Accumulated other comprehensive income (loss) at January 1, net of tax                                                                             |  |      | 1,205   |      |   | (2,122) |  |   | (1,700)
|Other comprehensive (loss) income, net of tax                                                                                                      |  |      | (195)   |      |   | 3,327   |  |   | 572    
|Cumulative effect of change in accounting for adoption of SFAS No. 158                                                                             |  |      | (39)    |      |   |        |  |   | (994)  
|                                                                                                                                                   |  |      |         |      |   |         |  |   |        
|                                                                                                                                                   |  |      |        
|Accumulated other comprehensive income (loss) at December 31, net of tax                                                                           |  | $    | 971     |      | $ | 1,205   |  | $ | (2,122)
|                                                                                                                                                   |  |      |         |      |   |         |  |   |        

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 and former employees of Bridge Street. The Bridge Street defined contribution 401(k) plan was terminated on October 6, 2006 and all plan assets were transferred to the Companys
plan. Former Bridge Street employees service with Bridge Street at the time of the acquisition is deemed to be service with the Company for eligibility and vesting purposes only. Contributions to the Companys 401(k) plan are determined
by the Board of Directors and are based on percentages of compensation for eligible employees. Contributions are funded following the end of the plan (calendar) year. Company contributions to the plan were $484,000, $42,000, and $522,000 in 2008,
2007, and 2006, 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, 2008, other liabilities included approximately $135,000 accrued under the Executive Plan.



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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.)



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 September 2006, the Financial Accounting
Standards Board (FASB) issued SFAS No. 158, Employers Accounting for Defined Benefit Pension and Other Postretirement Plans  an amendment of FASB Statements No. 87, 88, 106 and 132(R). This Statement requires that 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 FASB Statement No. 87
Employers Accounting for Pensions, 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 spouses, if applicable.

In connection with the
Settlement of the Post-Retirement Plan, the Company recorded a deferred gain of $517,000, representing the difference between the accrued accumulated benefit obligation of $966,000 and the lump sum payments to the qualifying participants of
$449,000. This gain was offset against existing unrecognized losses recorded in accumulated other comprehensive income. Unrealized losses in excess of 10% of the accumulated projected benefit obligation are amortized on a straight line basis over
the expected future lifetime of the retiree group. No payments were made to participants in connection with the Negative Amendment. The Company reversed the accrued accumulated benefit obligation of $831,000 as of September 30, 2007 through
accumulated other comprehensive income. The remaining balance of unrecognized prior service benefit of $651,000 will be amortized on a straight line basis over 15 years.

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
October 1 in 2007 for the Pension Plan and December 31 for the Post-Retirement Plan and the Pension Plan in 2008):



|                                                       |  |              |                |                      |   |       |  |      |         |  |   |        
|------------------------------------------------------ |  | ------------ | -------------- | -------------------- | - | ----- |  | ---- | ------- |  | - | -------
|                                                       |  | Pension Plan |                | Post-Retirement Plan
|                                                       |  | 2008         |                | 2007                 |   | 2008  |  | 2007
|Change in benefit obligation:                          |  |              | (In thousands)
|Benefit obligation at beginning of year                |  | $            | 4,192          |                      | $ | 4,150 |  | $    | 3,935   |  | $ | 6,060  
|Service cost                                           |  |              |               |                      |   |      |  |      |        |  |   | 133    
|Interest cost                                          |  |              | 257            |                      |   | 239   |  |      | 241     |  |   | 322    
|Actuarial loss (gain)                                  |  |              | 625            |                      |   | 21    |  |      | 240     |  |   | (462)  
|Benefits paid                                          |  |              | (274)          |                      |   | (218) |  |      | (314)   |  |   | (799)  
|Participant contributions                              |  |              |               |                      |   |      |  |      | 27      |  |   | 29     
|Adjustment for measurement date change                 |  |              | 64             |                      |   |      |  |      |        |  |   |       
|Settlement gain                                        |  |              |               |                      |   |      |  |      |        |  |   | (517)  
|Plan amendment                                         |  |              |               |                      |   |      |  |      |        |  |   | (831)  
|                                                       |  |              |                |                      |   |       |  |      |         |  |   |        
|Benefit obligation at end of year                      |  |              | 4,864          |                      |   | 4,192 |  |      | 4,129   |  |   | 3,935  
|Change in plan assets:                                 |  |              |                |                      |   |       |  |      |         |  |   |        
|Fair value of plan assets at the beginning of the year |  |              | 4,914          |                      |   | 4,524 |  |      |        |  |   |       
|Actual return on plan assets                           |  |              | (1,395)        |                      |   | 608   |  |      |        |  |   |       
|Benefits paid                                          |  |              | (274)          |                      |   | (218) |  |      | (314)   |  |   | (799)  
|Participant contributions                              |  |              |               |                      |   |      |  |      | 27      |  |   | 29     
|Employer contributions                                 |  |              |               |                      |   |      |  |      | 287     |  |   | 770    
|                                                       |  |              |                |                      |   |       |  |      |         |  |   |        
|Fair value of plan assets at the end of year           |  |              | 3,245          |                      |   | 4,914 |  |      |        |  |   |       
|                                                       |  |              |                |                      |   |       |  |      |         |  |   |        
|Funded status at end of year                           |  | $            | (1,619)        |                      | $ | 722   |  | $    | (4,129) |  | $ | (3,935)
|                                                       |  |              |                |                      |   |       |  |      |         |  |   |        



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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.)



