##### Table of Contents





UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549





FORM 10-Q







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

For the Quarterly Period Ended September 30, 2009

OR



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

For the transition period from  to

Commission File Number: 000-15366





ALLIANCE FINANCIAL CORPORATION

(Exact name of Registrant as specified in its charter)







|                                                               |  |                                     
|-------------------------------------------------------------- |  | ------------------------------------
|New York                                                       |  | 16-1276885                          
|(State or Other Jurisdiction of Incorporation or Organization) |  | (IRS Employer Identification Number)

120 Madison Street,Syracuse, New York 13202

(Address of Principal Executive Offices) (Zip Code)

(315) 475-2100

(Registrants Telephone Number including area code)





Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act
of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No   ̈

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

Indicate by check mark 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   ̈    No  x

The number of shares outstanding of the Registrants common stock, $1.00 par value, on October 29, 2009 was 4,624,635 shares.









---

##### Table of Contents

TABLE OF CONTENTS



|         |  |                       |  |                                                                                       |  |      
|-------- |  | --------------------- |  | ------------------------------------------------------------------------------------- |  | -----
|         |  |                       |  | Page Number(s)                                                                       
|Part I.  |  | FINANCIAL INFORMATION |  |                                                                                      
|         |  |                       | 
|         |  | Item 1.               |  | Financial Statements (All Unaudited)                                                  |  |      
|         |  |                       | 
|         |  |                       |  | Consolidated Balance Sheets                                                           |  | 3    
|         |  |                       |  | Consolidated Statements of Income                                                     |  | 4    
|         |  |                       |  | Consolidated Statements of Changes in Shareholders Equity                            |  | 5    
|         |  |                       |  | Consolidated Statements of Cash Flow                                                  |  | 6    
|         |  |                       |  | Notes to Consolidated Financial Statements                                            |  | 7-19 
|         |  |                       | 
|         |  | Item 2.               |  | Managements Discussion and Analysis of Financial Condition and Results of Operations |  | 20-34
|         |  |                       | 
|         |  | Item 3.               |  | Quantitative and Qualitative Disclosures About Market Risk                            |  | 35   
|         |  |                       | 
|         |  | Item 4.               |  | Controls and Procedures                                                               |  | 35   
|         |  |                      
|Part II. |  | OTHER INFORMATION     |  |                                                                                      
|         |  |                       | 
|         |  | Item 1.               |  | Legal Proceedings                                                                     |  | 36   
|         |  |                       | 
|         |  | Item 1A.              |  | Risk Factors                                                                          |  | 36   
|         |  |                       | 
|         |  | Item 2.               |  | Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 37   
|         |  |                       | 
|         |  | Item 3.               |  | Defaults Upon Senior Securities                                                       |  | 37   
|         |  |                       | 
|         |  | Item 4.               |  | Submission of Matters to a Vote of Security Holders                                   |  | 37   
|         |  |                       | 
|         |  | Item 5.               |  | Other Information                                                                     |  | 37   
|         |  |                       | 
|         |  | Item 6.               |  | Exhibits                                                                              |  | 38   
|         |  |                      
|         |  | Signatures            |  | 39                                                                                   



2



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)



(In thousands, except share data)



|                                                                                                                                                                                  |  |                    |           |   |                   |   |           |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------------ | --------- | - | ----------------- | - | --------- | -
|                                                                                                                                                                                  |  | September 30, 2009 |           |   | December 31, 2008 |  
|Assets                                                                                                                                                                            |  |                    |           |   |                   |   |           |  
|Cash and cash equivalents                                                                                                                                                         |  | $                  | 24,820    |   |                   | $ | 48,090    |  
|Securities available-for-sale                                                                                                                                                     |  |                    | 396,730   |   |                   |   | 299,149   |  
|Federal Home Loan Bank of New York (FLHB) and Federal Reserve Bank (FRB) stock                                                                                                |  |                    | 11,821    |   |                   |   | 11,844    |  
|Loans held-for-sale                                                                                                                                                               |  |                    | 1,365     |   |                   |   | 875       |  
|Loans and leases, net of unearned income and deferred costs                                                                                                                       |  |                    | 927,732   |   |                   |   | 910,755   |  
|Allowance for credit losses                                                                                                                                                       |  |                    | 10,006    |   |                   |   | 9,161     |  
|                                                                                                                                                                                  |  |                    |           |   |                   |   |           |  
|Net loans and leases                                                                                                                                                              |  |                    | 917,726   |   |                   |   | 901,594   |  
|                                                                                                                                                                                  |  |                   
|Premises and equipment, net                                                                                                                                                       |  |                    | 20,388    |   |                   |   | 21,202    |  
|Accrued interest receivable                                                                                                                                                       |  |                    | 4,988     |   |                   |   | 4,218     |  
|Bank-owned life insurance                                                                                                                                                         |  |                    | 25,693    |   |                   |   | 24,940    |  
|Goodwill                                                                                                                                                                          |  |                    | 32,073    |   |                   |   | 32,073    |  
|Intangible assets, net                                                                                                                                                            |  |                    | 10,365    |   |                   |   | 11,528    |  
|Other assets                                                                                                                                                                      |  |                    | 10,307    |   |                   |   | 11,845    |  
|                                                                                                                                                                                  |  |                    |           |   |                   |   |           |  
|Total assets                                                                                                                                                                      |  | $                  | 1,456,276 |   |                   | $ | 1,367,358 |  
|                                                                                                                                                                                  |  |                    |           |   |                   |   |           |  
|                                                                                                                                                                                  |  |                   
|Liabilities and shareholders equity                                                                                                                                              |  |                    |           |   |                   |   |           |  
|Liabilities                                                                                                                                                                       |  |                    |           |   |                   |   |           |  
|Deposits:                                                                                                                                                                         |  |                    |           |   |                   |   |           |  
|Non-interest-bearing deposits                                                                                                                                                     |  | $                  | 151,998   |   |                   | $ | 140,845   |  
|Interest-bearing deposits                                                                                                                                                         |  |                    | 932,913   |   |                   |   | 797,037   |  
|                                                                                                                                                                                  |  |                    |           |   |                   |   |           |  
|Total deposits                                                                                                                                                                    |  |                    | 1,084,911 |   |                   |   | 937,882   |  
|Borrowings                                                                                                                                                                        |  |                    | 201,240   |   |                   |   | 238,972   |  
|Accrued interest payable                                                                                                                                                          |  |                    | 1,177     |   |                   |   | 3,037     |  
|Other liabilities                                                                                                                                                                 |  |                    | 18,404    |   |                   |   | 17,212    |  
|Junior subordinated obligations issued to unconsolidated subsidiary trusts                                                                                                        |  |                    | 25,774    |   |                   |   | 25,774    |  
|                                                                                                                                                                                  |  |                    |           |   |                   |   |           |  
|Total liabilities                                                                                                                                                                 |  |                    | 1,331,506 |   |                   |   | 1,222,877 |  
|                                                                                                                                                                                  |  |                   
|Shareholders equity                                                                                                                                                              |  |                    |           |   |                   |   |           |  
|Preferred stock  par value $1.00 a share; 900,000 shares authorized, $1,000 liquidation value, none issued and outstanding
in 2009; 26,918 shares issued and outstanding in 2008 |  |                    |          |   |                   |   | 26,331    |  
|Preferred stock  par value $1.00 a share; 100,000 shares authorized, Series A, junior preferred stock, none issued and
outstanding                                               |  |                    |          |   |                   |   |          |  
|Common stock (par value $1.00) 10,000,000 shares authorized, 4,937,311 and 4,901,222 shares issued; and 4,614,999 and 4,578,910
shares outstanding, respectively                  |  |                    | 4,937     |   |                   |   | 4,901     |  
|Surplus                                                                                                                                                                           |  |                    | 42,865    |   |                   |   | 41,922    |  
|Undivided profits                                                                                                                                                                 |  |                    | 83,988    |   |                   |   | 81,110    |  
|Accumulated other comprehensive income                                                                                                                                            |  |                    | 4,051     |   |                   |   | 971       |  
|Directors stock-based deferred compensation plan (100,462 and 85,510 shares, respectively)                                                                                       |  |                    | (2,415    | ) |                   |   | (2,098    | )
|Treasury stock - common, at cost (322,312 shares)                                                                                                                                 |  |                    | (8,656    | ) |                   |   | (8,656    | )
|                                                                                                                                                                                  |  |                    |           |   |                   |   |           |  
|Total shareholders equity                                                                                                                                                        |  |                    | 124,770   |   |                   |   | 144,481   |  
|                                                                                                                                                                                  |  |                    |           |   |                   |   |           |  
|                                                                                                                                                                                  |  |                   
|Total liabilities & shareholders equity                                                                                                                                          |  | $                  | 1,456,276 |   |                   | $ | 1,367,358 |  
|                                                                                                                                                                                  |  |                    |           |   |                   |   |           |  

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



3



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)



(In thousands, except share data)



|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|-------------------------------------------------------------------------- |  | ------------------------------- | ------ | ------------------------------ | - | ------ |  | - | ------ | - |  | - | ------
|                                                                           |  | Three months endedSeptember 30, |        | Nine months endedSeptember 30,
|                                                                           |  | 2009                            |        | 2008                           |   | 2009   |  |   | 2008  
|Interest income:                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Interest and fees on loans and leases                                      |  | $                               | 12,417 |                                | $ | 13,585 |  | $ | 37,605 |   |  | $ | 41,421
|Federal funds sold and interest bearing deposits                           |  |                                 | 1      |                                |   | 10     |  |   | 15     |   |  |   | 99    
|Securities                                                                 |  |                                 | 3,711  |                                |   | 3,139  |  |   | 10,273 |   |  |   | 9,745 
|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Total interest income                                                      |  |                                 | 16,129 |                                |   | 16,734 |  |   | 47,893 |   |  |   | 51,265
|                                                                           |  |                                 |        |                               
|Interest expense:                                                          |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Deposits:                                                                  |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Savings accounts                                                           |  |                                 | 105    |                                |   | 124    |  |   | 339    |   |  |   | 361   
|Money market accounts                                                      |  |                                 | 766    |                                |   | 1,099  |  |   | 2,573  |   |  |   | 3,615 
|Time accounts                                                              |  |                                 | 2,347  |                                |   | 3,480  |  |   | 7,523  |   |  |   | 12,030
|NOW accounts                                                               |  |                                 | 120    |                                |   | 177    |  |   | 404    |   |  |   | 564   
|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Total deposits                                                             |  |                                 | 3,338  |                                |   | 4,880  |  |   | 10,839 |   |  |   | 16,570
|Borrowings:                                                                |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Repurchase agreements                                                      |  |                                 | 211    |                                |   | 252    |  |   | 691    |   |  |   | 752   
|FHLB advances                                                              |  |                                 | 1,171  |                                |   | 1,698  |  |   | 3,819  |   |  |   | 5,024 
|Junior subordinated obligations issued to unconsolidated subsidiary trusts |  |                                 | 179    |                                |   | 325    |  |   | 647    |   |  |   | 1,066 
|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Total interest expense                                                     |  |                                 | 4,899  |                                |   | 7,155  |  |   | 15,996 |   |  |   | 23,412
|                                                                           |  |                                 |        |                               
|Net interest income                                                        |  |                                 | 11,230 |                                |   | 9,579  |  |   | 31,897 |   |  |   | 27,853
|Provision for credit losses                                                |  |                                 | 1,125  |                                |   | 849    |  |   | 4,675  |   |  |   | 3,526 
|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Net interest income after provision for credit losses                      |  |                                 | 10,105 |                                |   | 8,730  |  |   | 27,222 |   |  |   | 24,327
|                                                                           |  |                                 |        |                               
|Non-interest income:                                                       |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Investment management income                                               |  |                                 | 1,743  |                                |   | 2,179  |  |   | 5,289  |   |  |   | 6,717 
|Service charges on deposit accounts                                        |  |                                 | 1,297  |                                |   | 1,379  |  |   | 3,758  |   |  |   | 3,869 
|Card-related fees                                                          |  |                                 | 566    |                                |   | 533    |  |   | 1,654  |   |  |   | 1,578 
|Insurance agency income                                                    |  |                                 | 338    |                                |   | 384    |  |   | 1,027  |   |  |   | 1,204 
|Income from bank-owned life insurance                                      |  |                                 | 255    |                                |   | 243    |  |   | 753    |   |  |   | 606   
|Gain on the sale of loans                                                  |  |                                 | 230    |                                |   | 55     |  |   | 505    |   |  |   | 217   
|Gain on sale of securities available-for-sale                              |  |                                 |       |                                |   |       |  |   | 1,015  |   |  |   | 137   
|Other non-interest income                                                  |  |                                 | 333    |                                |   | 361    |  |   | 887    |   |  |   | 1,278 
|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Total non-interest income                                                  |  |                                 | 4,762  |                                |   | 5,134  |  |   | 14,888 |   |  |   | 15,606
|                                                                           |  |                                 |        |                               
|Non-interest expense:                                                      |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Salaries and employee benefits                                             |  |                                 | 5,307  |                                |   | 5,108  |  |   | 14,728 |   |  |   | 15,025
|Occupancy and equipment expense                                            |  |                                 | 1,728  |                                |   | 1,751  |  |   | 5,279  |   |  |   | 5,148 
|Communication expense                                                      |  |                                 | 207    |                                |   | 200    |  |   | 594    |   |  |   | 602   
|Office supplies and postage expense                                        |  |                                 | 359    |                                |   | 310    |  |   | 971    |   |  |   | 861   
|Marketing expense                                                          |  |                                 | 228    |                                |   | 278    |  |   | 727    |   |  |   | 847   
|Amortization of intangible assets                                          |  |                                 | 388    |                                |   | 444    |  |   | 1,163  |   |  |   | 1,267 
|Professional fees                                                          |  |                                 | 734    |                                |   | 602    |  |   | 2,165  |   |  |   | 1,964 
|FDIC insurance premium                                                     |  |                                 | 434    |                                |   | 50     |  |   | 1,820  |   |  |   | 104   
|Other non-interest expense                                                 |  |                                 | 1,515  |                                |   | 1,156  |  |   | 4,419  |   |  |   | 3,505 
|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Total non-interest expense                                                 |  |                                 | 10,900 |                                |   | 9,899  |  |   | 31,866 |   |  |   | 29,323
|                                                                           |  |                                 |        |                               
|Income before income tax expense                                           |  |                                 | 3,967  |                                |   | 3,965  |  |   | 10,244 |   |  |   | 10,610
|Income tax expense                                                         |  |                                 | 1,009  |                                |   | 955    |  |   | 2,293  |   |  |   | 2,637 
|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Net income                                                                 |  | $                               | 2,958  |                                | $ | 3,010  |  | $ | 7,951  |   |  | $ | 7,973 
|Dividend and accretion of discount on preferred stock                      |  |                                 |       |                                |   |       |  |   | (1,084 | ) |  |   |      
|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Net income available to common shareholders                                |  | $                               | 2,958  |                                | $ | 3,010  |  | $ | 6,867  |   |  | $ | 7,973 
|                                                                           |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|                                                                           |  |                                 |        |                               
|Net income per common share:                                               |  |                                 |        |                                |   |        |  |   |        |   |  |   |       
|Basic earnings per common share                                            |  | $                               | 0.64   |                                | $ | 0.65   |  | $ | 1.50   |   |  | $ | 1.71  
|Diluted earnings per common share                                          |  | $                               | 0.64   |                                | $ | 0.65   |  | $ | 1.49   |   |  | $ | 1.69  
|Cash dividends declared per share                                          |  | $                               | 0.28   |                                | $ | 0.26   |  | $ | 0.80   |   |  | $ | 0.74  

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



4



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders Equity (Unaudited)