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
|                                          |  | 2008           |       | 2007                 |   | 2008  |  | 2007
|                                          |  | (In thousands)
|Unrecognized actuarial loss (gain)        |  | $              | 2,372 |                      | $ | (188) |  | $    | (607) |  | $ | 289  
|Unrecognized prior service cost (benefit) |  |                |      |                      |   |      |  |      | 529   |  |   | (651)
|                                          |  |                |       |                      |   |       |  |      |       |  |   |      
|                                          |  | $              | 2,372 |                      | $ | (188) |  | $    | (78)  |  | $ | (362)
|                                          |  |                |       |                      |   |       |  |      |       |  |   |      

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



|                                                |  |                |       |                      |   |       |  |      |      |      |   |     |  |   |    
|----------------------------------------------- |  | -------------- | ----- | -------------------- | - | ----- |  | ---- | ---- | ---- | - | --- |  | - | ---
|                                                |  | Pension Plan   |       | Post-Retirement Plan
|                                                |  | 2008           |       | 2007                 |   | 2008  |  | 2007 |      | 2006
|                                                |  | (In thousands)
|Service cost                                    |  | $              |      |                      | $ |      |  | $    |     |      | $ | 133 |  | $ | 121
|Interest cost                                   |  |                | 257   |                      |   | 239   |  |      | 241  |      |   | 322 |  |   | 284
|Amortization of unrecognized prior service cost |  |                |      |                      |   |      |  |      | (44) |      |   | 6   |  |   | 23 
|Amortization of unrecognized actuarial loss     |  |                |      |                      |   |      |  |      |     |      |   | 30  |  |   | 56 
|Expected return on assets                       |  |                | (433) |                      |   | (399) |  |      |     |      |   |    |  |   |   
|                                                |  |                |       |                      |   |       |  |      |      |      |   |     |  |   |    
|Total net periodic (benefit) cost               |  | $              | (176) |                      | $ | (160) |  | $    | 197  |      | $ | 491 |  | $ | 484
|                                                |  |                |       |                      |   |       |  |      |      |      |   |     |  |   |    

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 cost 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 $165,000 and $8,000, respectively.

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



|                               |  |              |  |                      |  |       |  |      
|------------------------------ |  | ------------ |  | -------------------- |  | ----- |  | -----
|                               |  | Pension Plan |  | Post-Retirement Plan
|                               |  | 2008         |  | 2007                 |  | 2008  |  | 2007 
|Discount rate                  |  | 5.87%        |  | 6.29%                |  | 5.77% |  | 6.38%
|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
|                               |  | 2008         |  | 2007                 |  | 2008  |  | 2007  |  | 2006 
|Discount rate                  |  | 6.29%        |  | 5.90%                |  | 6.38% |  | 6.00% |  | 5.50%
|Expected return on plan assets |  | 9.00%        |  | 9.00%                |  |      |  |      |  |     

The discount rates used in determining the benefit obligations for the Pension Plan and
Post-Retirement Plan as of December 31, 2008, 2007 and 2006 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.

Pension Plan assets are
invested in six diversified investment funds of the RSI Retirement Trust (the Trust), a no load series open-ended mutual fund. The investment funds include four equity mutual funds and two bond mutual funds, each with its own investment
objectives, investment strategies and risks, as detailed in the Trusts prospectus. 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 objective is to be
invested 65% in equity securities (equity mutual funds) and 35% in debt securities (bond mutual funds). If the Pension Plan is underfunded under the Guidelines, the bond fund portion will be temporarily increased to 50% in order to lessen asset
value volatility. When the Pension Plan is no longer underfunded, the bond fund portion will be decreased back to 35%. Asset rebalancing is performed at least annually, with interim adjustments made when the investment mix varies more than 10% from
the target (i.e., a 20% target range).

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.



63



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



|                                    |  |  |  |      |  |      |  | 
|----------------------------------- |  |  |  | ---- |  | ---- |  | 
|Asset Category                      |  |  |  | 2008 |  | 2007
|Equity securities                   |  |  |  | 59%  |  | 70% 
|Debt Securities (Bond Mutual Funds) |  |  |  | 41%  |  | 30% 
|                                    |  |  |  |      |  |     
|Total                               |  |  |  | 100% |  | 100%
|                                    |  |  |  |      |  |      |  | 

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 are applied to the Pension Plans target allocation, the result is an expected rate of return of 7%
to 11%.

Due to recent changes in pension funding law and sharp declines in market asset values, a reasonable estimate of expected
contributions cannot be determined at this time.

For measurement purposes, with respect to the Post-Retirement Plan, a 10.0% annual rate
of increase in the per capita cost of covered health care benefits is assumed for 2008. The rate is assumed to decrease gradually to 4.5% by the year 2016 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 |  |  |  | 247                              |  | (215)                           

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: |  |   |      
|                         | 
|2009                     |  | $ | 221  
|2010                     |  |   | 219  
|2011                     |  |   | 255  
|2012                     |  |   | 253  
|2013                     |  |   | 259  
|Years 2014-2018          |  |   | 1,347

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



|                         |  |   |      
|------------------------ |  | - | -----
|Year ending December 31: |  |   |      
|                         | 
|2009                     |  | $ | 312  
|2010                     |  |   | 335  
|2011                     |  |   | 348  
|2012                     |  |   | 346  
|2013                     |  |   | 340  
|Years 2014-2018          |  |   | 1,549

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 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.



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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 obligations, plan assets
and funded status of the Directors Plan at December 31:



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

Pre-tax amounts recognized in accumulated other comprehensive income at December 31, 2008
that have not been recognized as components of net periodic benefit or cost consist of:



|                                   |  |                |    
|---------------------------------- |  | -------------- | ---
|                                   |  | 2008          
|                                   |  | (in thousands)
|Unrecognized actuarial (gain) loss |  | $              |   
|Unrecognized prior service cost    |  |                | 454
|                                   |  |                |    
|                                   |  | $              | 454
|                                   |  |                |    

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



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

The discount rate used in determining the benefit obligation for the Directors Plan as of
December 31, 2008 was 5.87%. 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%.