(In thousands, except share data)



|                                                                                     |  |                                      |   |  |                 |         |   |              |   |       |         |  |   |                   |   |  |                                        |        |   |                       |   |        |                           |  |   |        |   |  |   |        |   |  |   |         |  
|------------------------------------------------------------------------------------ |  | ------------------------------------ | - |  | --------------- | ------- | - | ------------ | - | ----- | ------- |  | - | ----------------- | - |  | -------------------------------------- | ------ | - | --------------------- | - | ------ | ------------------------- |  | - | ------ | - |  | - | ------ | - |  | - | ------- | -
|                                                                                     |  | Issued and Outstanding Common Shares |   |  | Preferred Stock |         |   | Common Stock |   |       | Surplus |  |   | Undivided Profits |   |  | Accumulated Other Comprehensive Income |        |   | Treasury Stock Common |   |        | Directors Deferred Stock |  |   | Total  |  
|Balance at December 31, 2007                                                         |  | 4,710,885                            |   |  | $               |        |   |              | $ | 4,889 |         |  | $ | 38,847            |   |  | $                                      | 75,844 |   |                       | $ | 1,205  |                           |  | $ | (5,225 | ) |  | $ |       |   |  | $ | 115,560 |  
|Comprehensive income:                                                                |  |                                      |   |  |                 |         |   |              |   |       |         |  |   |                   |   |  |                                        |        |   |                       |   |        |                           |  |   |        |   |  |   |        |   |  |   |         |  
|Net income                                                                           |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        | 7,973  |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | 7,973   |  
|Other comprehensive income, net of taxes:                                            |  |                                      |   |  |                 |         |   |              |   |       |         |  |   |                   |   |  |                                        |        |   |                       |   |        |                           |  |   |        |   |  |   |        |   |  |   |         |  
|Change in unrealized appreciation in available-for-sale securities (net of tax)      |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        |       |   |                       |   | (1,331 | )                         |  |   |       |   |  |   |       |   |  |   | (1,331  | )
|Change in accumulated unrealized losses and prior service costs for retirement
plans |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        |       |   |                       |   | (4     | )                         |  |   |       |   |  |   |       |   |  |   | (4      | )
|Total comprehensive income                                                           |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        | 7,973  |   |                       |   | (1,335 | )                         |  |   |       |   |  |   |       |   |  |   | 6,638   |  
|Cumulative effect of change in pension measurement date                              |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        | 27     |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | 27      |  
|Cumulative effect of change in accounting for adoption of EITF06-4                   |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        | (462   | ) |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | (462    | )
|Issuance of restricted stock                                                         |  | 15,500                               |   |  |                 |        |   |              |   | 16    |         |  |   | (16               | ) |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   |        |  
|Forfeiture of restricted stock                                                       |  | (125                                 | ) |  |                 |        |   |              |   |      |         |  |   | (2                | ) |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | (2      | )
|Amortization of restricted stock                                                     |  |                                     |   |  |                 |        |   |              |   |      |         |  |   | 280               |   |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | 280     |  
|Tax benefit of restricted stock plan                                                 |  |                                     |   |  |                 |        |   |              |   |      |         |  |   | 26                |   |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | 26      |  
|Tax benefit of stock-based compensation                                              |  |                                     |   |  |                 |        |   |              |   |      |         |  |   | 2                 |   |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | 2       |  
|Cash dividend $0.74 per share                                                        |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        | (3,436 | ) |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | (3,436  | )
|Treasury stock purchased                                                             |  | (143,900                             | ) |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        |       |   |                       |   |       |                           |  |   | (3,431 | ) |  |   |       |   |  |   | (3,431  | )
|Directors deferred stock plan purchase                                              |  |                                     |   |  |                 |        |   |              |   |      |         |  |   | 2,041             |   |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   | (2,041 | ) |  |   |        |  
|Balance at September 30, 2008                                                        |  | 4,582,360                            |   |  | $               |        |   |              | $ | 4,905 |         |  | $ | 41,178            |   |  | $                                      | 79,946 |   |                       | $ | (130   | )                         |  | $ | (8,656 | ) |  | $ | (2,041 | ) |  | $ | 115,202 |  
|                                                                                     |  |                                      |   |  |                 |         |   |              |  
|                                                                                     |  |                                      |   |  |                 |         |   |              |   |       |         |  |   |                   |   |  |                                        |        |   |                       |   |        |                           |  |   |        |   |  |   |        |   |  |   |         |  
|Balance at December 31, 2008                                                         |  | 4,578,910                            |   |  | $               | 26,331  |   |              | $ | 4,901 |         |  | $ | 41,922            |   |  | $                                      | 81,110 |   |                       | $ | 971    |                           |  | $ | (8,656 | ) |  | $ | (2,098 | ) |  | $ | 144,481 |  
|Comprehensive income:                                                                |  |                                      |   |  |                 |         |   |              |   |       |         |  |   |                   |   |  |                                        |        |   |                       |   |        |                           |  |   |        |   |  |   |        |   |  |   |         |  
|Net income                                                                           |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        | 7,951  |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | 7,951   |  
|Other comprehensive income, net of taxes:                                            |  |                                      |   |  |                 |         |   |              |   |       |         |  |   |                   |   |  |                                        |        |   |                       |   |        |                           |  |   |        |   |  |   |        |   |  |   |         |  
|Change in unrealized appreciation in available-for-sale securities (net of tax)      |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        |       |   |                       |   | 3,067  |                           |  |   |       |   |  |   |       |   |  |   | 3,067   |  
|Change in accumulated unrealized losses and prior service costs for retirement
plans |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        |       |   |                       |   | 13     |                           |  |   |       |   |  |   |       |   |  |   | 13      |  
|Total comprehensive income                                                           |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        | 7,951  |   |                       |   | 3,080  |                           |  |   |       |   |  |   |       |   |  |   | 11,031  |  
|Redemption of preferred stock                                                        |  |                                     |   |  |                 | (26,918 | ) |              |   |      |         |  |   |                  |   |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | (26,918 | )
|Accretion of preferred stock discount                                                |  |                                     |   |  |                 | 587     |   |              |   |      |         |  |   |                  |   |  |                                        | (587   | ) |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   |        |  
|Issuance of restricted stock                                                         |  | 11,850                               |   |  |                 |        |   |              |   | 12    |         |  |   | (12               | ) |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   |        |  
|Forfeiture of restricted stock                                                       |  | (16,450                              | ) |  |                 |        |   |              |   | (16   | )       |  |   | (49               | ) |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | (65     | )
|Amortization of restricted stock                                                     |  |                                     |   |  |                 |        |   |              |   |      |         |  |   | 286               |   |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | 286     |  
|Stock options exercised                                                              |  | 40,689                               |   |  |                 |        |   |              |   | 40    |         |  |   | 966               |   |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | 1,006   |  
|Tax benefit of stock-based compensation                                              |  |                                     |   |  |                 |        |   |              |   |      |         |  |   | 28                |   |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | 28      |  
|Cash dividend $0.80 per common share                                                 |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        | (3,682 | ) |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | (3,682  | )
|Preferred stock dividend                                                             |  |                                     |   |  |                 |        |   |              |   |      |         |  |   |                  |   |  |                                        | (497   | ) |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | (497    | )
|Repurchase of warrant                                                                |  |                                     |   |  |                 |        |   |              |   |      |         |  |   | (593              | ) |  |                                        | (307   | ) |                       |   |       |                           |  |   |       |   |  |   |       |   |  |   | (900    | )
|Directors deferred stock plan purchase                                              |  |                                     |   |  |                 |        |   |              |   |      |         |  |   | 317               |   |  |                                        |       |   |                       |   |       |                           |  |   |       |   |  |   | (317   | ) |  |   |        |  
|Balance at September 30, 2009                                                        |  | 4,614,999                            |   |  | $               |        |   |              | $ | 4,937 |         |  | $ | 42,865            |   |  | $                                      | 83,988 |   |                       | $ | 4,051  |                           |  | $ | (8,656 | ) |  | $ | (2,415 | ) |  | $ | 124,770 |  

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



5



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flow (Unaudited)



(In thousands)



|                                                                                                                  |  |                                 |          |   |      |   |         |  
|----------------------------------------------------------------------------------------------------------------- |  | ------------------------------- | -------- | - | ---- | - | ------- | -
|                                                                                                                  |  | Nine months ended September 30, |         
|                                                                                                                  |  | 2009                            |          |   | 2008 |  
|Operating Activities:                                                                                             |  |                                 |          |   |      |   |         |  
|Net Income                                                                                                        |  | $                               | 7,951    |   |      | $ | 7,973   |  
|                                                                                                                  |  |                                
|Adjustments to reconcile net income to net cash provided by operating activities:                                 |  |                                 |          |   |      |   |         |  
|Provision for credit losses                                                                                       |  |                                 | 4,675    |   |      |   | 3,526   |  
|Depreciation expense                                                                                              |  |                                 | 1,807    |   |      |   | 1,892   |  
|Increase in surrender value of life insurance                                                                     |  |                                 | (753     | ) |      |   | (606    | )
|Deferred income tax benefit                                                                                       |  |                                 | 306      |   |      |   | 704     |  
|Amortization of investment security discounts and premiums, net                                                   |  |                                 | 1,002    |   |      |   | 185     |  
|Net gain on sale of securities available-for-sale                                                                 |  |                                 | (1,015   | ) |      |   | (137    | )
|Net (gain) loss on sale of premises and equipment                                                                 |  |                                 | (16      | ) |      |   | 2       |  
|Proceeds from the sale of loans and leases held-for-sale                                                          |  |                                 | 26,658   |   |      |   | 23,514  |  
|Origination of loans held-for-sale                                                                                |  |                                 | (26,928  | ) |      |   | (9,606  | )
|Gain on sale of loans held-for-sale                                                                               |  |                                 | (505     | ) |      |   | (217    | )
|Write-down of leases transferred to held-for-sale                                                                 |  |                                 |         |   |      |   | 160     |  
|Impairment loss on long-lived asset                                                                               |  |                                 | 105      |   |      |   |        |  
|Gain on sale of assets held-for-sale                                                                              |  |                                 |         |   |      |   | (99     | )
|Loss (gain) on foreclosed real estate                                                                             |  |                                 | 15       |   |      |   | (30     | )
|Amortization of capitalized servicing rights                                                                      |  |                                 | 247      |   |      |   | 207     |  
|Amortization of intangible assets                                                                                 |  |                                 | 1,163    |   |      |   | 1,267   |  
|Restricted stock expense, net                                                                                     |  |                                 | 221      |   |      |   | 280     |  
|Change in other assets and liabilities                                                                            |  |                                 | (1,910   | ) |      |   | 1       |  
|                                                                                                                  |  |                                 |          |   |      |   |         |  
|Net cash provided by operating activities                                                                         |  |                                 | 13,023   |   |      |   | 29,016  |  
|                                                                                                                  |  |                                
|Investing Activities:                                                                                             |  |                                 |          |   |      |   |         |  
|Proceeds from maturities, redemptions, calls and principal repayments of investment securities available-for-sale |  |                                 | 116,664  |   |      |   | 71,731  |  
|Proceeds from sales of investment securities available-for-sale                                                   |  |                                 | 33,926   |   |      |   | 6,299   |  
|Purchase of investment securities available-for-sale                                                              |  |                                 | (243,156 | ) |      |   | (97,739 | )
|Purchase of FHLB and FRB stock                                                                                    |  |                                 | (18,315  | ) |      |   | (16,696 | )
|Redemption of FHLB stock                                                                                          |  |                                 | 18,338   |   |      |   | 14,130  |  
|Net increase in loans and leases                                                                                  |  |                                 | (20,941  | ) |      |   | (34,969 | )
|Purchases of premises and equipment                                                                               |  |                                 | (1,113   | ) |      |   | (1,062  | )
|Proceeds from the sale of premises and equipment                                                                  |  |                                 | 31       |   |      |   | 25      |  
|Proceeds from disposition of foreclosed assets                                                                    |  |                                 | 196      |   |      |   | 395     |  
|Proceeds from assets held-for-sale                                                                                |  |                                 |         |   |      |   | 176     |  
|Purchase of bank-owned life insurance                                                                             |  |                                 |         |   |      |   | (7,000  | )
|                                                                                                                  |  |                                 |          |   |      |   |         |  
|Net cash used in investing activities                                                                             |  |                                 | (114,370 | ) |      |   | (64,710 | )
|                                                                                                                  |  |                                
|Financing Activities:                                                                                             |  |                                 |          |   |      |   |         |  
|Net increase in demand deposits, NOW and savings accounts                                                         |  |                                 | 111,949  |   |      |   | 51,242  |  
|Net increase (decrease) in time deposits                                                                          |  |                                 | 35,080   |   |      |   | (51,063 | )
|Net (decrease) increase in short-term borrowings                                                                  |  |                                 | (17,732  | ) |      |   | 7,204   |  
|Proceeds from long-term borrowings                                                                                |  |                                 | 35,000   |   |      |   | 50,000  |  
|Payments on long-term borrowings                                                                                  |  |                                 | (55,000  | ) |      |   | (15,000 | )
|Treasury stock purchased                                                                                          |  |                                 |         |   |      |   | (3,431  | )
|Proceeds from exercise of stock options                                                                           |  |                                 | 1,006    |   |      |   |        |  
|Tax benefit of stock-based compensation                                                                           |  |                                 | 28       |   |      |   | 26      |  
|Purchase of shares for directors deferred stock-based plan                                                       |  |                                 | (317     | ) |      |   | (2,041  | )
|Redemption of preferred stock                                                                                     |  |                                 | (26,918  | ) |      |   |        |  
|Repurchase of warrant                                                                                             |  |                                 | (900     | ) |      |   |        |  
|Cash dividends paid to common shareholders                                                                        |  |                                 | (3,581   | ) |      |   | (3,366  | )
|Cash dividends paid to preferred shareholders                                                                     |  |                                 | (538     | ) |      |   |        |  
|                                                                                                                  |  |                                 |          |   |      |   |         |  
|Net cash provided by financing activities                                                                         |  |                                 | 78,077   |   |      |   | 33,571  |  
|                                                                                                                  |  |                                 |          |   |      |   |         |  
|Net decrease in cash and cash equivalents                                                                         |  |                                 | (23,270  | ) |      |   | (2,123  | )
|Cash and cash equivalents at beginning of period                                                                  |  |                                 | 48,090   |   |      |   | 30,704  |  
|                                                                                                                  |  |                                 |          |   |      |   |         |  
|Cash and cash equivalents at end of period                                                                        |  | $                               | 24,820   |   |      | $ | 28,581  |  
|                                                                                                                  |  |                                 |          |   |      |   |         |  
|                                                                                                                  |  |                                
|Supplemental Disclosures of Cash Flow Information:                                                                |  |                                 |          |   |      |   |         |  
|Interest received during the period                                                                               |  | $                               | 47,123   |   |      | $ | 50,692  |  
|Interest paid during the period                                                                                   |  |                                 | 17,856   |   |      |   | 24,471  |  
|Income taxes paid during the period                                                                               |  |                                 | 2,384    |   |      |   | 921     |  
|Non-cash investing activities:                                                                                    |  |                                 |          |   |      |   |         |  
|Change in unrealized gain/loss on available-for-sale securities                                                   |  |                                 | 5,002    |   |      |   | (2,126  | )
|Transfer of leases to held-for-sale                                                                               |  |                                 |         |   |      |   | 10,819  |  
|Transfer of loans to other real estate and repossessed assets                                                     |  |                                 | 134      |   |      |   | 576     |  
|Non-cash financing activities:                                                                                    |  |                                 |          |   |      |   |         |  
|Common dividend declared and unpaid                                                                               |  |                                 | 1,292    |   |      |   | 1,205   |  

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



6



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





|1. | Basis of Presentation and Significant Accounting Policies
|-- | ---------------------------------------------------------

The accompanying unaudited financial statements were prepared in accordance with the instructions for Form 10-Q and Regulation S-X and, therefore, do not include information for footnotes necessary for a
complete presentation of financial condition, results of operations, and cash flows in conformity with generally accepted accounting principles. The following material under the heading Managements Discussion and Analysis of Financial
Condition and Results of Operations is written with the presumption that the users of the interim financial statements have read, or have access to, the latest audited financial statements and notes thereto of the Company, together with
Managements Discussion and Analysis of Financial Condition and Results of Operations as of December 31, 2008 and for the three-year period then ended, included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2008. Accordingly, only material changes in the results of operations and financial condition are discussed in the remainder of Part I. Certain amounts from prior year periods are reclassified, when necessary, to conform to the
current period presentation.

All adjustments that in the opinion of management are necessary for a fair presentation of the financial
statements have been included in the results of operations for the nine months ended September 30, 2009 and 2008.

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.

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.
Where there is other than temporary impairment, the impairment loss is recognized in the consolidated statements of income. Purchases and sales of securities are recognized on a trade-date basis.

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 collectability 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
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



7



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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. Anticipated decreases in specific future residual values that
are considered to be other than temporary are recognized immediately.

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. Smaller balance homogenous loans, such as consumer and residential real estate loans less than $250,000, are aggregated and 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. The Companys delinquency
policy 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. Special circumstances to include fraudulent loans and loans in bankruptcy 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.

Directors Stock-Based Deferral Plan

In accordance with Accounting Standards Codification (ASC) Topic 710-10-05-08, Deferred Compensation-Rabbi Trusts, the stock held in
the trust is classified in equity similar to the manner in which treasury stock is classified.

Subsequent Events

Management has evaluated events occurring subsequent to the balance sheet date through October 30, 2009 (the financial statement issuance date),
determining no events require adjustment to or additional disclosure in the consolidated financial statements.

New Accounting
Pronouncements

The Company adopted ASC Topic 260-10-45-59A through 61A (ASC 260-10-45), Participating Securities and the
Two Class Method. ASC 206-10-45 requires the use of the two-class method for computing earnings per share when



8



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





stock compensation awards with non-forfeitable dividend rights are present. Prior earnings per share amounts have been retrospectively adjusted to conform to the provisions of ASC 206-10-45. See
Note 5 to the Companys consolidated financial statements for disclosure of the earnings per share calculation in accordance with ASC 206-10-45.

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

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

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

The Company adopted ASC Topic 825-10-50
Fair Value Measurements and Disclosures relating to interim periods. The ASC provides that publicly traded companies shall provide information concerning the fair value of its financial instruments whenever it issues summarized
financial information for interim reporting periods. In periods after initial adoption this ASC requires comparative disclosures only for periods ending after initial adoption.

The Company adopted ASC Topic 855, Subsequent Events.ASC Topic 855 establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but
before financial statements are issued or are available to be issued. Specifically, the ASC sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for
potential recognition or disclosure in the financial statements; the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements; and the disclosures that an entity
should make about events or transactions that occurred after the balance sheet date. The adoption did not have a material impact on the Companys consolidated financial position, results of operations or cash flows.