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



|                         |  |   |    
|------------------------ |  | - | ---
|Year ending December 31: |  |   |    
|2009                     |  | $ |   
|2010                     |  |   |   
|2011                     |  |   |   
|2012                     |  |   | 33 
|2013                     |  |   | 49 
|Years 2014-2018          |  |   | 317

In 2009, $46,000 in unrecognized prior service costs 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 has segregated assets of $174,000 and $332,000 at December 31, 2008 and 2007, respectively, to fund the estimated benefit obligation associated with certain SRP plans.



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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 obligations, plan assets
and funded status of the SRPs at December 31:



|                                             |  |  |  |  |  |                |  |             |  |  |  | 
|-------------------------------------------- |  |  |  |  |  | -------------- |  | ----------- |  |  |  | 
|                                             |  |  |  |  |  | 2008           |  | 2007       
|Change in benefit obligation:                |  |  |  |  |  | (In thousands)
|Benefit obligation at beginning of year      |  |  |  |  |  | $     3,334    |  | $     3,535
|Service cost                                 |  |  |  |  |  | 61             |  | 57         
|Interest cost                                |  |  |  |  |  | 199            |  | 192        
|Actuarial loss (gain)                        |  |  |  |  |  | 262            |  | (53)       
|Benefits paid                                |  |  |  |  |  | (390)          |  | (397)      
|                                             |  |  |  |  |  |                |  |            
|Benefit obligation at end of year            |  |  |  |  |  | 3,466          |  | 3,334      
|Change in plan assets:                       |  |  |  |  |  |                |  |            
|Benefits paid                                |  |  |  |  |  | (390)          |  | (397)      
|Employer contributions                       |  |  |  |  |  | 390            |  | 397        
|                                             |  |  |  |  |  |                |  |            
|Fair value of plan assets at the end of year |  |  |  |  |  |               |  |           
|                                             |  |  |  |  |  |                |  |            
|Funded status at end of year                 |  |  |  |  |  | $   (3,466)    |  | $   (3,334)
|                                             |  |  |  |  |  |                |  |            

Pre-tax amounts recognized in accumulated other comprehensive income at December 31, 2008
that has not been recognized as components of net periodic benefit or cost consist of:



|                                   |  |  |  |                |  |          |  | 
|---------------------------------- |  |  |  | -------------- |  | -------- |  | 
|                                   |  |  |  | 2008           |  | 2007    
|                                   |  |  |  | (In thousands)
|Unrecognized actuarial loss (gain) |  |  |  | $    243       |  | $   (10)
|Unrecognized prior service cost    |  |  |  | 111            |  | 121     
|                                   |  |  |  |                |  |         
|                                   |  |  |  | $    354       |  | $    111
|                                   |  |  |  |                |  |         

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



|                                                |  |    |  |                |  |           |  |           |  | 
|----------------------------------------------- |  | -- |  | -------------- |  | --------- |  | --------- |  | 
|                                                |  |    |  | 2008           |  | 2007      |  | 2006     
|                                                |  |    |  | (In thousands)
|Service cost                                    |  |    |  | $      61      |  | $      57 |  | $      64
|Interest cost                                   |  |    |  | 199            |  | 192       |  | 83       
|Amortization of unrecognized prior service cost |  | 10 |  | 10             |  | 81       
|Amortization of unrecognized actuarial loss     |  | 9  |  |               |  | 251      
|                                                |  |    |  |                |  |           |  |          
|Total net periodic cost                         |  |    |  | $    279       |  | $    259  |  | $    479 
|                                                |  |    |  |                |  |           |  |          

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 compensation expense resulting from the full recognition of unrecognized losses and prior service costs totaled
$319,000 in 2006. There was no such expense in 2008 and 2007.

The discount rate used in determining the benefit obligation of the
SRPs as of December 31, 2008 and 2007 was 5.77% and 6.38%, respectively. The discount rate used in determining the net periodic benefit cost was 6.38%, 5.80%, and 5.50% for 2008, 2007 and 2006, 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. For measurement purposes in 2008 and 2007, with respect to the SRPs, an 8.5% annual rate was assumed as the investment return on account balances and
salaries were assumed to increase at an annual rate of 4.0%.

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



|                         |  |   |      
|------------------------ |  | - | -----
|Year ending December 31: |  |   |      
|2009                     |  | $ | 262  
|2010                     |  |   | 261  
|2011                     |  |   | 251  
|2012                     |  |   | 249  
|2013                     |  |   | 246  
|Years 2014-2018          |  |   | 1,741

In 2009, $10,000 in unrecognized prior service costs and $10,000 in unrecognized actuarial losses
are estimated to be amortized from accumulated other comprehensive income into the net periodic cost for the SRPs.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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



The Company assumed a SRP for directors from Bridge Street, providing for extended compensation after
retirement. Cash surrender value of these policies approximated $6.9 million and $6.7 million at December 31, 2008 and 2007, respectively. At December 31, 2008 and 2007 other liabilities include approximately $679,000 and $708,000,
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, 2008 and 2007 approximated $66,000 and $69,000, respectively.

The Company expects to contribute $356,000 to its SRPs in 2009.

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, 2008, 85,510 shares are held in trust with a cost basis of $2.1 million.

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, 2008 and 2007, other liabilities included
approximately $580,000 and $2.5 million, respectively, relating to deferred compensation. Deferred compensation expense resulting from the earnings on deferred balances for the years ended December 31, 2008, 2007, and 2006 approximated $76,000,
$342,000, and $319,000, 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, 2008 and 2007, deferred director fees included in other liabilities, and the corresponding assets included in other assets, aggregated approximately $485,000 and
$767,000, 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.

There were 182,555 options outstanding at December 31, 2008, of which 166,555 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. 15,000 options were issued with a 10-year term and vest ratably over a three-year period. 1,000 options were issued with a five-year term and vested on issuance. No options were granted during 2008, 2007 and 2006.

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. 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.