In June 2009, FASB issued Statement No. 166: Accounting for Transfers of Financial Assets - An Amendment of FASB Statement No. 140. Statement 166
will require more information about transfers of financial assets, including securitization transactions, and where entities have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a
qualifying special-purpose entity, changes the requirements for derecognizing



9



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





financial assets, and requires additional disclosures. Statement 166 will be effective January 1, 2010, and the Company does not expect the adoption to have a material impact on the
Companys consolidated financial position, results of operations or cash flows.

In June 2009, FASB issued Statement No. 167:
Amendments to FASB Interpretation No. 46(R). Statement 167 is a revision to FASB Interpretation No. 46 (Revised December 2003), Consolidation of Variable Interest Entities, and changes how a reporting entity determines when an entity that
is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a reporting entity is required to consolidate another entity is based on, among other things, the other
entitys purpose and design and the reporting entitys ability to direct the activities of the other entity that most significantly impact the other entitys economic performance. Statement 167 will be effective January 1, 2010,
and the Company does not expect the adoption to have a material impact on the Companys consolidated financial position, results of operations or cash flows.



|2. | Securities
|-- | ----------

The amortized cost and
estimated fair value of securities for the dates indicated (in thousands):



|                                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|----------------------------------------------------- |  | ------------------ | ------- | -------------------- | - | --------------------- |  | ------------------- | --- |  | - | -------
|                                                      |  | September 30, 2009
|                                                      |  | Amortized Cost     |         | GrossUnrealizedGains |   | GrossUnrealizedLosses |  | EstimatedFair
Value
|Debt Securities:                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|U.S. Treasury obligations                             |  | $                  | 100     |                      | $ |                      |  | $                   |    |  | $ | 100    
|Obligations of U.S. government-sponsored corporations |  |                    | 6,189   |                      |   | 320                   |  |                     |    |  |   | 6,509  
|Obligations of states and political subdivisions      |  |                    | 82,762  |                      |   | 3,373                 |  |                     | 4   |  |   | 86,131 
|Mortgage-backed securities - residential              |  |                    | 295,025 |                      |   | 5,946                 |  |                     | 143 |  |   | 300,828
|                                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|Total debt securities                                 |  |                    | 384,076 |                      |   | 9,639                 |  |                     | 147 |  |   | 393,568
|Stock Investments:                                    |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|Equity securities                                     |  |                    | 1,958   |                      |   | 199                   |  |                     | 6   |  |   | 2,151  
|Mutual Funds                                          |  |                    | 1,000   |                      |   | 26                    |  |                     | 15  |  |   | 1,011  
|                                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|Total stock investments                               |  |                    | 2,958   |                      |   | 225                   |  |                     | 21  |  |   | 3,162  
|                                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|Total available-for-sale                              |  | $                  | 387,034 |                      | $ | 9,864                 |  | $                   | 168 |  | $ | 396,730
|                                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|                                                      | 
|                                                      |  | 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 - residential              |  |                    | 167,753 |                      |   | 2,521                 |  |                     | 314 |  |   | 169,960
|                                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|Total debt securities                                 |  |                    | 291,497 |                      |   | 5,324                 |  |                     | 583 |  |   | 296,238
|Stock Investments:                                    |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|Equity securities                                     |  |                    | 1,958   |                      |   |                      |  |                     | 35  |  |   | 1,923  
|Mutual funds                                          |  |                    | 1,000   |                      |   | 14                    |  |                     | 26  |  |   | 988    
|                                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|Total stock investments                               |  |                    | 2,958   |                      |   | 14                    |  |                     | 61  |  |   | 2,911  
|                                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        
|Total available-for-sale                              |  | $                  | 294,455 |                      | $ | 5,338                 |  | $                   | 644 |  | $ | 299,149
|                                                      |  |                    |         |                      |   |                       |  |                     |     |  |   |        

As of September 30, 2009 and December 31, 2008, mortgage-backed securities were comprised
of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae, which in turn, are supported by the full faith and credit of the United States government.

For the periods ending September 30, 2009 and December 31, 2008, securities with a carrying value of $368.1 million and $293.1 million,
respectively, were pledged as collateral for certain deposits and other purposes as required or permitted by law.



10



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





The Company recognized gross gains on sales of securities of $1.0 million and $137,000 for the nine
months ended September 30, 2009 and 2008, respectively. The tax provision related to these net realized gains was $394,000 and $53,000, respectively.

The carrying value and estimated fair value of debt securities at September 30, 2009, 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                |  | $              | 97,140  |                      | $ | 98,990 
|Due after one year through five years  |  |                | 180,880 |                      |   | 185,958
|Due after five years through ten years |  |                | 70,464  |                      |   | 72,438 
|Due after ten years                    |  |                | 35,592  |                      |   | 36,182 
|                                       |  |                |         |                      |   |        
|Total debt securities                  |  | $              | 384,076 |                      | $ | 393,568
|                                       |  |                |         |                      |   |        

The following table shows the securities with unrealized losses for the periods indicated, 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):



|                                                 |  |                     |        |                     |   |                    |  |                  |       |                    |   |                  |  |   |        |  |   |    
|------------------------------------------------ |  | ------------------- | ------ | ------------------- | - | ------------------ |  | ---------------- | ----- | ------------------ | - | ---------------- |  | - | ------ |  | - | ---
|                                                 |  | September 30, 2009 
|                                                 |  | Less than 12 Months |        | 12 Months or Longer |   | Total             
|Type of Security                                 |  | EstimatedFairValue  |        | UnrealizedLosses    |   | EstimatedFairValue |  | UnrealizedLosses |       | EstimatedFairValue |   | UnrealizedLosses
|Obligations of states and political subdivisions |  | $                   |       |                     | $ |                   |  | $                | 203   |                    | $ | 4                |  | $ | 203    |  | $ | 4  
|Mortgage-backed securities - residential         |  |                     | 15,947 |                     |   | 64                 |  |                  | 1,761 |                    |   | 79               |  |   | 17,708 |  |   | 143
|                                                 |  |                     |        |                     |   |                    |  |                  |       |                    |   |                  |  |   |        |  |   |    
|Subtotal, debt securities                        |  |                     | 15,947 |                     |   | 64                 |  |                  | 1,964 |                    |   | 83               |  |   | 17,911 |  |   | 147
|Equity securities                                |  |                     |       |                     |   |                   |  |                  | 17    |                    |   | 6                |  |   | 17     |  |   | 6  
|Mutual funds                                     |  |                     |       |                     |   |                   |  |                  | 485   |                    |   | 15               |  |   | 485    |  |   | 15 
|                                                 |  |                     |        |                     |   |                    |  |                  |       |                    |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities            |  | $                   | 15,947 |                     | $ | 64                 |  | $                | 2,466 |                    | $ | 104              |  | $ | 18,413 |  | $ | 168
|                                                 |  |                     |        |                     |   |                    |  |                  |       |                    |   |                  |  |   |        |  |   |    



|                                                      |  |                     |        |                     |   |                    |  |                  |       |                    |   |                  |  |   |        |  |   |    
|----------------------------------------------------- |  | ------------------- | ------ | ------------------- | - | ------------------ |  | ---------------- | ----- | ------------------ | - | ---------------- |  | - | ------ |  | - | ---
|                                                      |  | December 31, 2008  
|                                                      |  | Less than 12 Months |        | 12 Months or Longer |   | Total             
|Type of Security                                      |  | EstimatedFairValue  |        | UnrealizedLosses    |   | EstimatedFairValue |  | UnrealizedLosses |       | EstimatedFairValue |   | UnrealizedLosses
|Obligations of U.S. government-sponsored corporations |  | $                   | 8,342  |                     | $ | 269                |  | $                |      |                    | $ |                 |  | $ | 8,342  |  | $ | 269
|Mortgage-backed securities - residential              |  |                     | 22,804 |                     |   | 164                |  |                  | 5,636 |                    |   | 150              |  |   | 28,440 |  |   | 314
|                                                      |  |                     |        |                     |   |                    |  |                  |       |                    |   |                  |  |   |        |  |   |    
|Subtotal debt securities                              |  |                     | 31,146 |                     |   | 433                |  |                  | 5,636 |                    |   | 150              |  |   | 36,782 |  |   | 583
|Equity securities                                     |  |                     | 1,923  |                     |   | 35                 |  |                  |      |                    |   |                 |  |   | 1,923  |  |   | 35 
|Mutual funds                                          |  |                     |       |                     |   |                   |  |                  | 474   |                    |   | 26               |  |   | 474    |  |   | 26 
|                                                      |  |                     |        |                     |   |                    |  |                  |       |                    |   |                  |  |   |        |  |   |    
|Total temporarily impaired securities                 |  | $                   | 33,069 |                     | $ | 468                |  | $                | 6,110 |                    | $ | 176              |  | $ | 39,179 |  | $ | 644
|                                                      |  |                     |        |                     |   |                    |  |                  |       |                    |   |                  |  |   |        |  |   |    

Management does not believe any individual unrealized loss as of September 30, 2009 represents
an other-than-temporary impairment. A total of 17 available-for-sale securities were in a continuous unrealized loss position for less than 12 months and 5 securities for 12 months or longer. The unrealized losses relate primarily to securities
issued by FNMA, GNMA, FHLMC, the State of New York and various political subdivisions within the State of New York. The Company does not intend to sell these securities and does not believe it will be required to sell them prior to recovery of the
amortized cost.



11



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





|3. | Loans and Leases
|-- | ----------------

Major classifications
of loans and leases at the dates indicated (in thousands):



|                            |  |                   |         |   |                  |   |         |  
|--------------------------- |  | ----------------- | ------- | - | ---------------- | - | ------- | -
|                            |  | September 30,2009 |         |   | December 31,2008 |  
|Residential real estate     |  | $                 | 353,721 |   |                  | $ | 314,039 |  
|Commercial loans            |  |                   | 206,472 |   |                  |   | 214,315 |  
|Leases                      |  |                   | 85,197  |   |                  |   | 117,691 |  
|Indirect auto loans         |  |                   | 194,267 |   |                  |   | 182,807 |  
|Other consumer loans        |  |                   | 92,953  |   |                  |   | 90,906  |  
|                            |  |                   |         |   |                  |   |         |  
|                            |  |                   | 932,610 |   |                  |   | 919,758 |  
|                            |  |                  
|Less: Unearned income       |  |                   | (9,080  | ) |                  |   | (13,036 | )
|Net deferred loan costs     |  |                   | 4,202   |   |                  |   | 4,033   |  
|                            |  |                   |         |   |                  |   |         |  
|Total loans and leases      |  |                   | 927,732 |   |                  |   | 910,755 |  
|Allowance for credit losses |  |                   | (10,006 | ) |                  |   | (9,161  | )
|                            |  |                   |         |   |                  |   |         |  
|Net loans and leases        |  | $                 | 917,726 |   |                  | $ | 901,594 |  
|                            |  |                   |         |   |                  |   |         |  

Nonperforming loans and leases at the dates indicated are as follows (in thousands):



|                                                     |  |                    |        |                   |   |      
|---------------------------------------------------- |  | ------------------ | ------ | ----------------- | - | -----
|                                                     |  | September 30, 2009 |        | December 31, 2008
|Loans and leases 90 days past due and still accruing |  | $                  | 127    |                   | $ | 126  
|Non-accrual loans and leases                         |  |                    | 10,084 |                   |   | 4,352
|                                                     |  |                    |        |                   |   |      
|Total nonperforming loans and leases                 |  | $                  | 10,211 |                   | $ | 4,478
|                                                     |  |                    |        |                   |   |      

As of September 30, 2009 and December 31, 2008, impaired loans and leases totaled
approximately $4.6 million and $1.4 million, respectively. The related allowance for credit losses specifically allocated to impaired loans at September 30, 2009 and December 31, 2008 was $961,000 and $193,000, respectively.

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:



|                                                      |  |                                 |        |   |                                |   |       |      |  |   |        |   |  |   |        |  
|----------------------------------------------------- |  | ------------------------------- | ------ | - | ------------------------------ | - | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                      |  | Three months endedSeptember 30, |        |   | Nine months endedSeptember 30, |  
|                                                      |  | 2009                            |        |   | 2008                           |   |       | 2009 |  |   | 2008   |  
|                                                      |  | (In thousands)                  |       
|Allowance for credit losses, beginning of period      |  | $                               | 9,859  |   |                                | $ | 8,651 |      |  | $ | 9,161  |   |  | $ | 8,426  |  
|                                                      |  |                                 |        |  
|Loans and leases charged-off                          |  |                                 | (1,292 | ) |                                |   | (805  | )    |  |   | (4,991 | ) |  |   | (3,762 | )
|Recoveries of loans and leases previously charged-off |  |                                 | 314    |   |                                |   | 180   |      |  |   | 1,161  |   |  |   | 685    |  
|                                                      |  |                                 |        |   |                                |   |       |      |  |   |        |   |  |   |        |  
|Net loans and leases charged-off                      |  |                                 | (978   | ) |                                |   | (625  | )    |  |   | (3,830 | ) |  |   | (3,077 | )
|                                                      |  |                                 |        |  
|Provision for credit losses                           |  |                                 | 1,125  |   |                                |   | 849   |      |  |   | 4,675  |   |  |   | 3,526  |  
|                                                      |  |                                 |        |   |                                |   |       |      |  |   |        |   |  |   |        |  
|Allowance for credit losses, end of period            |  | $                               | 10,006 |   |                                | $ | 8,875 |      |  | $ | 10,006 |   |  | $ | 8,875  |  
|                                                      |  |                                 |        |   |                                |   |       |      |  |   |        |   |  |   |        |  



12



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





|4. | Deposits
|-- | --------

Deposits consisted of the
following at the periods indicated (in thousands):



|                              |  |                    |           |                   |   |        
|----------------------------- |  | ------------------ | --------- | ----------------- | - | -------
|                              |  | September 30, 2009 |           | December 31, 2008
|Non-interest-bearing checking |  | $                  | 151,998   |                   | $ | 140,845
|Interest-bearing checking     |  |                    | 119,048   |                   |   | 106,292
|Savings accounts              |  |                    | 93,329    |                   |   | 88,242 
|Money market accounts         |  |                    | 330,345   |                   |   | 247,392
|Time deposits                 |  |                    | 390,191   |                   |   | 355,111
|                              |  |                    |           |                   |   |        
|Total deposits                |  | $                  | 1,084,911 |                   | $ | 937,882
|                              |  |                    |           |                   |   |        



|5. | Earnings Per Share
|-- | ------------------

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

Basic and diluted net income per common share calculations are as follows:



|                                                                                                 |  |                                                  |           |   |                                        |   |           |      |  |   |           |   |  |   |           |  
|------------------------------------------------------------------------------------------------ |  | ------------------------------------------------ | --------- | - | -------------------------------------- | - | --------- | ---- |  | - | --------- | - |  | - | --------- | -
|                                                                                                 |  | For the three monthsended
September 30,          |           |   | For the nine monthsended
September 30, |  
|                                                                                                 |  | 2009                                             |           |   | 2008                                   |   |           | 2009 |  |   | 2008      |  
|                                                                                                 |  | (Dollars in thousands, except per share amounts) |          
|Distributed earnings allocated to common shareholders                                            |  | $                                                | 1,270     |   |                                        | $ | 1,168     |      |  | $ | 3,627     |   |  | $ | 3,325     |  
|Undistributed earnings allocated to common shareholders                                          |  |                                                  | 1,633     |   |                                        |   | 1,783     |      |  |   | 3,111     |   |  |   | 4,491     |  
|                                                                                                 |  |                                                  |           |   |                                        |   |           |      |  |   |           |   |  |   |           |  
|Net earnings allocated to common shareholders                                                    |  | $                                                | 2,903     |   |                                        | $ | 2,951     |      |  | $ | 6,738     |   |  | $ | 7,816     |  
|                                                                                                 |  |                                                  |           |   |                                        |   |           |      |  |   |           |   |  |   |           |  
|                                                                                                 |  |                                                  |           |  
|Weighted average common shares outstanding, including shares considered participating securities |  |                                                  | 4,610,603 |   |                                        |   | 4,634,907 |      |  |   | 4,595,658 |   |  |   | 4,647,813 |  
|Less: average participating securities                                                           |  |                                                  | (89,272   | ) |                                        |   | (89,550   | )    |  |   | (92,360   | ) |  |   | (88,019   | )
|                                                                                                 |  |                                                  |           |   |                                        |   |           |      |  |   |           |   |  |   |           |  
|Weighted average shares                                                                          |  |                                                  | 4,521,331 |   |                                        |   | 4,545,357 |      |  |   | 4,503,298 |   |  |   | 4,559,794 |  
|                                                                                                 |  |                                                  |           |  
|Net income per common share  basic                                                              |  | $                                                | 0 .64     |   |                                        | $ | 0.65      |      |  | $ | 1.50      |   |  | $ | 1.71      |  
|                                                                                                 |  |                                                  |           |   |                                        |   |           |      |  |   |           |   |  |   |           |  
|                                                                                                 |  |                                                  |           |  
|Diluted:                                                                                         |  |                                                  |           |   |                                        |   |           |      |  |   |           |   |  |   |           |  
|Net earnings allocated to common shareholders                                                    |  | $                                                | 2,903     |   |                                        | $ | 2,951     |      |  | $ | 6,738     |   |  | $ | 7,816     |  
|                                                                                                 |  |                                                  |           |   |                                        |   |           |      |  |   |           |   |  |   |           |  
|                                                                                                 |  |                                                  |           |  
|Weighted average common shares outstanding for basic earnings per common share                   |  |                                                  | 4,521,331 |   |                                        |   | 4,545,357 |      |  |   | 4,503,298 |   |  |   | 4,559,794 |  
|Incremental shares from assumed conversion of stock options and warrants                         |  |                                                  | 41,837    |   |                                        |   | 19,547    |      |  |   | 20,759    |   |  |   | 52,094    |  
|                                                                                                 |  |                                                  |           |   |                                        |   |           |      |  |   |           |   |  |   |           |  
|Average common shares outstanding  diluted                                                      |  |                                                  | 4,563,168 |   |                                        |   | 4,564,904 |      |  |   | 4,524,057 |   |  |   | 4,611,888 |  
|                                                                                                 |  |                                                  |           |  
|Net income per common share  diluted                                                            |  | $                                                | 0.64      |   |                                        | $ | 0.65      |      |  | $ | 1.49      |   |  | $ | 1.69      |  
|                                                                                                 |  |                                                  |           |   |                                        |   |           |      |  |   |           |   |  |   |           |  

Dividends of $23,000 for each of the quarters ending September 30, 2009 and 2008 were paid on
unvested shares with non-forfeitable dividend rights. Dividends of $71,000 and $65,000 for the nine months ended September 30, 2009 and 2008, respectively, were paid on unvested shares with non-forfeitable dividend rights. For the three months
ended September 30, 2009 and 2008, 1,000 and 122,373 of anti-dilutive stock options were excluded from the diluted weighted average common share calculations. For the nine months ended September 30, 2009 and 2008, 104,066 and 67,561,
respectively, of anti-dilutive stock options and warrants were excluded from the diluted weighted average common share calculations.