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



|                                 |  |         |  |                               
|-------------------------------- |  | ------- |  | ------------------------------
|                                 |  | 2008   
|                                 |  | Shares  |  | Weighted AverageExercise Price
|                                 |  |        
|Outstanding at beginning of year |  | 182,555 |  | $    21.77                    
|Granted                          |  |        |  |                               
|Vested                           |  |        |  |                               
|Exercised                        |  |        |  |                               
|Forfeited                        |  |        |  |                               
|                                 |  |         |  |                               
|Outstanding at end of year       |  | 182,555 |  | $    21.77                    
|                                 |  |         |  |                               



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





14. Stock Based Compensation Plans (contd)



The following table summarizes the Companys stock options at December 31, 2008:



|                         |  |                     |  |                                 |  |                                         |  |                     |  |                                
|------------------------ |  | ------------------- |  | ------------------------------- |  | --------------------------------------- |  | ------------------- |  | -------------------------------
|                         |  | Options Outstanding |  | Options Exercisable            
|                         |  |                     |  |                                 | 
|Range of Exercise Prices |  | Options Outstanding |  | Weighted Average Exercise Price |  | Weighted Average Remaining Life (Years) |  | Options Exercisable |  | Weighted Average Exercise Price
|$17.75 - $19.00          |  | 75,500              |  | $18.28                          |  | 1.3                                     |  | 75,500              |  | $18.28                         
|$21.75 - $23.50          |  | 41,000              |  | $23.29                          |  | 2.7                                     |  | 41,000              |  | $23.29                         
|$24.75 - $28.65          |  | 66,055              |  | $24.81                          |  | 1.1                                     |  | 38,782              |  | $24.85                         

The total intrinsic value of options exercised during 2007 and 2006 was $66,000 and $408,000,
respectively. The aggregate intrinsic value of shares outstanding and exercisable at December 31, 2008 was $426,000. Cash received from options exercised was $178,000 and $1.1 million in 2007 and 2006, respectively. The tax benefit realized
from stock option exercised was $26,000 and $120,000 in 2007 and 2006, 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. No shares were vested in 2008. 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. Compensation expense associated with the amortization of the cost of all restricted shares issued for the years ended December 31, 2008, 2007
and 2006 was $359,000, $241,000, and $213,000, respectively. The unrecognized compensation cost for restricted stock awards was $1.3 million at December 31, 2008, which will be recognized as compensation expense over a weighted average period
of 4.3 years.

The following is a summary of the Companys restricted stock activity for the years ended December 31, 2008, 2007
and 2006:



|                                 |  |                  |  |                            |  |                  |  |                            |  |                  |  |                           
|-------------------------------- |  | ---------------- |  | -------------------------- |  | ---------------- |  | -------------------------- |  | ---------------- |  | --------------------------
|                                 |  | 2008             |  | 2007                       |  | 2006            
|                                 |  |                  |  |                            |  |                 
|                                 |  | Non-vestedShares |  | WeightedAverageGrant Price |  | Non-vestedShares |  | WeightedAverageGrant Price |  | Non-vestedShares |  | WeightedAverageGrant Price
|                                 |  |                  |  |                            |  |                 
|Outstanding at beginning of year |  | 74,175           |  | $30.95                     |  | 67,375           |  | $31.06                     |  | 62,775           |  | $31.00                    
|Granted                          |  | 15,500           |  | 25.19                      |  | 16,950           |  | 30.88                      |  | 26,500           |  | 30.81                     
|Forfeited                        |  | 3,575            |  | 26.55                      |  | 10,150           |  | 31.44                      |  | (19,995)         |  | 30.67                     
|Vested                           |  |                 |  |                           |  |                 |  |                           |  | (1,905)          |  | 30.21                     
|                                 |  |                  |  |                            |  |                  |  |                            |  |                  |  |                           
|Outstanding at end of year       |  | 86,100           |  | $30.32                     |  | 74,175           |  | $30.95                     |  | 67,375           |  | $31.06                    
|                                 |  |                  |  |                            |  |                  |  |                            |  |                  |  |                           

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
|                                       |  | 2008            |  | 2007         |  | 2006        
|Commitments to extend credit, variable |  | $    129,818    |  | $    122,099 |  | $    127,590
|Commitments to extend credit, fixed    |  | 32,782          |  | 30,955       |  | 7,587       
|Standby letters of credit              |  | 1,572           |  | 1,289        |  | 2,663       

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



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





15. Commitments and Contingent Liabilities (contd)



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 2008, $1.0 million in 2007, and $982,000 in 2006.

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



|                             |  |         
|---------------------------- |  | --------
|Year ending December 31:     |  |         
|2009                         |  | $  1,113
|2010                         |  | 967     
|2011                         |  | 945     
|2012                         |  | 549     
|2013                         |  | 456     
|Thereafter                   |  | 3,033   
|                             |  |         
|Total minimum lease payments |  | $  7,063
|                             |  |         

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 2008, $120,000 in 2007, and $75,000 in 2006, and will pay $152,000 annually from 2009 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, 2008 was $600,000.

FASB Interpretation No. 47 (FIN 47) issued in March 2005
clarified that the term conditional retirement obligation as used in FASB Statement No. 143 (FAS 143), Accounting for 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. FAS 143 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. 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 any major renovations or demolition of any of its facilities have not been planned and 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.

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, 2008, approximately $13.8 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, 2008.

Prior to December 19, 2011, unless the Company has redeemed the Series A Preferred Stock or the
Treasury Department has transferred the Series A Preferred Stock to a third party, the consent of the Treasury Department will be required for the Company to (1) declare or pay any dividend or make any distribution on its common stock
(other than regular quarterly cash dividends of not more than $0.26 per share of common stock) or (2) redeem, purchase or acquire any shares of its common stock or other equity or capital securities, other than in connection with benefit plans
consistent with past practice and certain other circumstances specified in the Purchase Agreement.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





17. Fair Value of Financial Instruments



Statement of Financial Accounting Standards No. 157, Fair Value Measurements,
establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure
fair value:

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 securities
available-for-sale are determined by obtaining quoted prices on nationally recognized securities exchanges.

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



|                              |  |                                                    |  |   |         |                                                                       |  |                |  |  |  |                                               |  |  |  |  |              |  |  |  |  |  |  |  |  |  |  |  |                     
|----------------------------- |  | -------------------------------------------------- |  | - | ------- | --------------------------------------------------------------------- |  | -------------- |  |  |  | --------------------------------------------- |  |  |  |  | ------------ |  |  |  |  |  |  |  |  |  |  |  | --------------------
|                              |  | Fair Value Measurements at December 31, 2008 Using
|                              |  | Fair Value at December 31, 2008                    |  |   |         | Quoted market prices in active markets for identical assets (Level 1) |  |                |  |  |  | Significant other observable inputs (Level
2)
|                              |  |                                                    |  |   |         |                                                                       |  | (in thousands) |  |  |  |                                               |  |  |  |  |              | 
|Available for sale securities |  |                                                    |  | $ | 299,149 |                                                                       |  |                |  |  |  |                                               |  |  |  |  | $        988 |  |  |  |  |  |  |  |  |  |  |  | $            298,161
|                              |  |                                                    |  |   |         |                                                                       |  |                |  |  |  |                                               |  |  |  |  |              |  |  |  |  |  |  |  |  |  |  |  |                     

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. 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.

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.

Mortgage servicing rights  The fair value of mortgage servicing
rights is based on a valuation model that calculates the present value of estimated net servicing income. The valuation model incorporates assumptions that market participants would used in estimating future net servicing income. The Company is able
to compare the valuation model inputs and results to widely available published industry data for reasonableness.

Certain impaired loans
are reported at the fair value of the underlying collateral if repayment is expected solely from the collateral. 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 and the related non-recurring fair value measurement adjustments have generally been classified as Level 2. Estimates of fair value used for other collateral supporting
commercial loans generally are not observable in the marketplace and therefore, such valuations have been classified as Level 3.

The
following represents impairment charges recognized during 2008:

During the first quarter of 2008, loans and leases held-for-sale were
carried at a fair value of $15.1 million (of which $10.6 million, $3.8 million and $800,000 were measured using Level 1, Level 2 and Level 3 inputs, respectively within the fair value hierarchy), resulting in a valuation allowance of $187,000. There
are no leases held for sale at December 31, 2008. During the first quarter of 2008, losses of $187,000 were recorded in other income.

Loans subject to non-recurring fair value measurement using Level 3 inputs had a gross carrying amount of $1.4 million with an associated valuation allowance of $193,000 for a fair value of $1.3 million. Impairment write-downs during 2008
resulted in $2.0 million in charges to the allowance for credit losses.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





17. Fair Value of Financial Instruments (contd)



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



|                                         |  |   |         |                |   |                     |  |                |         |                     |   |         |  | 
|---------------------------------------- |  | - | ------- | -------------- | - | ------------------- |  | -------------- | ------- | ------------------- | - | ------- |  | 
|                                         |  |   |         | 2008           |   | 2007               
|                                         |  |   |         | CarryingAmount |   | EstimatedFair Value |  | CarryingAmount |         | EstimatedFair Value
|Financial Assets:                        |  |   |         |                |   |                     |  |                |         |                     |   |         |  | 
|Cash and cash equivalents                |  | $ | 21,172  |                | $ | 21,172              |  | $              | 30,704  |                     | $ | 30,704 
|Fed funds sold                           |  |   | 26,918  |                |   | 26,918              |  |                |        |                     |   |       
|FHLB and FRB stock                       |  |   | 11,844  |                |   | N/A                 |  |                | 9,507   |                     |   | N/A    
|Loans held for sale                      |  |   | 875     |                |   | 875                 |  |                | 3,163   |                     |   | 3,163  
|Loans and leases, net of unearned income |  |   | 910,755 |                |   | 930,920             |  |                | 895,533 |                     |   | 890,990
|Allowance for credit losses              |  |   | (9,161) |                |   |                    |  |                | (8,426) |                     |   |       
|                                         |  |   |         |                |   |                     |  |                |         |                     |   |         |  | 
|                                         |  |   |         |                |   |                     |  |                |         |                     |   |         |  | 
|Net loans and leases                     |  |   | 901,594 |                |   | 930,920             |  |                | 887,107 |                     |   | 890,990
|Accrued interest receivable              |  |   | 4,218   |                |   | 4,218               |  |                | 4,501   |                     |   | 4,501  
|                                         |  |   |         |                |  
|Financial Liabilities:                   |  |   |         |                |   |                     |  |                |         |                     |   |         |  | 
|Deposits                                 |  | $ | 937,882 |                | $ | 943,182             |  | $              | 945,230 |                     | $ | 945,563
|Borrowings                               |  |   | 238,972 |                |   | 241,421             |  |                | 200,757 |                     |   | 199,176
|Junior subordinated obligations          |  |   | 25,774  |                |   | 20,792              |  |                | 25,774  |                     |   | 25,774 
|Accrued interest payable                 |  |   | 3,037   |                |   | 3,037               |  |                | 3,903   |                     |   | 3,903  

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.

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.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





17. Fair Value of Financial Instruments (contd)



Junior Subordinated Obligations

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

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, 2008, 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.