13



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





|6. | Other Comprehensive Income
|-- | --------------------------

The
components of accumulated other comprehensive income (loss), net of tax, for the periods indicated were as follows (in thousands):



|                                                        |  |                                       |       |                     |   |                  |  |               |       |  |                     |        |   |                  |   |      |   |  |   |       |  
|------------------------------------------------------- |  | ------------------------------------- | ----- | ------------------- | - | ---------------- |  | ------------- | ----- |  | ------------------- | ------ | - | ---------------- | - | ---- | - |  | - | ----- | -
|                                                        |  | For three months ending September 30, |      
|                                                        |  | 2009                                  |       | 2008                |  
|                                                        |  | Pre-taxamount                         |       | Taxexpense(benefit) |   | Net-of-taxamount |  | Pre-taxamount |       |  | Taxexpense(benefit) |        |   | Net-of-taxamount |  
|Securities available-for-sale:                          |  |                                       |       |                     |   |                  |  |               |       |  |                     |        |   |                  |   |      |   |  |   |       |  
|Net unrealized gains (losses) arising during the period |  | $                                     | 4,336 |                     | $ | 1,677            |  | $             | 2,659 |  | $                   | (1,174 | ) |                  | $ | (427 | ) |  | $ | (747  | )
|Retirement plan liabilities                             |  |                                       | 8     |                     |   | 3                |  |               | 5     |  |                     | (5     | ) |                  |   | (2   | ) |  |   | (3    | )
|                                                        |  |                                       |       |                     |   |                  |  |               |       |  |                     |        |   |                  |   |      |   |  |   |       |  
|Other comprehensive income (loss)                       |  |                                       | 4,344 |                     |   | 1,680            |  |               | 2,664 |  |                     | (1,179 | ) |                  |   | (429 | ) |  |   | (750  | )
|                                                        |  |                                       |       |                     |   |                  |  |               |       |  |                     |        |   |                  |   |      |   |  |   |       |  
|Net income                                              |  |                                       |       |                     |   |                  |  |               | 2,958 |  |                     |        |   |                  |   |      |   |  |   | 3,010 |  
|                                                        |  |                                       |       |                     |   |                  |  |               |       |  |                     |        |   |                  |   |      |   |  |   |       |  
|Comprehensive income                                    |  |                                       |       |                     |   |                  |  | $             | 5,622 |  |                     |        |   |                  |   |      |   |  | $ | 2,260 |  
|                                                        |  |                                       |       |                     |   |                  |  |               |       |  |                     |        |   |                  |   |      |   |  |   |       |  



|                                                                      |  |                                      |       |                     |   |                  |  |               |        |  |                     |        |   |                  |   |      |   |  |   |        |  
|--------------------------------------------------------------------- |  | ------------------------------------ | ----- | ------------------- | - | ---------------- |  | ------------- | ------ |  | ------------------- | ------ | - | ---------------- | - | ---- | - |  | - | ------ | -
|                                                                      |  | For nine months ending September 30, |      
|                                                                      |  | 2009                                 |       | 2008                |  
|                                                                      |  | Pre-taxamount                        |       | Taxexpense(benefit) |   | Net-of-taxamount |  | Pre-taxamount |        |  | Taxexpense(benefit) |        |   | Net-of-taxamount |  
|Securities available-for-sale:                                        |  |                                      |       |                     |   |                  |  |               |        |  |                     |        |   |                  |   |      |   |  |   |        |  
|Net unrealized gains (losses) arising during the period               |  | $                                    | 6,017 |                     | $ | 2,329            |  | $             | 3,688  |  | $                   | (1,989 | ) |                  | $ | (742 | ) |  | $ | (1,247 | )
|Reclassification adjustment for (gains) losses included in net income |  |                                      | 1,015 |                     |   | 394              |  |               | 621    |  |                     | 137    |   |                  |   | 53   |   |  |   | 84     |  
|                                                                      |  |                                      |       |                     |   |                  |  |               |        |  |                     |        |   |                  |   |      |   |  |   |        |  
|                                                                      |  |                                      | 5,002 |                     |   | 1,935            |  |               | 3,067  |  |                     | (2,126 | ) |                  |   | (795 | ) |  |   | (1,331 | )
|Retirement plan liabilities                                           |  |                                      | 21    |                     |   | 8                |  |               | 13     |  |                     | (7     | ) |                  |   | (3   | ) |  |   | (4     | )
|                                                                      |  |                                      |       |                     |   |                  |  |               |        |  |                     |        |   |                  |   |      |   |  |   |        |  
|Other comprehensive income (loss)                                     |  |                                      | 5,023 |                     |   | 1,943            |  |               | 3,080  |  |                     | (2,133 | ) |                  |   | (798 | ) |  |   | (1,335 | )
|                                                                      |  |                                      |       |                     |   |                  |  |               |        |  |                     |        |   |                  |   |      |   |  |   |        |  
|Net income                                                            |  |                                      |       |                     |   |                  |  |               | 7,951  |  |                     |        |   |                  |   |      |   |  |   | 7,973  |  
|                                                                      |  |                                      |       |                     |   |                  |  |               |        |  |                     |        |   |                  |   |      |   |  |   |        |  
|Comprehensive income                                                  |  |                                      |       |                     |   |                  |  | $             | 11,031 |  |                     |        |   |                  |   |      |   |  | $ | 6,638  |  
|                                                                      |  |                                      |       |                     |   |                  |  |               |        |  |                     |        |   |                  |   |      |   |  |   |        |  



|7. | Employee and Director Benefit Plans
|-- | -----------------------------------

Defined Benefit Plan and Post-Retirement Benefits

The Company has a noncontributory defined benefit pension plan
(Pension Plan) which it assumed from Bridge Street Financial Inc. (Bridge Street). The 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 plan, retirement benefits are primarily a function of both the years of service and the level of compensation. The amount contributed to the 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. 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.

Post-retirement medical and life insurance benefits (Post-retirement Plan) are available to certain retirees and their spouses, if applicable.



14



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





Supplemental Retirement Plans

The Company has supplemental executive retirement plans (SRPs) for certain current and former employees.

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.

The components of
all of the plans net periodic costs (benefit) for the three months ended September 30, 2009 and 2008 are as follows (in thousands):



|                                                |  |              |     |   |                     |   |      |          |  |                         |      |   |  |      |     |      |  |      |    |      |   |    |  |   |    |  |   |   
|----------------------------------------------- |  | ------------ | --- | - | ------------------- | - | ---- | -------- |  | ----------------------- | ---- | - |  | ---- | --- | ---- |  | ---- | -- | ---- | - | -- |  | - | -- |  | - | --
|                                                |  | Pension Plan |     |   | Post-retirementPlan |   |      | SRP Plan |  | DirectorsRetirementPlan
|                                                |  | 2009         |     |   | 2008                |   |      | 2009     |  |                         | 2008 |   |  | 2009 |     | 2008 |  | 2009 |    | 2008
|Service cost                                    |  | $            |    |   |                     | $ |     |          |  | $                       |     |   |  | $    |    |      |  | $    | 20 |      | $ | 15 |  | $ | 14 |  | $ | 14
|Interest cost                                   |  |              | 70  |   |                     |   | 64   |          |  |                         | 57   |   |  |      | 60  |      |  |      | 48 |      |   | 50 |  |   | 8  |  |   | 7 
|Expected return on assets                       |  |              | (71 | ) |                     |   | (108 | )        |  |                         |     |   |  |      |    |      |  |      |   |      |   |   |  |   |   |  |   |  
|Amortization of unrecognized prior service cost |  |              | 41  |   |                     |   |     |          |  |                         | (9   | ) |  |      | (11 | )    |  |      | 5  |      |   | 5  |  |   | 11 |  |   | 12
|                                                |  |              |     |   |                     |   |      |          |  |                         |      |   |  |      |     |      |  |      |    |      |   |    |  |   |    |  |   |   
|Net periodic pension cost (benefit)             |  | $            | 40  |   |                     | $ | (44  | )        |  | $                       | 48   |   |  | $    | 49  |      |  | $    | 73 |      | $ | 70 |  | $ | 33 |  | $ | 33
|                                                |  |              |     |   |                     |   |      |          |  |                         |      |   |  |      |     |      |  |      |    |      |   |    |  |   |    |  |   |   

The components of all of the plans net periodic costs (benefit) for the nine months ended
September 30, 2009 and 2008 are as follows (in thousands):



|                                                |  |              |      |   |                     |   |      |          |  |                          |      |   |  |      |     |      |  |      |     |      |   |     |  |   |     |  |   |   
|----------------------------------------------- |  | ------------ | ---- | - | ------------------- | - | ---- | -------- |  | ------------------------ | ---- | - |  | ---- | --- | ---- |  | ---- | --- | ---- | - | --- |  | - | --- |  | - | --
|                                                |  | Pension Plan |      |   | Post-retirementPlan |   |      | SRP Plan |  | DirectorsRetirement Plan
|                                                |  | 2009         |      |   | 2008                |   |      | 2009     |  |                          | 2008 |   |  | 2009 |     | 2008 |  | 2009 |     | 2008
|Service cost                                    |  | $            |     |   |                     | $ |     |          |  | $                        |     |   |  | $    |    |      |  | $    | 60  |      | $ | 46  |  | $ | 43  |  | $ | 14
|Interest cost                                   |  |              | 209  |   |                     |   | 193  |          |  |                          | 172  |   |  |      | 180 |      |  |      | 144 |      |   | 150 |  |   | 23  |  |   | 7 
|Expected return on assets                       |  |              | (212 | ) |                     |   | (325 | )        |  |                          |     |   |  |      |    |      |  |      |    |      |   |    |  |   |    |  |   |  
|Amortization of unrecognized prior service cost |  |              | 124  |   |                     |   |     |          |  |                          | (27  | ) |  |      | (33 | )    |  |      | 14  |      |   | 14  |  |   | 34  |  |   | 12
|                                                |  |              |      |   |                     |   |      |          |  |                          |      |   |  |      |     |      |  |      |     |      |   |     |  |   |     |  |   |   
|Net periodic pension cost (benefit)             |  | $            | 121  |   |                     | $ | (132 | )        |  | $                        | 145  |   |  | $    | 147 |      |  | $    | 218 |      | $ | 210 |  | $ | 100 |  | $ | 33
|                                                |  |              |      |   |                     |   |      |          |  |                          |      |   |  |      |     |      |  |      |     |      |   |     |  |   |     |  |   |   



|8. | Fair Value Measurements
|-- | -----------------------

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.



15



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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 September 30, 2009 Using               
|                                                      |  | Fair Value |         | Quoted market pricesin active
markets foridentical assets(Level 1) |   | Significant otherobservable inputs(Level 2)
|Debt Securities:                                      |  |            |         |                                                                    |   |                                             |  |   |        
|U.S. Treasury obligations                             |  | $          | 100     |                                                                    | $ |                                            |  | $ | 100    
|Obligations of U.S. government-sponsored corporations |  |            | 6,509   |                                                                    |   |                                            |  |   | 6,509  
|Obligations of states and political subdivisions      |  |            | 86,131  |                                                                    |   |                                            |  |   | 86,131 
|Mortgage-backed securities - residential              |  |            | 300,828 |                                                                    |   |                                            |  |   | 300,828
|                                                      |  |            |         |                                                                    |   |                                             |  |   |        
|Total debt securities                                 |  |            | 393,568 |                                                                    |   |                                            |  |   | 393,568
|Stock Investments:                                    |  |            |         |                                                                    |   |                                             |  |   |        
|Equity securities                                     |  |            | 2,151   |                                                                    |   | 17                                          |  |   | 2,134  
|Mutual Funds                                          |  |            | 1,011   |                                                                    |   | 1,011                                       |  |   |       
|                                                      |  |            |         |                                                                    |   |                                             |  |   |        
|Total stock investments                               |  |            | 3,162   |                                                                    |   | 1,028                                       |  |   | 2,134  
|                                                      |  |            |         |                                                                    |   |                                             |  |   |        
|Total available-for-sale                              |  | $          | 396,730 |                                                                    | $ | 1,028                                       |  | $ | 395,702
|                                                      |  |            |         |                                                                    |   |                                             |  |   |        
|                                                      |  |           
|                                                      |  |            |         | Fair Value Measurements at December 31, 2008 Using                
|                                                      |  | Fair Value |         | Quoted market pricesin active markets
foridentical assets(Level 1) |   | Significant otherobservable inputs(Level 2)
|Debt Securities:                                      |  |            |         |                                                                    |   |                                             |  |   |        
|U.S. Treasury obligations                             |  | $          | 102     |                                                                    | $ |                                            |  | $ | 102    
|Obligations of U.S. government-sponsored corporations |  |            | 35,143  |                                                                    |   |                                            |  |   | 35,143 
|Obligations of states and political subdivisions      |  |            | 91,033  |                                                                    |   |                                            |  |   | 91,033 
|Mortgage-backed securities - residential              |  |            | 169,960 |                                                                    |   |                                            |  |   | 169,960
|                                                      |  |            |         |                                                                    |   |                                             |  |   |        
|Total debt securities                                 |  |            | 296,238 |                                                                    |   |                                            |  |   | 296,238
|Stock Investments:                                    |  |            |         |                                                                    |   |                                             |  |   |        
|Equity securities                                     |  |            | 1,923   |                                                                    |   |                                            |  |   | 1,923  
|Mutual Funds                                          |  |            | 988     |                                                                    |   | 988                                         |  |   |       
|                                                      |  |            |         |                                                                    |   |                                             |  |   |        
|Total stock investments                               |  |            | 2,911   |                                                                    |   | 988                                         |  |   | 1,923  
|                                                      |  |            |         |                                                                    |   |                                             |  |   |        
|Total available-for-sale                              |  | $          | 299,149 |                                                                    | $ | 988                                         |  | $ | 298,161
|                                                      |  |            |         |                                                                    |   |                                             |  |   |        

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.

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.



16



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





Loans subject to non-recurring fair value measurement using Level 3 inputs at September 30, 2009
had a gross carrying amount of $1.9 million with an associated valuation allowance of $961,000 for a fair value of $979,000. Impairment write-downs during 2009 resulted in $936,000 in charges to the allowance for credit losses.

The carrying amounts and estimated fair values of financial instruments, not previously presented, as of the dates indicated (in thousands):



|                                         |  |                    |           |                   |                     |   |                |  |   |                     |   |  |   |        
|---------------------------------------- |  | ------------------ | --------- | ----------------- | ------------------- | - | -------------- |  | - | ------------------- | - |  | - | -------
|                                         |  | September 30, 2009 |           | December 31, 2008
|                                         |  | CarryingAmount     |           |                   | EstimatedFair Value |   | CarryingAmount |  |   | EstimatedFair Value
|Financial Assets:                        |  |                    |           |                   |                     |   |                |  |   |                     |   |  |   |        
|Cash and cash equivalents                |  | $                  | 24,820    |                   |                     | $ | 24,820         |  | $ | 21,172              |   |  | $ | 21,172 
|Fed funds sold                           |  |                    |          |                   |                     |   |               |  |   | 26,918              |   |  |   | 26,918 
|FHLB and FRB stock                       |  |                    | 11,821    |                   |                     |   | N/A            |  |   | 11,844              |   |  |   | N/A    
|Loans held for sale                      |  |                    | 1,365     |                   |                     |   | 1,365          |  |   | 875                 |   |  |   | 875    
|Loans and leases, net of unearned income |  |                    | 927,732   |                   |                     |   | 957,114        |  |   | 910,755             |   |  |   | 930,920
|Allowance for credit losses              |  |                    | (10,006   | )                 |                     |   |               |  |   | (9,161              | ) |  |   |       
|                                         |  |                    |           |                   |                     |   |                |  |   |                     |   |  |   |        
|Net loans and leases                     |  |                    | 917,726   |                   |                     |   | 957,114        |  |   | 901,594             |   |  |   | 930,920
|Accrued interest receivable              |  |                    | 4,988     |                   |                     |   | 4,988          |  |   | 4,218               |   |  |   | 4,218  
|                                         |  |                    |           |                  
|Financial Liabilities:                   |  |                    |           |                   |                     |   |                |  |   |                     |   |  |   |        
|Deposits                                 |  | $                  | 1,084,911 |                   |                     | $ | 1,090,053      |  | $ | 937,882             |   |  | $ | 943,182
|Borrowings                               |  |                    | 201,240   |                   |                     |   | 205,429        |  |   | 238,972             |   |  |   | 241,421
|Junior subordinated obligations          |  |                    | 25,774    |                   |                     |   | 9,311          |  |   | 25,774              |   |  |   | 14,131 
|Accrued interest payable                 |  |                    | 1,177     |                   |                     |   | 1,177          |  |   | 3,037               |   |  |   | 3,037  

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

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

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

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.



17



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





Deposits

The fair values disclosed for non-interest-bearing accounts and accounts with no stated maturity are, by definition, equal to the amount payable on demand at the reporting date. The fair value of time
deposits was estimated by discounting expected monthly maturities at interest rates approximating those currently being offered at the FHLB on similar terms. The fair value of accrued interest approximates carrying value.

Borrowings

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

Junior Subordinated Obligations

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

Off-balance-sheet Instruments

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



|9. | 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.



18



---

##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





The following table compares the Companys actual capital amounts and ratios with those needed to
qualify for the well capitalized category, which is the highest capital category as defined in the regulations.



|                         |  |        |         |                              |        |                                                                |   |        |  |        |  |        |  |        
|------------------------ |  | ------ | ------- | ---------------------------- | ------ | -------------------------------------------------------------- | - | ------ |  | ------ |  | ------ |  | -------
|                         |  | Actual |         | For CapitalAdequacy Purposes |        | To Be Well CapitalizedUnder Prompt CorrectiveAction
Provisions
|                         |  | Amount |         | Ratio                        |        | Amount                                                         |   | Ratio  |  | Amount |  | Ratio 
|As of September 30, 2009 |  |        |         |                              |        |                                                                |   |        |  |        |  |        |  |        
|Total risk-based capital |  |        |         |                              |        |                                                                |   |        |  |        |  |        |  |        
|Company                  |  | $      | 113,450 |                              | 12.66% |                                                                | $ | 71,690 |  | 38.00% |  | N/A    |  | N/A    
|Bank                     |  |        | 106,307 |                              | 11.97% |                                                                |   | 71,077 |  | 38.00% |  | 88,847 |  | 310.00%
|Tier 1 capital           |  |        |         |                              |        |                                                                |   |        |  |        |  |        |  |        
|Company                  |  |        | 103,346 |                              | 11.53% |                                                                |   | 35,845 |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  |        | 96,296  |                              | 10.84% |                                                                |   | 35,539 |  | 34.00% |  | 53,308 |  | 36.00% 
|Leverage                 |  |        |         |                              |        |                                                                |   |        |  |        |  |        |  |        
|Company                  |  |        | 103,346 |                              | 7.42%  |                                                                |   | 55,694 |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  |        | 96,296  |                              | 6.95%  |                                                                |   | 55,450 |  | 34.00% |  | 69,313 |  | 35.00% 
|                         |  |        |         |                              |        |                                                               
|As of December 31, 2008  |  |        |         |                              |        |                                                                |   |        |  |        |  |        |  |        
|Total risk-based capital |  |        |         |                              |        |                                                                |   |        |  |        |  |        |  |        
|Company                  |  | $      | 133,962 |                              | 15.08% |                                                                | $ | 71,047 |  | 38.00% |  | N/A    |  | N/A    
|Bank                     |  |        | 124,941 |                              | 14.19% |                                                                |   | 70,415 |  | 38.00% |  | 88,019 |  | 310.00%
|Tier 1 capital           |  |        |         |                              |        |                                                                |   |        |  |        |  |        |  |        
|Company                  |  |        | 124,801 |                              | 14.05% |                                                                |   | 35,523 |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  |        | 115,780 |                              | 13.15% |                                                                |   | 35,207 |  | 34.00% |  | 52,811 |  | 36.00% 
|Leverage                 |  |        |         |                              |        |                                                                |   |        |  |        |  |        |  |        
|Company                  |  |        | 124,801 |                              | 9.59%  |                                                                |   | 52,064 |  | 34.00% |  | N/A    |  | N/A    
|Bank                     |  |        | 115,780 |                              | 8.97%  |                                                                |   | 51,657 |  | 34.00% |  | 64,571 |  | 35.00% 

The decrease in the Companys and the Banks regulatory capital ratios in 2009 resulted
from redemption of preferred stock issued under the U.S. Treasurys Capital Purchase Program and the repurchase of the related warrant to purchase common stock.

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

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

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

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



19



---

##### Table of Contents

|Item 2. | Managements Discussion and Analysis of Financial Condition and Results of Operations
|------- | -------------------------------------------------------------------------------------

General

Throughout this discussion, the
term the Company or Alliance refers to the consolidated entity of Alliance Financial Corporation, its wholly-owned subsidiaries Ladds Agency, Inc. and Alliance Bank, N.A. (the Bank), and the Banks
subsidiaries, Alliance Preferred Funding Corp. and Alliance Leasing, Inc. The Company is a New York corporation which was formed in November 1998 as a result of the merger of Cortland First Financial Corporation and Oneida Valley Bancshares, Inc.

The following discussion presents material changes in the Companys results of operations and financial condition during the nine months
ended September 30, 2009, which are not otherwise apparent from the consolidated financial statements included in this report.

This
discussion and analysis contains certain forward-looking statements (within the meaning of the Private Securities Litigation Reform Act of 1995) with respect to the financial condition, results of operations and business of the Company. These
forward-looking statements 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 pressures in the banking industry;
| | - |  | -------------------------------------------------------------



| |  |  | changes in the interest rate environment that reduce margins;
| | - |  | -------------------------------------------------------------



| |  |  | changes in the regulatory environment;
| | - |  | --------------------------------------



| |  |  | general economic conditions, either nationally or regionally, resulting in, among other things, a deterioration in credit quality;
| | - |  | ----------------------------------------------------------------------------------------------------------------------------------



| |  |  | changes in business conditions and inflation;
| | - |  | ---------------------------------------------



| |  |  | changes in credit market conditions;
| | - |  | ------------------------------------



| |  |  | changes in the securities markets which affect investment management revenues;
| | - |  | ------------------------------------------------------------------------------



| |  |  | increases in FDIC deposit insurance premiums and assessments could adversely affect our financial condition;
| | - |  | ------------------------------------------------------------------------------------------------------------



| |  |  | changes in technology used in the banking business;
| | - |  | ---------------------------------------------------



| |  |  | our ability to maintain and increase market share and control expenses;
| | - |  | -----------------------------------------------------------------------



| |  |  | the soundness of other financial services institutions may adversely affect our credit risk;
| | - |  | --------------------------------------------------------------------------------------------



| |  |  | certain of our intangible assets may become impaired in the future;
| | - |  | -------------------------------------------------------------------



| |  |  | the Companys controls and procedures may fail or be circumvented;
| | - |  | ------------------------------------------------------------------



| |  |  | new line of business or new products and services may subject the Company to additional risks;
| | - |  | ----------------------------------------------------------------------------------------------



| |  |  | changes in key management personnel may adversely impact our operations;
| | - |  | ------------------------------------------------------------------------



| |  |  | severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact the Companys business; and
| | - |  | --------------------------------------------------------------------------------------------------------------------------------------------



| |  |  | other factors detailed from time to time in the Companys Securities and Exchange Commission filings
| | - |  | ----------------------------------------------------------------------------------------------------

Operating results for the three and nine months ended September 30, 2009 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2009.

Comparison of Operating Results for the Three and Nine Months Ended September 30, 2009 and
2008

General

Net
income available to common shareholders for the quarter ended September 30, 2009 was $3.0 million, or $0.64 per diluted share, compared to $3.0 million, or $0.65 per diluted share in the year-ago quarter. The return on average assets and return
on average common shareholders equity were 0.82% and 9.68%, respectively, for the quarter ended September 30, 2009 compared with 0.92% and 10.42%, respectively, for the third quarter of 2008.

Net income was $8.0 million for the nine months ended September 30, 2009 and 2008, respectively. Net income available to common shareholders for the
nine months ended September 30, 2009 was $6.9 million or $1.49 per diluted share, compared with $8.0 million or $1.69 per diluted share in the year-ago period. Preferred dividends and accretion on the preferred stock discount associated with
Alliances participation in and withdrawal from the U.S. Treasurys Capital Purchase Program (CPP) were $1.1 million for the nine months ended September 30, 2009.



20



---

##### Table of Contents

There was no preferred stock outstanding for the nine months ended September 30, 2008. The return on average assets and return on average common shareholders equity were 0.65% and
7.92%, respectively, for the nine months ended September 30, 2009 compared with 0.81% and 9.17%, respectively, for the same period in 2008.

The results for the third quarter and year-to-date reflect continued growth in net interest income, which offset higher credit costs and a decrease in investment management income compared to the year-ago periods. In addition to the impact
of the Companys CPP participation and withdrawal, third quarter and year-to-date earnings were impacted by a significant increase in the premiums assessed by the Federal Deposit Insurance Corporation (FDIC) to all FDIC-insured
banks. FDIC insurance premium expense for the three and nine month periods in 2009 increased $384,000 and $1.7 million, respectively, compared with the same periods in 2008. A large portion of the FDICs insurance premium increase in 2009 was
in the form of a special assessment charged to all FDIC-insured banks in the second quarter which totaled $676,000 before tax or $0.09 per diluted common share after tax.

Net Interest Income

Net interest income totaled $11.2 million in the third quarter,
representing an increase of $1.7 million or 17.2% compared with the third quarter of 2008. The increase in net interest income was driven by a higher net interest margin combined with earning asset growth. Average earning assets increased $118.0
million in the third quarter compared with the year-ago quarter, due in large part to increases in the average balance of residential mortgages and the securities portfolio. On a linked-quarter basis, net interest income increased $608,000 or 5.7%
as a result of a higher net interest margin and a $17.7 million increase in average earning assets.

The Companys tax-equivalent net
interest margin increased 19 basis points in the third quarter compared with the year-ago quarter, and was up 12 basis points compared to the second quarter of 2009. The net interest margin on a tax-equivalent basis was 3.62% in the third quarter of
2009, compared with 3.43% in the third quarter of 2008 and 3.50% in the second quarter of 2009. The increase in the net interest margin was the result of a decrease in the tax-equivalent earning asset yield of 73 basis points in the third quarter
compared with the year-ago quarter, which was offset by a decrease in the cost of funds of 103 basis points over the same period. The Companys yield on earning assets decreased one basis point in the third quarter of 2009 compared with the
second quarter of 2009, which was more than offset by a decrease in its cost of funds of 16 basis points during the same period.

The overall
net interest margin growth since the first quarter of 2008 is primarily the result of the Companys ongoing active balance sheet management and deposit pricing strategies and the positive effects of those strategies in the interest rate
environment of the past two years. 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 drop in equity markets, economic recession and federal government
monetary and economic stimulus efforts have contributed to a 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 320 basis points, 200 basis
points and 120 basis points, respectively from August 31, 2007 to September 30, 2009. Yields on commercial loans and consumer loans were most affected by these conditions, with yields on these assets down 116 basis points and 188 basis
points, respectively, in the third quarter of 2009 compared with the year-ago quarter. Other earning-asset classes have also experienced declines in yields, though not to the same magnitude. The commercial and consumer loan portfolios 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 segment of these portfolios and to the high levels of annual amortization in the portfolios as a result
of their relatively shorter duration.

Average interest-earning assets increased $118.0 million or 10.0% in the third quarter compared with
the year-ago period, due primarily to growth in investment securities and the residential mortgage portfolio which offset declines in the commercial loan and lease portfolios. Loans and leases comprised 71.2% of average interest-earning assets in
the third quarter, compared with 76.1% in the third quarter of 2008.

The Companys cost of funds declined throughout 2008 and into the
third quarter of 2009 in all interest-bearing liability categories except savings accounts. The average cost of money market and time deposit accounts dropped 96 basis points and 142 basis points, respectively in the third quarter of 2009 compared
with the year-ago quarter as a result of the lower rate environment and the Companys actively managed deposit pricing strategies. The rate of decline in the Companys cost of interest bearing liabilities in the third quarter of 2009 was
less that that experienced in 2008 as our ability to further reduce already low offering rates has diminished. On a linked-quarter basis, the average cost of money market and time accounts decreased 12 basis points and 26 basis points, respectively,
in the third quarter of 2009. Wholesale funding costs also dropped significantly, with the average cost of borrowings



21



---

##### Table of Contents

down 50 basis points in the third quarter compared with the year-ago quarter. At the same time the Company was lowering its borrowing costs due to the lower market rates over the past two years,
it took the opportunity to lower its sensitivity to rising rates by extending the maturity on new or renewed borrowings.

The average cost of
the Companys junior subordinated obligations decreased 226 basis points in the third quarter of 2009 compared with the third quarter of 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 and into the first nine months of 2009 as the Company continued to focus on
growing lower cost savings, demand and money market accounts (transaction accounts) and relied less on higher promotional rates to attract or retain retail time accounts. The growth in money market accounts has also been enhanced by the low interest
rate environment, which has caused some depositors to favor money market accounts over fixed term time accounts. The aggregate average balance of transaction accounts was $683.1 million in the third quarter of 2009, which was an increase of $123.8
million or 22.1% from the aggregate average balances of $559.4 million in the third quarter of 2008. Average time account balances in the third quarter of 2009 were 43.6% of total average deposits, compared with 46.8% in the year-ago period.

Net interest income for the nine months ended September 30, 2009 totaled $31.9 million, an increase of $4.0 million or 14.5% compared
with $27.9 million in the year-ago period. Average earning assets increased $89.4 million in the first nine months of 2009 compared with the year-ago period. The tax-equivalent net interest margin was 3.51% in the first nine months of 2009, compared
with 3.32% in the first nine months of 2008. A decrease of 77 basis points in the Companys tax-equivalent earning assets yield in the first nine months of 2009 compared with the same period in 2008 was offset by a 104 basis point decrease in
its cost of funds over the same period.

Changes in net interest income and net interest margin for the first nine months of 2009 compared
with the same period in 2008 were driven largely by the same factors in the analysis of the third quarter of 2009 to the third quarter of 2008 discussed above.