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, 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% 
|                         |  |          |  |                              |  |                                                               
|As of December 31, 2007  |  |          |  |                              |  |                                                                |  |        |  |        |  |        
|Total risk-based capital |  |          |  |                              |  |                                                                |  |        |  |        |  |        
|Company                  |  | $102,311 |  | 11.59%                       |  | $70,610                                                        |  | 38.00% |  | N/A    |  | N/A    
|Bank                     |  | 99,024   |  | 11.30%                       |  | 70,098                                                         |  | 38.00% |  | 87,622 |  | 310.00%
|Tier 1 capital           |  |          |  |                              |  |                                                                |  |        |  |        |  |        
|Company                  |  | 93,885   |  | 10.64%                       |  | 35,305                                                         |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  | 90,598   |  | 10.34%                       |  | 35,049                                                         |  | 34.00% |  | 52,573 |  | 36.00% 
|Leverage                 |  |          |  |                              |  |                                                                |  |        |  |        |  |        
|Company                  |  | 93,885   |  | 7.53%                        |  | 49,899                                                         |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  | 90,598   |  | 7.26%                        |  | 49,905                                                         |  | 34.00% |  | 62,382 |  | 35.00% 

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

In December 2008, the Treasury Department purchased 26,918 shares of the Companys newly issued, non-voting senior cumulative preferred stock valued
at $26.9 million, with an initial annual dividend of 5% for five years and 9% thereafter. Dividends are accrued as earned by the Treasury Department. The preferred stock may not be redeemed for a period of three years from the date of the
investment, except with the proceeds from a qualified equity offering. After the third anniversary of the date of this investment, the preferred stock may be redeemed, in whole or in part, at any time, at the option of the Company. The
preferred stock qualifies as Tier 1 capital for regulatory reporting purposes.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





18. Capital and Regulatory Matters (contd.)



The American Recovery and Reinvestment Act of 2009 (ARRA) provides an opportunity for
TARP recipients to immediately repay a TARP financing assistance without first needing to raise any funds, subject to the consultation by the Treasury Department with the appropriate federal banking agency. The nature of the consultation process is
not defined under the ARRA, and banking regulators might seek to require a withdrawing TARP recipient to raise additional funds from third parties if the regulators determine that there are not otherwise sufficient capital reserves. Under repayment,
the Treasury Department is required to liquidate any warrants it received from the Company.

The Treasury Departments consent is
required for any increase in common dividends per share and any repurchases of common stock until the earlier of a redemption or third anniversary of the date of the preferred stock issuance.

The Treasury Department also received warrants 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 or 15% of the preferred stock investment. The warrants are immediately exercisable and expire in ten years. The Company allocated $1.1 million of the proceeds from the issuance of the preferred stock to the value of the warrants
representing an unamortized discount on preferred stock. The discount is being amortized to preferred stock using an effective yield method over a five year period. $6,000 of the discount was accreted to preferred stock during 2008.

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:                                           |  |   |         | 2008 |         | 2007   
|Investment in subsidiaries                        |  | $ | 160,770 |      | $       | 135,308
|Cash                                              |  |   |         |      | 4,927   |         |   | 1,504  
|Securities                                        |  |   |         |      | 1,512   |         |   | 1,538  
|Investment in limited partnerships                |  |   | 2,350   |      |         | 2,110  
|Other Assets                                      |  |   |         |      | 2,081   |         |   | 2,215  
|                                                  |  |   |         |      |         |         |   |        
|Total Assets                                      |  |   |         | $    | 171,640 |         | $ | 142,675
|                                                  |  |   |         |      |         |         |   |        
|                                                  |  |   |        
|Liabilities:                                      |  |   |         |      |         |         |   |        
|Junior subordinated obligations                   |  | $ | 25,774  |      | $       | 25,774 
|Dividends payable                                 |  |   | 1,232   |      |         | 1,135  
|Other liabilities                                 |  |   | 153     |      |         | 206    
|                                                  |  |   |         |      |         |         |   |        
|Total Liabilities                                 |  |   |         |      | 27,159  |         |   | 27,115 
|                                                  |  |   |        
|Shareholders Equity:                             |  |   |         |      |         |         |   |        
|Preferred stock                                   |  |   |         |      | 25,785  |         |   |       
|Common stock                                      |  |   |         |      | 4,901   |         |   | 4,889  
|Surplus                                           |  |   |         |      | 42,468  |         |   | 38,847 
|Undivided profits                                 |  |   |         |      | 81,110  |         |   | 75,844 
|Accumulated other comprehensive income            |  |   | 971     |      |         | 1,205  
|Directors stock-based deferred compensation plan |  |   | (2,098) |      |         |       
|Treasury stock                                    |  |   |         |      | (8,656) |         |   | (5,225)
|                                                  |  |   |         |      |         |         |   |        
|Total Shareholders Equity                        |  |   | 144,481 |      |         | 115,560
|                                                  |  |   |         |      |         |         |   |        
|Total Liabilities and Shareholders Equity        |  | $ | 171,640 |      | $       | 142,675
|                                                  |  |   |         |      |         |         |   |        

Condensed Statements of Income



|                                                   |  |   |         |      |       |         |  |       |         |  |        
|-------------------------------------------------- |  | - | ------- | ---- | ----- | ------- |  | ----- | ------- |  | -------
|                                                   |  |   |         | 2008 |       | 2007    |  | 2006 
|                                                   |  |   |        
|Dividend income from subsidiary Bank               |  | $ | 9,500   |      | $     | 7,600   |  | $     |       
|Interest and dividends on securities               |  |   | 43      |      |       | 58      |  |       | 58     
|Income from limited partnerships                   |  |   | 202     |      |       | 230     |  |       | 100    
|Interest expense on junior subordinated debentures |  |   | (1,399) |      |       | (1,960) |  |       | (1,139)
|Non-interest expenses                              |  |   | (129)   |      |       | (101)   |  |       | (87)   
|                                                   |  |   |         |      |       |         |  |       |         |  |        
|                                                   |  |   |         |      | 8,217 |         |  | 5,827 |         |  | (1,068)
|Equity in undistributed income of subsidiaries     |  |   | 2,140   |      |       | 3,650   |  |       | 8,379  
|                                                   |  |   |         |      |       |         |  |       |         |  |        
|Net Income                                         |  | $ | 10,357  |      | $     | 9,477   |  | $     | 7,311  
|                                                   |  |   |         |      |       |         |  |       |         |  |        



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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



|                                                                                  |  |   |          |      |         |         |  |         |          |  |         
|--------------------------------------------------------------------------------- |  | - | -------- | ---- | ------- | ------- |  | ------- | -------- |  | --------
|                                                                                  |  |   |          | 2008 |         | 2007    |  | 2006   
|Operating Activities:                                                             |  |   |          |      |         |         |  |         |          |  |         
|Net Income                                                                        |  | $ | 10,357   |      | $       | 9,477   |  | $       | 7,311   
|Adjustments to reconcile net income to net cash provided by operating activities: |  |   |          |      |         |         |  |         |         
|Equity in undistributed net income of subsidiary                                  |  |   | (2,140)  |      |         | (3,650) |  |         | (8,379) 
|Depreciation expense                                                              |  |   | 116      |      |         | 89      |  |         | 24      
|Net change in other assets and liabilities                                        |  |   | 114      |      |         | 270     |  |         | 3,590   
|                                                                                  |  |   |          |      |         |         |  |         |          |  |         
|Net cash provided by operating activities                                         |  |   | 8,447    |      |         | 6,186   |  |         | 2,546   
|                                                                                  |  |   |          |     
|Investing Activities:                                                             |  |   |          |      |         |         |  |         |          |  |         
|Purchase of securities available-for-sale                                         |  |   | (23)     |      |         |        |  |         | (464)   
|Acquisition                                                                       |  |   |          |      |        |         |  |        |          |  | (13,171)
|                                                                                  |  |   |          |      |         |         |  |         |          |  |         
|Net cash used in investing activities                                             |  |   | (23)     |      |         |        |  |         | (13,635)
|                                                                                  |  |   |          |     
|Financing Activities:                                                             |  |   |          |      |         |         |  |         |          |  |         
|Proceeds from issuing subordinated debentures                                     |  |   |         |      |         |        |  |         | 15,464  
|Treasury stock purchased                                                          |  |   |          |      | (3.431) |         |  | (2,314) |          |  | (3,407) 
|Proceeds from the exercise of stock options                                       |  |   |         |      |         | 178     |  |         | 1,127   
|Issuance of preferred stock                                                       |  |   | 26,918   |      |         |        |  |         |        
|Capital contribution to subsidiary                                                |  |   | (23,918) |      |         | (660)   |  |         |        
|Cash dividends paid                                                               |  |   | (4,570)  |      |         | (4,213) |  |         | (3,111) 
|                                                                                  |  |   |          |      |         |         |  |         |          |  |         
|Net cash (used in) provided by financing activities                               |  |   | (5,001)  |      |         | (7,009) |  |         | 10,073  
|Increase (decrease) in cash and cash equivalents                                  |  |   | 3,423    |      |         | (823)   |  |         | (1,016) 
|Cash and cash equivalents at beginning of year                                    |  |   | 1,504    |      |         | 2,327   |  |         | 3,343   
|                                                                                  |  |   |          |      |         |         |  |         |          |  |         
|Cash and cash equivalents at end of year                                          |  | $ | 4,927    |      | $       | 1,504   |  | $       | 2,327   
|                                                                                  |  |   |          |      |         |         |  |         |          |  |         
|                                                                                  |  |   |         
|Supplemental Disclosures of Cash Flow Information:                                |  |   |          |      |         |         |  |         |         
|Non-cash financing activities:                                                    |  |   |          |      |         |         |  |         |         
|Dividend declared and unpaid                                                      |  | $ | 1,191    |      | $       | 1,135   |  | $       | 1,057   

On October 26, 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.

MANAGEMENTS 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 35 and is incorporated herein by reference, management assessed the Corporations system of internal control over financial reporting as
of December 31, 2008, 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, 2008, its system of internal control over financial reporting met those criteria and is effective.

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, 2008 that has materially affected, or is reasonably likely to materially affect, the Companys internal control over
financial reporting.

EVALUATION OF DISCLOSURE CONTROLS AND PROCEDURES

The Companys principal executive officer and principal financial officer evaluated, as of December 31, 2008, 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, 2008 were effective.

AUDIT REPORT OF THE INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The effectiveness of the Companys internal control over financial reporting as of December 31, 2008 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 36 and is incorporated herein by reference.

Item 9B  Other Information

Not applicable



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##### Table of Contents

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 Concerning Nominees for Directors, Directors Continuing in Office and
Executive Officers, Audit Committee Report, and Section 16 (a) Beneficial Ownership Reporting Compliance in the Companys Proxy Statement issued in connection with its 2008 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 section entitled Executive
Compensation 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 section entitled Information Concerning Nominees For Directors, Directors Continuing In Office And Executive Officers and Security Ownership of Certain Beneficial Owners 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 section entitled Certain Transactions 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 Public Accountants 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, 2008 and 2007.                                                                    
|        |  | Consolidated Statements of Income for the years ended December 31, 2008, 2007 and 2006.                                       
|        |  | Consolidated Statements of Comprehensive Income for the years ended December 31, 2008, 2007 and 2006.                         
|        |  | Consolidated Statements of Shareholders Equity for each of the years ended December 31, 2008, 2007 and 2006.                 
|        |  | Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006.                                   
|        |  | 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) |  | Exhibits:                                                                                                                     

The following documents are filed as Exhibits to this Form 10-K or are incorporated by reference
to the prior filings of the Company with the Securities and Exchange Commission (the Commission).