22



---

##### Table of Contents

Average Balance Sheet and Net Interest Analysis

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



|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|-------------------------------------------------------------------------------------------------------- |  | ---------------------------------------- | --------- | - | --------------------- | - | ------ | ---------- |  | ---- | --------------- |  | - | --------------------- | - |  | ---------- | ------ | - |  | ---- | -
|                                                                                                         |  | For the three months ended September 30, |          
|                                                                                                         |  | 2009                                     |           |   | 2008                  |  
|                                                                                                         |  | Average Balance                          |           |   | Interest Earned/ Paid |   |        | Yield Rate |  |      | Average Balance |  |   | Interest Earned/ Paid |   |  | Yield Rate |       
|                                                                                                         |  | (Dollars in thousands)                   |          
|Assets:                                                                                                  |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Interest earning assets:                                                                                 |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Federal funds sold                                                                                       |  | $                                        |          |   |                       | $ |       |            |  |     | %               |  | $ | 1,596                 |   |  | $          | 9      |   |  | 2.26 | %
|Taxable investment securities                                                                            |  |                                          | 281,587   |   |                       |   | 2,722  |            |  | 3.87 | %               |  |   | 181,093               |   |  |            | 2,076  |   |  | 4.59 | %
|Nontaxable investment securities                                                                         |  |                                          | 82,223    |   |                       |   | 1,215  |            |  | 5.91 | %               |  |   | 89,053                |   |  |            | 1,347  |   |  | 6.05 | %
|FHLB and FRB stock                                                                                       |  |                                          | 10,907    |   |                       |   | 187    |            |  | 6.87 | %               |  |   | 11,002                |   |  |            | 174    |   |  | 6.33 | %
|Real estate loans(1)                                                                                     |  |                                          | 350,798   |   |                       |   | 4,823  |            |  | 5.50 | %               |  |   | 301,338               |   |  |            | 4,452  |   |  | 5.91 | %
|Commercial loans                                                                                         |  |                                          | 201,051   |   |                       |   | 2,742  |            |  | 5.46 | %               |  |   | 203,933               |   |  |            | 3,377  |   |  | 6.62 | %
|Nontaxable commercial loans                                                                              |  |                                          | 9,578     |   |                       |   | 145    |            |  | 6.05 | %               |  |   | 8,386                 |   |  |            | 139    |   |  | 6.65 | %
|Taxable leases (net of unearned discount)(1)                                                             |  |                                          | 63,834    |   |                       |   | 917    |            |  | 5.75 | %               |  |   | 100,782               |   |  |            | 1,546  |   |  | 6.14 | %
|Nontaxable leases (net of unearned discount)                                                             |  |                                          | 15,695    |   |                       |   | 254    |            |  | 6.47 | %               |  |   | 15,696                |   |  |            | 245    |   |  | 6.26 | %
|Indirect auto loans                                                                                      |  |                                          | 195,244   |   |                       |   | 2,689  |            |  | 5.51 | %               |  |   | 181,747               |   |  |            | 2,566  |   |  | 5.65 | %
|Consumer loans                                                                                           |  |                                          | 92,109    |   |                       |   | 983    |            |  | 4.27 | %               |  |   | 90,406                |   |  |            | 1,390  |   |  | 6.15 | %
|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|                                                                                                         |  |                                          |           |   |                       |  
|Total interest-earning assets                                                                            |  | $                                        | 1,303,026 |   |                       | $ | 16,677 |            |  | 5.12 | %               |  | $ | 1,185,032             |   |  | $          | 17,321 |   |  | 5.85 | %
|                                                                                                         |  |                                          |           |   |                       |  
|Non-interest earning assets:                                                                             |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Other assets                                                                                             |  |                                          | 135,516   |   |                       |   |        |            |  |      |                 |  |   | 134,588               |   |  |            |        |   |  |      |  
|Less: Allowance for credit losses                                                                        |  |                                          | (10,193   | ) |                       |   |        |            |  |      |                 |  |   | (8,884                | ) |  |            |        |   |  |      |  
|Net unrealized gains (losses) on securities available-for-sale                                           |  |                                          | 6,346     |   |                       |   |        |            |  |      |                 |  |   | 356                   |   |  |            |        |   |  |      |  
|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Total assets                                                                                             |  | $                                        | 1,434,695 |   |                       |   |        |            |  |      |                 |  | $ | 1,311,092             |   |  |            |        |   |  |      |  
|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|                                                                                                         |  |                                          |           |   |                       |  
|Liabilities and shareholders equity:                                                                    |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Interest bearing liabilities:                                                                            |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Demand deposits                                                                                          |  | $                                        | 116,665   |   |                       | $ | 120    |            |  | 0.41 | %               |  | $ | 107,410               |   |  | $          | 177    |   |  | 0.66 | %
|Savings deposits                                                                                         |  |                                          | 95,048    |   |                       |   | 105    |            |  | 0.44 | %               |  |   | 88,843                |   |  |            | 124    |   |  | 0.56 | %
|MMDA deposits                                                                                            |  |                                          | 311,788   |   |                       |   | 766    |            |  | 0.98 | %               |  |   | 226,134               |   |  |            | 1,099  |   |  | 1.94 | %
|Time deposits                                                                                            |  |                                          | 404,397   |   |                       |   | 2,347  |            |  | 2.32 | %               |  |   | 372,010               |   |  |            | 3,480  |   |  | 3.74 | %
|Borrowings                                                                                               |  |                                          | 182,905   |   |                       |   | 1,382  |            |  | 3.02 | %               |  |   | 221,855               |   |  |            | 1,950  |   |  | 3.52 | %
|Junior subordinated obligations issued to unconsolidated trusts                                          |  |                                          | 25,774    |   |                       |   | 179    |            |  | 2.78 | %               |  |   | 25,774                |   |  |            | 325    |   |  | 5.04 | %
|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Total interest-bearing liabilities                                                                       |  | $                                        | 1,136,577 |   |                       | $ | 4,899  |            |  | 1.72 | %               |  | $ | 1,042,026             |   |  | $          | 7,155  |   |  | 2.75 | %
|                                                                                                         |  |                                          |           |   |                       |  
|Non-interest bearing liabilities:                                                                        |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Demand deposits                                                                                          |  |                                          | 159,616   |   |                       |   |        |            |  |      |                 |  |   | 136,968               |   |  |            |        |   |  |      |  
|Other liabilities                                                                                        |  |                                          | 16,214    |   |                       |   |        |            |  |      |                 |  |   | 16,501                |   |  |            |        |   |  |      |  
|Shareholders equity                                                                                     |  |                                          | 122,288   |   |                       |   |        |            |  |      |                 |  |   | 115,597               |   |  |            |        |   |  |      |  
|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Total liabilities and shareholders equity                                                               |  | $                                        | 1,434,695 |   |                       |   |        |            |  |      |                 |  | $ | 1,311,092             |   |  |            |        |   |  |      |  
|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|                                                                                                         |  |                                          |           |   |                       |  
|Net interest income (tax equivalent)                                                                     |  |                                          |           |   |                       | $ | 11,778 |            |  |      |                 |  |   |                       |   |  | $          | 10,166 |   |  |      |  
|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Net interest rate spread                                                                                 |  |                                          |           |   |                       |   |        |            |  | 3.40 | %               |  |   |                       |   |  |            |        |   |  | 3.10 | %
|Net interest margin (tax equivalent)                                                                     |  |                                          |           |   |                       |   |        |            |  | 3.62 | %               |  |   |                       |   |  |            |        |   |  | 3.43 | %
|Federal tax exemption on non-taxable investment securities, loans and leases included in interest income |  |                                          |           |   |                       |   | (548   | )          |  |      |                 |  |   |                       |   |  |            | (587   | ) |  |      |  
|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  
|Net interest income                                                                                      |  |                                          |           |   |                       | $ | 11,230 |            |  |      |                 |  |   |                       |   |  | $          | 9,579  |   |  |      |  
|                                                                                                         |  |                                          |           |   |                       |   |        |            |  |      |                 |  |   |                       |   |  |            |        |   |  |      |  



|(1) | Includes loans and leases held-for-sale
|--- | ---------------------------------------



23



---

##### Table of Contents

|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|-------------------------------------------------------------------------------------------------------- |  | --------------------------------------- | --------- | - | ------------------- | - | ------ | --------- |  | ---- | -------------- |  | - | ------------------- | - |  | --------- | ------ | - |  | ---- | -
|                                                                                                         |  | For the nine months ended September 30, |          
|                                                                                                         |  | 2009                                    |           |   | 2008                |  
|                                                                                                         |  | Average Balance                         |           |   | InterestEarned/Paid |   |        | YieldRate |  |      | AverageBalance |  |   | InterestEarned/Paid |   |  | YieldRate |       
|                                                                                                         |  | (Dollars in thousands)                  |          
|Assets:                                                                                                  |  |                                         |           |  
|Interest earning assets:                                                                                 |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Federal funds sold                                                                                       |  | $                                       | 17,176    |   |                     | $ | 15     |           |  | 0.11 | %              |  | $ | 5,184               |   |  | $         | 99     |   |  | 2.55 | %
|Taxable investment securities                                                                            |  |                                         | 242,226   |   |                     |   | 7,271  |           |  | 4.00 | %              |  |   | 186,483             |   |  |           | 6,522  |   |  | 4.66 | %
|Nontaxable investment securities                                                                         |  |                                         | 86,275    |   |                     |   | 3,941  |           |  | 6.09 | %              |  |   | 87,590              |   |  |           | 4,033  |   |  | 6.14 | %
|FHLB and FRB stock                                                                                       |  |                                         | 10,965    |   |                     |   | 401    |           |  | 4.88 | %              |  |   | 10,740              |   |  |           | 561    |   |  | 6.96 | %
|Real estate loans(1)                                                                                     |  |                                         | 340,632   |   |                     |   | 14,218 |           |  | 5.57 | %              |  |   | 289,730             |   |  |           | 12,863 |   |  | 5.92 | %
|Commercial loans                                                                                         |  |                                         | 203,432   |   |                     |   | 8,491  |           |  | 5.57 | %              |  |   | 208,629             |   |  |           | 10,781 |   |  | 6.89 | %
|Nontaxable commercial loans                                                                              |  |                                         | 9,645     |   |                     |   | 437    |           |  | 6.04 | %              |  |   | 8,315               |   |  |           | 418    |   |  | 6.70 | %
|Taxable leases (net of unearned discount)(1)                                                             |  |                                         | 72,422    |   |                     |   | 3,242  |           |  | 5.97 | %              |  |   | 107,108             |   |  |           | 5,033  |   |  | 6.26 | %
|Nontaxable leases (net of unearned discount)                                                             |  |                                         | 16,891    |   |                     |   | 822    |           |  | 6.49 | %              |  |   | 16,504              |   |  |           | 774    |   |  | 6.25 | %
|Indirect auto loans                                                                                      |  |                                         | 187,415   |   |                     |   | 7,759  |           |  | 5.52 | %              |  |   | 177,648             |   |  |           | 7,543  |   |  | 5.66 | %
|Consumer loans                                                                                           |  |                                         | 90,939    |   |                     |   | 3,065  |           |  | 4.49 | %              |  |   | 90,686              |   |  |           | 4,414  |   |  | 6.49 | %
|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Total interest-earning assets                                                                            |  | $                                       | 1,278,018 |   |                     | $ | 49,662 |           |  | 5.18 | %              |  | $ | 1,188,617           |   |  | $         | 53,041 |   |  | 5.95 | %
|                                                                                                         |  |                                         |           |   |                     |  
|Non-interest earning assets:                                                                             |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Other assets                                                                                             |  |                                         | 136,604   |   |                     |   |        |           |  |      |                |  |   | 132,833             |   |  |           |        |   |  |      |  
|Less: Allowance for credit losses                                                                        |  |                                         | (9,850    | ) |                     |   |        |           |  |      |                |  |   | (8,648              | ) |  |           |        |   |  |      |  
|Net unrealized gains (losses) on securities available-for-sale                                           |  |                                         | 6,151     |   |                     |   |        |           |  |      |                |  |   | 2,431               |   |  |           |        |   |  |      |  
|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Total assets                                                                                             |  | $                                       | 1,410,923 |   |                     |   |        |           |  |      |                |  | $ | 1,315,233           |   |  |           |        |   |  |      |  
|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|                                                                                                         |  |                                         |           |   |                     |  
|Liabilities and shareholders equity:                                                                    |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Interest bearing liabilities:                                                                            |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Demand deposits                                                                                          |  | $                                       | 116,097   |   |                     | $ | 404    |           |  | 0.46 | %              |  | $ | 106,920             |   |  | $         | 564    |   |  | 0.70 | %
|Savings deposits                                                                                         |  |                                         | 91,671    |   |                     |   | 339    |           |  | 0.49 | %              |  |   | 85,935              |   |  |           | 361    |   |  | 0.56 | %
|MMDA deposits                                                                                            |  |                                         | 295,551   |   |                     |   | 2,573  |           |  | 1.16 | %              |  |   | 221,721             |   |  |           | 3,615  |   |  | 2.17 | %
|Time deposits                                                                                            |  |                                         | 381,566   |   |                     |   | 7,523  |           |  | 2.63 | %              |  |   | 393,349             |   |  |           | 12,030 |   |  | 4.08 | %
|Borrowings                                                                                               |  |                                         | 194,951   |   |                     |   | 4,510  |           |  | 3.08 | %              |  |   | 216,349             |   |  |           | 5,776  |   |  | 3.56 | %
|Junior subordinated obligations issued to unconsolidated trusts                                          |  |                                         | 25,774    |   |                     |   | 647    |           |  | 3.35 | %              |  |   | 25,774              |   |  |           | 1,066  |   |  | 5.51 | %
|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Total interest-bearing liabilities                                                                       |  | $                                       | 1,105,610 |   |                     | $ | 15,996 |           |  | 1.93 | %              |  | $ | 1,050,048           |   |  | $         | 23,412 |   |  | 2.97 | %
|                                                                                                         |  |                                         |           |   |                     |  
|Non-interest bearing liabilities:                                                                        |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Demand deposits                                                                                          |  |                                         | 154,561   |   |                     |   |        |           |  |      |                |  |   | 131,665             |   |  |           |        |   |  |      |  
|Other liabilities                                                                                        |  |                                         | 16,832    |   |                     |   |        |           |  |      |                |  |   | 17,542              |   |  |           |        |   |  |      |  
|Shareholders equity                                                                                     |  |                                         | 133,920   |   |                     |   |        |           |  |      |                |  |   | 115,978             |   |  |           |        |   |  |      |  
|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Total liabilities and shareholders equity                                                               |  | $                                       | 1,410,923 |   |                     |   |        |           |  |      |                |  | $ | 1,315,233           |   |  |           |        |   |  |      |  
|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|                                                                                                         |  |                                         |           |   |                     |  
|Net interest income (tax equivalent)                                                                     |  |                                         |           |   |                     | $ | 33,666 |           |  |      |                |  |   |                     |   |  | $         | 29,629 |   |  |      |  
|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|                                                                                                         |  |                                         |           |   |                     |  
|Net interest rate spread                                                                                 |  |                                         |           |   |                     |   |        |           |  | 3.25 | %              |  |   |                     |   |  |           |        |   |  | 2.98 | %
|Net interest margin (tax equivalent)                                                                     |  |                                         |           |   |                     |   |        |           |  | 3.51 | %              |  |   |                     |   |  |           |        |   |  | 3.32 | %
|Federal tax exemption on non-taxable investment securities, loans and leases included in interest income |  |                                         |           |   |                     |   | (1,769 | )         |  |      |                |  |   |                     |   |  |           | (1,776 | ) |  |      |  
|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  
|Net interest income                                                                                      |  |                                         |           |   |                     | $ | 31,897 |           |  |      |                |  |   |                     |   |  | $         | 27,853 |   |  |      |  
|                                                                                                         |  |                                         |           |   |                     |   |        |           |  |      |                |  |   |                     |   |  |           |        |   |  |      |  



|(1) | Includes loans and leases held-for-sale
|--- | ---------------------------------------



24



---

##### Table of Contents

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



|                                                                           |  |                                                                                                     |       |   |                                                                                                    |   |        |           |  |   |        |   |  |      |        |   |           |   |        |   |  |   |        |  
|-------------------------------------------------------------------------- |  | --------------------------------------------------------------------------------------------------- | ----- | - | -------------------------------------------------------------------------------------------------- | - | ------ | --------- |  | - | ------ | - |  | ---- | ------ | - | --------- | - | ------ | - |  | - | ------ | -
|                                                                           |  | For the three months endedSeptember 30, 2009Compared toSeptember 30, 2008Increase/(Decrease) Due To |       |   | For the nine months endedSeptember 30, 2009Compared toSeptember 30, 2008Increase/(Decrease) Due To |  
|                                                                           |  | Volume                                                                                              |       |   | Rate                                                                                               |   |        | NetChange |  |   | Volume |   |  | Rate |        |   | NetChange |  
|Federal funds sold                                                         |  | $                                                                                                   | (5    | ) |                                                                                                    | $ | (4     | )         |  | $ | (9     | ) |  | $    | 120    |   |           | $ | (204   | ) |  | $ | (84    | )
|Taxable investment securities                                              |  |                                                                                                     | 2,537 |   |                                                                                                    |   | (1,891 | )         |  |   | 646    |   |  |      | 2,178  |   |           |   | (1,429 | ) |  |   | 749    |  
|Non-taxable investment securities                                          |  |                                                                                                     | (101  | ) |                                                                                                    |   | (31    | )         |  |   | (132   | ) |  |      | (60    | ) |           |   | (32    | ) |  |   | (92    | )
|FHLB and FRB stock                                                         |  |                                                                                                     | (10   | ) |                                                                                                    |   | 23     |           |  |   | 13     |   |  |      | 19     |   |           |   | (179   | ) |  |   | (160   | )
|Real estate loans                                                          |  |                                                                                                     | 1,998 |   |                                                                                                    |   | (1,627 | )         |  |   | 371    |   |  |      | 2,531  |   |           |   | (1,176 | ) |  |   | 1,355  |  
|Commercial loans                                                           |  |                                                                                                     | (47   | ) |                                                                                                    |   | (588   | )         |  |   | (635   | ) |  |      | (263   | ) |           |   | (2,027 | ) |  |   | (2,290 | )
|Non-taxable commercial loans                                               |  |                                                                                                     | 65    |   |                                                                                                    |   | (59    | )         |  |   | 6      |   |  |      | 80     |   |           |   | (61    | ) |  |   | 19     |  
|Taxable leases (net of unearned income)                                    |  |                                                                                                     | (536  | ) |                                                                                                    |   | (93    | )         |  |   | (629   | ) |  |      | (1,567 | ) |           |   | (224   | ) |  |   | (1,791 | )
|Non-taxable leases (net of unearned income)                                |  |                                                                                                     |      |   |                                                                                                    |   | 9      |           |  |   | 9      |   |  |      | 18     |   |           |   | 30     |   |  |   | 48     |  
|Indirect loans                                                             |  |                                                                                                     | 474   |   |                                                                                                    |   | (351   | )         |  |   | 123    |   |  |      | 492    |   |           |   | (276   | ) |  |   | 216    |  
|Consumer loans                                                             |  |                                                                                                     | 174   |   |                                                                                                    |   | (581   | )         |  |   | (407   | ) |  |      | 20     |   |           |   | (1,369 | ) |  |   | (1,349 | )
|                                                                           |  |                                                                                                     |       |   |                                                                                                    |   |        |           |  |   |        |   |  |      |        |   |           |   |        |   |  |   |        |  
|Total interest-earning assets                                              |  |                                                                                                     | 4,549 |   |                                                                                                    |   | (5,193 | )         |  |   | (644   | ) |  |      | 3,568  |   |           |   | (6,947 | ) |  |   | (3,379 | )
|                                                                           |  |                                                                                                     |       |   |                                                                                                    |   |        |           |  |   |        |   |  |      |        |   |           |   |        |   |  |   |        |  
|                                                                           |  |                                                                                                     |       |   |                                                                                                    |  
|Interest-bearing demand deposits                                           |  |                                                                                                     | 89    |   |                                                                                                    |   | (146   | )         |  |   | (57    | ) |  |      | 71     |   |           |   | (231   | ) |  |   | (160   | )
|Savings deposits                                                           |  |                                                                                                     | 48    |   |                                                                                                    |   | (67    | )         |  |   | (19    | ) |  |      | 34     |   |           |   | (56    | ) |  |   | (22    | )
|MMDA deposits                                                              |  |                                                                                                     | 1,738 |   |                                                                                                    |   | (2,071 | )         |  |   | (333   | ) |  |      | 1,433  |   |           |   | (2,475 | ) |  |   | (1,042 | )
|Time deposits                                                              |  |                                                                                                     | 1,759 |   |                                                                                                    |   | (2,892 | )         |  |   | (1,133 | ) |  |      | (350   | ) |           |   | (4,157 | ) |  |   | (4,507 | )
|Borrowings                                                                 |  |                                                                                                     | (315  | ) |                                                                                                    |   | (253   | )         |  |   | (568   | ) |  |      | (536   | ) |           |   | (730   | ) |  |   | (1,266 | )
|Junior subordinated obligations issued to unconsolidated subsidiary trusts |  |                                                                                                     |      |   |                                                                                                    |   | (146   | )         |  |   | (146   | ) |  |      |       |   |           |   | (419   | ) |  |   | (419   | )
|                                                                           |  |                                                                                                     |       |   |                                                                                                    |   |        |           |  |   |        |   |  |      |        |   |           |   |        |   |  |   |        |  
|Total interest-bearing liabilities                                         |  |                                                                                                     | 3,319 |   |                                                                                                    |   | (5,575 | )         |  |   | (2,256 | ) |  |      | 652    |   |           |   | (8,068 | ) |  |   | (7,416 | )
|                                                                           |  |                                                                                                     |       |   |                                                                                                    |   |        |           |  |   |        |   |  |      |        |   |           |   |        |   |  |   |        |  
|Net interest income tax equivalent                                         |  | $                                                                                                   | 1,230 |   |                                                                                                    | $ | 382    |           |  | $ | 1,612  |   |  | $    | 2,916  |   |           | $ | 1,121  |   |  | $ | 4,037  |  
|                                                                           |  |                                                                                                     |       |   |                                                                                                    |   |        |           |  |   |        |   |  |      |        |   |           |   |        |   |  |   |        |  