|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 31, 1998                                                                                                                                                                                                               
|              | 
|3.2           |  | Certificate of Amendment to Certificate of Incorporation of the Company                                                                                                                                                                                                                                                                                                                                                                                       
|              | 
|3.3           |  | Certificate of Amendment to Certificate of Incorporation of the Company (incorporated herein by reference to exhibit 4.1 to the Companys Current Report on Form 8-K
filed with the Commission on December 23, 2008).                                                                                                                                                                                                                                         
|              | 
|3.4           |  | 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)                                                                                                                                                                                                                                                                       
|              | 
|3.5           |  | 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)
|              | 
|4.2           |  | Warrant to Purchase Common Stock, dated December 19, 2008 (incorporated herein by reference to exhibit 4.2 to the Companys Current Report on Form 8-K filed with the
Commission on December 23, 2008).                                                                                                                                                                                                                                                       
|              | 
|4.3           |  | Letter Agreement, dated December 19, 2008, including the Securities Purchase Agreement-Standard Terms attached thereto, by and between the Company and the United States
Department of the Treasury (incorporated herein by reference to exhibit 10.1 to the Companys Current Report on Form 8-K filed with the Commission on December 23, 2008).                                                                                                            
|              | 
|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 July 6, 2006 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 July 7, 2006)                                                                                                                                                                                                                                  
|              | 
|10.3          |  | 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)                                                                                                                                                                                                                                                            
|              | 
|10.4          |  | Supplemental Retirement Agreement, dated as of May 1, 2000, by and among the Company, Alliance Bank, N.A. and Jack H. Webb (incorporated herein by reference to exhibit
10.2 to the Companys Quarterly Report on Form 10-Q filed with the Commission on August 14, 2000)                                                                                                                                                                                     



77



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##### Table of Contents

|      |  |                                                                                                                                                                                                                                                                                  
|----- |  | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|10.5  |  | 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)         
|      | 
|10.6  |  | 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)
|      | 
|10.7  |  | Change of Control Agreement, dated May 3, 2006 by and between the Company and J. Daniel Mohr (incorporated by reference to exhibit 10.2 to the Companys Current
Report on Form 8-K filed with the Commission on May 4, 2006)                                                    
|      | 
|10.8  |  | Employment Agreement dated October 6, 2005 by and among the Company and John H. Watt Jr. (incorporated herein by reference to exhibit 10.1 to the Companys Quarterly
Report on Form 10-Q filed with the Commission on November 3, 2005)                                         
|      | 
|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 |  | 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                                                                                                               
|      | 
|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 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)                                                                
|      | 
|10.14 |  | 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)                                                         
|      | 
|12    |  | Computation of Ratios of Earnings to Fixed Charges and Preferred Dividends                                                                                                                                                                                                       
|      | 
|21    |  | List of the Companys Subsidiaries                                                                                                                                                                                                                                               
|      | 
|23.1  |  | Consent of Crowe Horwath LLP                                                                                                                                                                                                                                                     
|      | 
|23.2  |  | Consent of PricewaterhouseCoopers 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, Treasurer 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, Treasurer 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                                                                               



| | (b) | See Item 15(a)(3) above.
| | --- | ------------------------



| | (c) | See Item 15(a)(2) above.
| | --- | ------------------------



78



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##### Table of Contents

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 13, 2009 |  |  |  | By                             |  | /s/ Jack H. Webb                            
|                   |  |  |  |                                |  | Jack H. Webb, Chairman, President & CEO     
|                   |  |  |  |                                |  | (Principal Executive Officer)               
|                   |  |  | 
|DateMarch 13, 2009 |  |  |  | By                             |  | /s/ J. Daniel Mohr                          
|                   |  |  |  |                                |  | J. Daniel Mohr, Treasurer & 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 11,
2009
|Mary Pat Adams, Director                               |  |  |  |                   
|                                                       |  | 
|/s/ Donald S. Ames                                     |  |  |  | DateMarch 11,
2009
|Donald S. Ames, Director                               |  |  |  |                   
|                                                       |  | 
|/s/ Donald H. Dew                                      |  |  |  | DateMarch 11,
2009
|Donald H. Dew, Director                                |  |  |  |                   
|                                                       |  | 
|/s/ John M. Endries                                    |  |  |  | DateMarch 11,
2009
|John M. Endries, Director                              |  |  |  |                   
|                                                       |  | 
|/s/ Samuel J. Lanzafame                                |  |  |  | DateMarch 11,
2009
|Samuel J. Lanzafame, Director                          |  |  |  |                   
|                                                       |  | 
|/s/ Margaret G. Ogden                                  |  |  |  | DateMarch 11,
2009
|Margaret G. Ogden, Director                            |  |  |  |                   
|                                                       |  | 
|/s/ Lowell A. Seifter                                  |  |  |  | DateMarch 11,
2009
|Lowell A. Seifter, Director                            |  |  |  |                   
|                                                       |  | 
|/s/ Charles E. Shafer                                  |  |  |  | DateMarch 11,
2009
|Charles E. Shafer, Director                            |  |  |  |                   
|                                                       |  | 
|/s/ Charles H. Spaulding                               |  |  |  | DateMarch 11,
2009
|Charles H. Spaulding, Director                         |  |  |  |                   
|                                                       |  | 
|/s/ Paul M. Solomon                                    |  |  |  | DateMarch 11,
2009
|Paul M. Solomon, Director                              |  |  |  |                   
|                                                       |  | 
|/s/ Deborah F. Stanley                                 |  |  |  | DateMarch 11,
2009
|Deborah F. Stanley, Director                           |  |  |  |                   
|                                                       |  | 
|/s/ John H. Watt, Jr.                                  |  |  |  | DateMarch 11,
2009
|John H. Watt, Jr., Executive Vice President & Director |  | 
|                                                       |  | 
|/s/ Jack H. Webb                                       |  |  |  | DateMarch 11,
2009
|Jack H. Webb, Chairman, President                      |  |  |  |                   
|& CEO and Director                                     |  |  |  |                   
|(Principal Executive Officer)                          |  |  |  |                   



79