25



---

##### Table of Contents

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         |  | September 30, 2009     |        |      | June 30, 2009 |   |   | December 31, 2008 |       
|                                    |  | $                      |        | %(1) |               |   | $ |                   | %(1)   |  |      | $ |  | %(1) |       
|                                    |  | (Dollars in thousands) |       
|30 days past due                    |  | $                      | 9,993  |      | 1.08          | % |   | $                 | 8,990  |  | 0.97 | % |  | $    | 11,124 |  | 1.22 | %
|60 days past due                    |  |                        | 2,141  |      | 0.23          | % |   |                   | 3,788  |  | 0.41 | % |  |      | 4,736  |  | 0.52 | %
|90 days past due and still accruing |  |                        | 127    |      | 0.01          | % |   |                   | 23     |  |     | % |  |      | 126    |  | 0.01 | %
|Non-accrual                         |  |                        | 10,084 |      | 1.10          | % |   |                   | 7,588  |  | 0.81 | % |  |      | 4,352  |  | 0.48 | %
|                                    |  |                        |        |      |               |   |   |                   |        |  |      |  
|Total                               |  | $                      | 22,345 |      | 2.42          | % |   | $                 | 20,389 |  | 2.19 | % |  | $    | 20,338 |  | 2.23 | %
|                                    |  |                        |        |      |               |   |   |                   |        |  |      |  



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

Continuing weakness in the local, state and national economies contributed to an increase in delinquencies and nonperforming loans and leases in the third quarter. Loans and leases past due 30 days or
more totaled $22.3 million or 2.4% of total loans and leases at September 30, 2009, compared with $20.4 million or 2.2% at June 30, 2009 and $20.3 million or 2.2% of total loans and leases at December 31, 2008. Approximately 45% of
all delinquent loans and leases at the end of the third quarter were past due for only one payment, compared with 44% at June 30, 2009 and 55% at the end of 2008.

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



|                                                     |  |                    |        |               |   |                   |  |   |      
|---------------------------------------------------- |  | ------------------ | ------ | ------------- | - | ----------------- |  | - | -----
|                                                     |  | September 30, 2009 |        | June 30, 2009 |   | December 31, 2008
|Non-accruing loans and leases:                       |  |                    |        |               |   |                   |  |   |      
|Residential real estate loans                        |  | $                  | 2,878  |               | $ | 1,925             |  | $ | 1,506
|Commercial loans                                     |  |                    | 4,926  |               |   | 4,400             |  |   | 1,997
|Leases                                               |  |                    | 1,976  |               |   | 995               |  |   | 595  
|Indirect loans                                       |  |                    | 116    |               |   | 82                |  |   | 101  
|Other consumer loans                                 |  |                    | 188    |               |   | 186               |  |   | 153  
|                                                     |  |                    |        |               |   |                   |  |   |      
|Total non-accruing loans and leases                  |  |                    | 10,084 |               |   | 7,588             |  |   | 4,352
|Accruing loans and leases delinquent 90 days or more |  |                    | 127    |               |   | 23                |  |   | 126  
|                                                     |  |                    |        |               |   |                   |  |   |      
|Total non-performing loans and leases                |  |                    | 10,211 |               |   | 7,611             |  |   | 4,478
|Other real estate and repossessed assets             |  |                    | 340    |               |   | 373               |  |   | 657  
|                                                     |  |                    |        |               |   |                   |  |   |      
|Total non-performing assets                          |  | $                  | 10,551 |               | $ | 7,984             |  | $ | 5,135
|                                                     |  |                    |        |               |   |                   |  |   |      

Nonperforming assets were $10.6 million or 0.72% of total assets at September 30, 2009, compared
with $8.0 million or 0.55% of total assets at June 30, 2009 and $5.1 million or 0.38% of total assets at December 31, 2008. Included in nonperforming assets at the end of the third quarter are nonperforming loans and leases totaling $10.2
million, compared with $7.6 million and $4.5 million at June 30, 2009 and December 31, 2008, respectively.

The Companys
exposure to any individual nonperforming credit is low, as reflected in the average balance of approximately $80,000 for each individual nonperforming loan and lease and the balance of the largest nonperforming credit was $669,000. Conventional
residential mortgages comprised $2.9 million (32 loans) or 28% of nonperforming loans and leases at September 30, 2009. Nonperforming commercial loans totaled $4.9 million (38 loans) or 48% of nonperforming loans and leases at the end of the
third quarter. Leases on nonperforming status totaled $2.0 million (28 leases) or 19% of nonperforming loans and leases at the end of the third quarter.

As a recurring part of its portfolio management program, the Company has identified approximately $8.8 million in potential problem loans at September 30, 2009 as compared to $13.3 million at
December 31, 2008. The average balance of potential problem loans was $226,000 at September 30, 2009 compared with $333,000 at December 31, 2008. 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 September 30, 2009, potential problem loans
primarily consisted of commercial real estate, commercial loans and leases. There can be no assurance that additional loans will not become nonperforming, require restructuring, or require increased provision for loan losses.



26



---

##### Table of Contents

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 review program continually audits the loan and lease portfolio to confirm managements loan and lease risk rating system, and 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
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 September 30, 2009, there was $4.6 million in impaired loans for which $961,000 in related allowance for credit losses was specifically allocated. As of December 31, 2008, there was
$1.4 million in impaired loans for which $193,000 in related allowance for credit losses was specifically allocated.

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. 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 Companys credit loss provisions have been somewhat elevated over the past five quarters,
reflecting relatively higher levels of loan delinquencies, charge-offs and classified loans, and managements assessment of the potential impact of macroeconomic factors and market conditions affecting the credit markets and financial
institutions sector generally.

The provision for credit losses was $1.1 million and $4.7 million in the quarter and nine months ended
September 30, 2009, respectively, compared with $849,000 and $3.5 million in the year-ago periods, respectively. Net charge-offs were $978,000 and $3.8 million in the three months and nine months ended September 30, 2009, respectively,
compared with $625,000 and $3.1 million in the year-ago periods, respectively. Net charge-offs declined $670,000 or 40.7% from the second quarter of 2009. The decrease in linked-quarter net charge-offs resulted from a $1.4 million or 71.6% decrease
in charge-offs in the Companys lease portfolio. Net charge-offs equaled 0.42% and 0.55%, respectively, of average loans and leases during the three months and nine months ended September 30, 2009, compared with 0.28% and 0.46%,
respectively, in the year-ago periods. The provision for credit losses as a percentage of net charge-offs was 115% and 122%, respectively, in the quarter and nine months ended September 30, 2009, compared with 136% and 115%, respectively, in
the comparable 2008 time periods.

The allowance for credit losses was $10.0 million at September 30, 2009, compared with $9.9 million at
June 30, 2009 and $9.2 million at December 31, 2008. The ratio of the allowance for credit losses to total loans and leases was 1.08% at September 30, 2009, compared with 1.05% at June 30, 2009 and 1.01% at December 31,
2008.



27



---

##### Table of Contents

The ratio of the allowance for credit losses to nonperforming loans and leases was 98.0% at
September 30, 2009, compared with 129.5% at June 30, 2009 and 204.6% at December 31, 2008.

The following table summarizes net
charge-offs (recoveries) by portfolio:



|                                 |  |                                 |     |                                |      |   |      |  |   |       |   |  |   |      
|-------------------------------- |  | ------------------------------- | --- | ------------------------------ | ---- | - | ---- |  | - | ----- | - |  | - | -----
|                                 |  | Three months endedSeptember 30, |     | Nine months endedSeptember 30,
|                                 |  | 2009                            |     |                                | 2008 |   | 2009 |  |   | 2008 
|                                 |  | (In thousands)                 
|Residential real estate          |  | $                               | (54 | )                              |      | $ | 20   |  | $ | 14    |   |  | $ | 65   
|Commercial loans                 |  |                                 | 281 |                                |      |   | 31   |  |   | (116  | ) |  |   | 1,649
|Leases                           |  |                                 | 555 |                                |      |   | 241  |  |   | 3,317 |   |  |   | 760  
|Indirect loans                   |  |                                 | 21  |                                |      |   | 38   |  |   | 139   |   |  |   | 111  
|Other consumer loans             |  |                                 | 175 |                                |      |   | 295  |  |   | 476   |   |  |   | 492  
|                                 |  |                                 |     |                                |      |   |      |  |   |       |   |  |   |      
|Net loans and leases charged-off |  | $                               | 978 |                                |      | $ | 625  |  | $ | 3,830 |   |  | $ | 3,077
|                                 |  |                                 |     |                                |      |   |      |  |   |       |   |  |   |      

Net charge-offs of commercial loans were $1.8 million lower in the first nine months of 2009 than in
the prior year period due primarily to two large charge-offs totaling $1.2 million in the first quarter of 2008. A net recovery of $116,000 was recorded in the first nine months of 2009, due in large part to a recovery on one previously charged-off
loan of $477,000 which offset a relatively low level of charge-offs.

Net charge-offs in the Companys lease portfolio comprised 86.6% of
total net charge-offs in the first nine months of 2009, compared with 24.7% in the same period in 2008. The charge-offs in the Companys lease portfolio in 2009 have been concentrated in four segments of the portfolio, in which the aggregate
balances (net of charge-downs) were $8.2 million at the end of the third quarter. Net charge-offs in these four segments totaled $2.4 million or 72.9% of all lease charge-offs in the first nine months of 2009. Approximately $2.5 million or 29.8% of
the leases in these segments was past due at the end of the third quarter, including $1.8 million (net of charge-downs of $584,000) which are on nonaccrual status. The allowance for credit losses allocated to these four segments totaled $1.8 million
or 21.3% of the net remaining balances. The remaining balance of the lease portfolio totaling $67.9 million is substantially current, with a delinquency and non-accrual rate of only 3.2% at September 30, 2009. As noted previously herein, the
Company ceased originating leases in 2008.

The following table presents certain asset quality ratios for the periods indicated:



|                                                                         |  |                                     |   |  |                                    |   |  |      |   |  |       |  
|------------------------------------------------------------------------ |  | ----------------------------------- | - |  | ---------------------------------- | - |  | ---- | - |  | ----- | -
|                                                                         |  | For three monthsended September 30, |   |  | For nine monthsended September 30, |  
|                                                                         |  | 2009                                |   |  | 2008                               |   |  | 2009 |   |  | 2008  |  
|Net loans and leases charged-off to average loans and leases, annualized |  | 0.42                                | % |  | 0.28                               | % |  | 0.55 | % |  | 0.46  | %
|Provision for credit losses to average loans and leases, annualized      |  | 0.49                                | % |  | 0.38                               | % |  | 0.68 | % |  | 0.52  | %
|Allowance for credit losses to period-end loans and leases               |  | 1.08                                | % |  | 0.97                               | % |  | 1.08 | % |  | 0.97  | %
|Allowance for credit losses to non-performing loans and leases           |  | 98.0                                | % |  | 187.9                              | % |  | 98.0 | % |  | 187.9 | %
|Non-performing loans and leases to period-end loans and leases           |  | 1.10                                | % |  | 0.52                               | % |  | 1.10 | % |  | 0.52  | %
|Non-performing assets to period-end assets                               |  | 0.72                                | % |  | 0.37                               | % |  | 0.72 | % |  | 0.37  | %



28



---

##### Table of Contents

Non-interest Income

The following table sets forth certain information on non-interest income for the periods indicated, dollars in thousands:



|                                    |  |                                  |       |      |                                 |        |  |   |      |   |      |       |        |   |   |        |  |   |        |  |   |        |   |  |       |   
|----------------------------------- |  | -------------------------------- | ----- | ---- | ------------------------------- | ------ |  | - | ---- | - | ---- | ----- | ------ | - | - | ------ |  | - | ------ |  | - | ------ | - |  | ----- | --
|                                    |  | Three months ended September 30, |       |      | Nine months ended September 30, |       
|                                    |  | 2009                             |       | 2008 |                                 | Change |  |   | 2009 |   | 2008 |       | Change |  
|                                    |  |                                  | $     |      |                                 | %      |  |   |      |   | $    |       |        | % |  
|Investment management income        |  | $                                | 1,743 |      | $                               | 2,179  |  | $ | (436 | ) |      | (20.0 | )%     |   | $ | 5,289  |  | $ | 6,717  |  | $ | (1,428 | ) |  | (21.3 | )%
|Service charges on deposit accounts |  |                                  | 1,297 |      |                                 | 1,379  |  |   | (82  | ) |      | (5.9  | )%     |   |   | 3,758  |  |   | 3,869  |  |   | (111   | ) |  | (2.9  | )%
|Card-related fees                   |  |                                  | 566   |      |                                 | 533    |  |   | 33   |   |      | 6.2   | %      |   |   | 1,654  |  |   | 1,578  |  |   | 76     |   |  | 4.8   | % 
|Insurance agency                    |  |                                  | 338   |      |                                 | 384    |  |   | (46  | ) |      | (12.0 | )%     |   |   | 1,027  |  |   | 1,204  |  |   | (177   | ) |  | (14.7 | )%
|Bank-owned life insurance           |  |                                  | 255   |      |                                 | 243    |  |   | 12   |   |      | 4.9   | %      |   |   | 753    |  |   | 606    |  |   | 147    |   |  | 24.3  | % 
|Gain on the sale of loans           |  |                                  | 230   |      |                                 | 55     |  |   | 175  |   |      | 318.2 | %      |   |   | 505    |  |   | 217    |  |   | 288    |   |  | 132.7 | % 
|Gain on sale of securities          |  |                                  |      |      |                                 |       |  |   |     |   |      |      |        |   |   | 1,015  |  |   | 137    |  |   | 878    |   |  | 640.9 | % 
|Other non-interest income           |  |                                  | 333   |      |                                 | 361    |  |   | (28  | ) |      | (7.8  | )%     |   |   | 887    |  |   | 1,278  |  |   | (391   | ) |  | (30.6 | )%
|                                    |  |                                  |       |      |                                 |        |  |   |      |   |      |       |        |   |   |        |  |   |        |  |   |        |   |  |       |   
|Total non-interest income           |  | $                                | 4,762 |      | $                               | 5,134  |  | $ | (372 | ) |      | (7.2  | )%     |   | $ | 14,888 |  | $ | 15,606 |  | $ | (718   | ) |  | (4.6  | )%
|                                    |  |                                  |       |      |                                 |        |  |   |      |   |      |       |        |   |   |        |  |   |        |  |   |        |   |  |       |   

Non-interest income was $4.8 million in the third quarter of 2009, which was a decrease of $372,000
or 7.2% from the third quarter of 2008. Investment management income, which is determined based on the value of assets under management, decreased $436,000 or 20.0% in the third quarter compared with the year-ago quarter as a result of the impact of
the decline in equity markets over the past two years on the value of assets under management. Non-interest income comprised 29.8% of total revenue in the third quarter of 2009 compared with 34.9% in the year-ago quarter. The decline in this ratio
has been driven largely by the increase in net interest income and to a lesser degree by the decrease in investment management income.

Non-interest income totaled $14.9 million in the first nine months of 2009, which is a decrease of $718,000 from $15.6 million in the year-ago period. The Company recognized $1.0 million in pre-tax gains on the sale of securities in the
first quarter of 2009, compared with gains of $137,000 in the first quarter of 2008. Absent the effect of these gains, non-interest income decreased $1.6 million or 10.3% due primarily to lower investment management fee income. Non-interest income
comprised 30.3% of total revenue in the first nine months of 2009 compared with 35.6% in the year-ago period.

Non-interest Expenses

The following table sets forth certain information on non-interest expenses for the periods indicated, dollars in thousands:



|                                  |  |                                      |        |      |                                     |        |  |   |       |   |      |       |        |   |   |        |  |   |        |  |   |       |   |  |         |   
|--------------------------------- |  | ------------------------------------ | ------ | ---- | ----------------------------------- | ------ |  | - | ----- | - | ---- | ----- | ------ | - | - | ------ |  | - | ------ |  | - | ----- | - |  | ------- | --
|                                  |  | For three months ended September 30, |        |      | For nine months ended September 30, |       
|                                  |  | 2009                                 |        | 2008 |                                     | Change |  |   | 2009  |   | 2008 |       | Change |  
|                                  |  |                                      | $      |      |                                     | %      |  |   |       |   | $    |       |        | % |  
|Salaries and benefits             |  | $                                    | 5,307  |      | $                                   | 5,108  |  | $ | 199   |   |      | 3.9   | %      |   | $ | 14,728 |  | $ | 15,025 |  | $ | (297  | ) |  | (2.0    | )%
|Occupancy and equipment           |  |                                      | 1,728  |      |                                     | 1,751  |  |   | (23   | ) |      | (1.3  | )%     |   |   | 5,279  |  |   | 5,148  |  |   | 131   |   |  | 2.5     | % 
|Communication                     |  |                                      | 207    |      |                                     | 200    |  |   | 7     |   |      | 3.5   | %      |   |   | 594    |  |   | 602    |  |   | (8    | ) |  | (1.3    | )%
|Office supplies and postage       |  |                                      | 359    |      |                                     | 310    |  |   | 49    |   |      | 15.8  | %      |   |   | 971    |  |   | 861    |  |   | 110   |   |  | 12.8    | % 
|Marketing                         |  |                                      | 228    |      |                                     | 278    |  |   | (50   | ) |      | (18.0 | )%     |   |   | 727    |  |   | 847    |  |   | (120  | ) |  | (14.2   | )%
|Amortization of intangible assets |  |                                      | 388    |      |                                     | 444    |  |   | (56   | ) |      | (12.6 | )%     |   |   | 1,163  |  |   | 1,267  |  |   | (104  | ) |  | (8.2    | )%
|Professional fees                 |  |                                      | 734    |      |                                     | 602    |  |   | 132   |   |      | 21.9  | %      |   |   | 2,165  |  |   | 1,964  |  |   | 201   |   |  | 10.2    | % 
|FDIC insurance                    |  |                                      | 434    |      |                                     | 50     |  |   | 384   |   |      | 768.0 | %      |   |   | 1,820  |  |   | 104    |  |   | 1,716 |   |  | 1,650.0 | % 
|Other operating                   |  |                                      | 1,515  |      |                                     | 1,156  |  |   | 359   |   |      | 31.1  | %      |   |   | 4,419  |  |   | 3,505  |  |   | 914   |   |  | 26.1    | % 
|                                  |  |                                      |        |      |                                     |        |  |   |       |   |      |       |        |   |   |        |  |   |        |  |   |       |   |  |         |   
|Total operating expenses          |  | $                                    | 10,900 |      | $                                   | 9,899  |  | $ | 1,001 |   |      | 10.1  | %      |   | $ | 31,866 |  | $ | 29,323 |  | $ | 2,543 |   |  | 8.7     | % 
|                                  |  |                                      |        |      |                                     |        |  |   |       |   |      |       |        |   |   |        |  |   |        |  |   |       |   |  |         |   



29



---

##### Table of Contents

Non-interest expenses increased $1.0 million or 10.1% in the quarter ended September 30, 2009 compared
to the third quarter of 2008. Federal Deposit Insurance Corporation (FDIC) insurance expense increased $384,000 in the third quarter compared with the year-ago quarter on higher assessment rates charged to all FDIC-insured banks in 2009.
Other operating expenses increased $359,000 or 31.1% due primarily to higher mortgage servicing costs from increased servicing volume and a $105,000 nonrecurring miscellaneous asset write-off. Non-interest expenses were unchanged in the third
quarter compared to the second quarter of 2009 as a $605,000 decrease in FDIC insurance expense was offset by a $586,000 increase in salaries and benefits resulting largely from an increase in incentive compensation accruals in the third quarter.
FDIC insurance was higher in the second quarter of 2009 because of a special assessment charged to all FDIC-insured banks in the second quarter.

Non-interest expenses increased $2.5 million in the nine months ended September 30, 2009 compared to the first nine months of 2008. The increase resulted largely from an increase in FDIC insurance expense of $1.7 million, due to a
special charge assessed by the FDIC to all FDIC-insured banks, and to overall higher rates charged to all FDIC insured banks in 2009. The special assessment charged to Alliance in the second quarter totaled $676,000. Also contributing to the
increase in non-interest expenses were higher mortgage servicing costs due to increased servicing volume and $354,000 in nonrecurring miscellaneous asset write-offs.

In September 2009, the FDIC announced a proposal that would require most FDIC-insured banks to prepay their projected insurance assessments for the years 2010 through 2012 in December 2009. Based on a
preliminary projection prepared for the Company by the FDIC, the Company expects to advance approximately $6.0 million of prepaid assessments. This projection anticipates average insured deposit growth for the Company of 5% through 2012 and
increases in assessment rates of approximately 22% from current rates. Prepaid assessments will be capitalized as an asset and amortized based on the expected period in which the assessment would have been incurred. The Companys average
quarterly FDIC insurance expense is preliminarily projected to be $420,000, $530,000, and $550,000 in 2010, 2011 and 2012, respectively. The actual FDIC insurance expense could be higher if the balance in the deposit insurance fund reaches levels
that cause the FDIC to implement additional special assessments or take other actions that result in an increase to the amounts paid by banks under the FDIC insurance program.

The Companys efficiency ratio was 68.2% in the third quarter of 2009, compared with 67.3% in the year-ago quarter and 70.0% in the first quarter of 2009. The Companys efficiency ratio was
69.6% in the nine months ended September 30, 2009, compared with 67.8% in the year-ago period. The special FDIC insurance assessment significantly impacted the Companys efficiency ratios in 2009; without it, the Companys efficiency
ratio would have been 68.2% for the three months and nine months ended September 30, 2009.

Income Taxes

The Companys effective tax rate was 25.4% and 22.4% for the three months and nine months ended September 30, 2009, compared with 24.1% and 24.9%
in the year-ago periods.



30



---

##### Table of Contents

Comparison of Financial Condition at September 30, 2009 and December 31, 2008

General

Total assets were $1.5 billion
at September 30, 2009, an increase of $88.9 million or 6.5% from December 31, 2008. Securities available-for-sale increased $97.6 million in 2009 to $396.7 million at the end of the third quarter. Total loans and leases (net of unearned
income) increased $17.0 million to $927.7 million at September 30, 2009, compared with $910.8 million at December 31, 2008.

Securities

The Companys securities portfolio is comprised entirely of investment grade securities, most of which are
rated AAA by one or more of the nationally recognized rating agencies. The breakdown of our securities portfolio at September 30, 2009 was 76% government sponsored entity guaranteed mortgage-backed securities, 22% municipal
securities and 2% obligations of U.S. Government sponsored corporations. Mortgage-backed securities, which totaled $300.8 million at September 30, 2009, are comprised 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 residential mortgages
or securities backed by commercial real estate. 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 $9.7 million in its securities portfolio at September 30, 2009, compared with net unrealized gains of $4.7 million at December 31, 2008.

Loans and Leases

Total
loans and leases, net of unearned income and deferred costs, decreased $9.1 million or 1.0% to $927.7 million in the third quarter of 2009.

Residential mortgages increased $7.1 million or 2.0% during the third quarter, and reached $353.7 million at September 30, 2009. Residential mortgage originations totaled $37.1 million and $133.4 million in the three months and nine
months ended September 30, 2009, respectively. The Companys mortgage originations for the first nine months of 2009 have exceeded its full year 2008 record originations of $103.2 million. Alliance has increased its market share of the
residential mortgage market due largely to its focused expansion of and investment in the Companys mortgage origination business in Central New York. The Company continues to originate only conventional residential mortgages in its local
markets, and does not originate sub-prime, Alt-A, negative amortizing or other higher risk residential mortgages.

The Company retains
bi-weekly payment fixed rate mortgages in portfolio and sells most of its qualifying fixed rate monthly payment residential mortgages in the secondary market in connection with its overall interest rate risk management practices. Sales of fixed rate
residential mortgages totaled $9.2 million and $26.7 million, respectively in the three months and nine months ended September 30, 2009. The Company retains all variable rate residential mortgage originations in portfolio.

Commercial loans decreased $10.4 million in the third quarter and totaled $206.5 million at September 30, 2009. Originations of commercial loans
(excluding lines of credit) in the third quarter totaled $10.5 million, compared with $10.8 million in the second quarter of 2009 and $13.1 million in the year-ago quarter. The decrease in outstanding balances during the third quarter was largely
the result of lower utilization of commercial lines-of-credit.

Leases (net of unearned income) continued to decrease in the third quarter as
a result of the Companys previously announced decision to cease new lease originations. The Companys lease portfolio decreased $9.2 million to $76.1 million at the end of the third quarter, and is expected to continue to run-off at the
rate of approximately $8.0 million per quarter over the next year.

Indirect auto loan balances were $194.3 million as of September 30,
2009. The Company originated $25.0 million of indirect auto loans in the third quarter, compared with $32.3 million in the second quarter of 2009 and $25.9 million in the year-ago quarter. Alliance originates auto loans through a network of
reputable, well established



31



---

##### Table of Contents

automobile dealers located in Central and Western New York. Applications received through the Companys indirect lending program are subject to the same comprehensive underwriting criteria
and procedures as are employed in its direct lending programs. Approximately 88% of all 2009 indirect auto loan originations of $78.0 million were to borrowers whose credit scores were in the prime category of 700 or higher.

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



|                                |  |                    |         |   |         |       |   |                   |   |         |         |  |       |  
|------------------------------- |  | ------------------ | ------- | - | ------- | ----- | - | ----------------- | - | ------- | ------- |  | ----- | -
|                                |  | September 30, 2009 |         |   | Percent |       |   | December 31, 2008 |   |         | Percent | 
|Residential real estate loans   |  | $                  | 353,721 |   |         | 38.3  | % |                   | $ | 314,039 |         |  | 34.6  | %
|Commercial loans                |  |                    | 206,472 |   |         | 22.4  | % |                   |   | 214,315 |         |  | 23.6  | %
|Leases (net of unearned income) |  |                    | 76,117  |   |         | 8.2   | % |                   |   | 104,655 |         |  | 11.6  | %
|Indirect loans                  |  |                    | 194,267 |   |         | 21.0  | % |                   |   | 182,807 |         |  | 20.2  | %
|Other consumer loans            |  |                    | 92,953  |   |         | 10.1  | % |                   |   | 90,906  |         |  | 10.0  | %
|                                |  |                    |         |   |         |       |   |                   |   |         |         |  |       |  
|                                |  | $                  | 923,530 |   |         | 100.0 | % |                   | $ | 906,722 |         |  | 100.0 | %
|                                |  |                    |         |   |         |       |   |                   |   |         |         |  |       |  
|Net deferred loan costs         |  |                    | 4,202   |   |         |       |   |                   |   | 4,033   |         |  |       |  
|                                |  |                    |         |   |         |       |   |                   |   |         |         |  |       |  
|Total loans and leases          |  |                    | 927,732 |   |         |       |   |                   |   | 910,755 |         |  |       |  
|Allowance for credit losses     |  |                    | (10,006 | ) |         |       |   |                   |   | (9,161  | )       |  |       |  
|                                |  |                    |         |   |         |       |   |                   |   |         |         |  |       |  
|Net loans and leases            |  | $                  | 917,726 |   |         |       |   |                   | $ | 901,594 |         |  |       |  
|                                |  |                    |         |   |         |       |   |                   |   |         |         |  |       |  

Deposits

Total deposits were $1.1 billion at September 30, 2009, which was an increase of $147.0 million or 15.7% compared with December 31, 2008, but were down slightly from June 30, 2009.
Approximately 70% of the deposit increase in 2009, or $102.3 million, resulted from growth across all of our retail, commercial and municipal business lines. This growth was due largely to retail and commercial business development efforts focusing
on these lower cost transaction accounts and to a greater awareness of the Alliance brand in our markets. The Companys strong capital and liquidity positions, in combination with generally lower risk tolerances by consumers and businesses and
increasing trends in household saving rates, have further enhanced the success of its deposit growth initiatives. The Companys deposit mix continued to be weighted heavily in lower cost demand, savings and money market accounts (transaction
accounts), which comprised 64.0% of total deposits at the end of the third quarter, compared with 62.1% at December 31, 2008 and 61.0% at September 30, 2008. The rest of the increase in deposits resulted from the acquisition of wholesale
time deposits to fund investment portfolio growth.

The following table sets forth the composition of the Banks deposits by business
line at the dates indicated, dollars in thousands:



|                      |  |                    |         |            |                   |           |  |       |         |         |   |           |        |       |            |  |           |         |       |   |         |  |   |         |  |   |         |  |       |  
|--------------------- |  | ------------------ | ------- | ---------- | ----------------- | --------- |  | ----- | ------- | ------- | - | --------- | ------ | ----- | ---------- |  | --------- | ------- | ----- | - | ------- |  | - | ------- |  | - | ------- |  | ----- | -
|                      |  | September 30, 2009 |         |            | December 31, 2008 |          
|                      |  | Retail             |         | Commercial |                   | Municipal |  | Total |         | Percent |   |           | Retail |       | Commercial |  | Municipal |         | Total |   | Percent | 
|Non-interest checking |  | $                  | 37,114  |            | $                 | 111,819   |  | $     | 3,065   |         | $ | 151,998   |        | 14.0  | %          |  | $         | 35,685  |       | $ | 101,423 |  | $ | 3,737   |  | $ | 140,845 |  | 15.0  | %
|Interest checking     |  |                    | 87,993  |            |                   | 13,313    |  |       | 17,742  |         |   | 119,048   |        | 11.0  | %          |  |           | 82,096  |       |   | 11,134  |  |   | 13,062  |  |   | 106,292 |  | 11.3  | %
|                      |  |                    |         |            |                   |           |  |       |         |         |   |           |        |       |            |  |           |         |       |   |         |  |   |         |  |   |         |  |       |  
|Total checking        |  |                    | 125,107 |            |                   | 125,132   |  |       | 20,807  |         |   | 271,046   |        | 25.0  | %          |  |           | 117,781 |       |   | 112,557 |  |   | 16,799  |  |   | 247,137 |  | 26.3  | %
|Savings               |  |                    | 80,013  |            |                   | 10,617    |  |       | 2,699   |         |   | 93,329    |        | 8.6   | %          |  |           | 76,811  |       |   | 8,049   |  |   | 3,382   |  |   | 88,242  |  | 9.4   | %
|Money market          |  |                    | 83,187  |            |                   | 80,682    |  |       | 166,476 |         |   | 330,345   |        | 30.4  | %          |  |           | 74,597  |       |   | 45,471  |  |   | 127,324 |  |   | 247,392 |  | 26.4  | %
|Time deposits         |  |                    | 326,592 |            |                   | 19,501    |  |       | 44,098  |         |   | 390,191   |        | 36.0  | %          |  |           | 296,381 |       |   | 20,189  |  |   | 38,541  |  |   | 355,111 |  | 37.9  | %
|                      |  |                    |         |            |                   |           |  |       |         |         |   |           |        |       |            |  |           |         |       |   |         |  |   |         |  |   |         |  |       |  
|Total deposits        |  | $                  | 614,899 |            | $                 | 235,932   |  | $     | 234,080 |         | $ | 1,084,911 |        | 100.0 | %          |  | $         | 565,570 |       | $ | 186,266 |  | $ | 186,046 |  | $ | 937,882 |  | 100.0 | %
|                      |  |                    |         |            |                   |           |  |       |         |         |   |           |        |       |            |  |           |         |       |   |         |  |   |         |  |   |         |  |       |  

Liquidity

The Companys liquidity primarily reflects the Banks ability to provide funds to meet loan and lease requests, to accommodate possible outflows in deposits, to take advantage of market interest
rate opportunities, and to pay dividends to the company. Funding loan and lease requests, providing for liability outflows, and managing 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 Committee
(ALCO) of the Bank is responsible for implementing the policies and guidelines for the maintenance of prudent



32



---

##### Table of Contents

levels of liquidity. As of September 30, 2009, liquidity as measured by the Bank was in compliance with and exceeds its policy guidelines.

The Banks principal sources of funds for operations are cash flows generated from earnings, deposits, loan and lease repayments, borrowings from the
Federal Home Loan Bank of New York (FHLB), and securities sold under repurchase agreements. During the nine months ended September 30, 2009, cash and cash equivalents decreased by $23.3 million, as net cash provided by operating and
financing activities of $91.1 million was more than offset by net cash used in investing activities of $114.4 million. Net cash used in investing activities primarily resulted from a net increase loans of $20.9 million and securities purchases
exceeding maturities, sales and principal repayments by $92.6 million. The net cash provided by financing activities principally reflects a $147.0 million net increase in deposits, partly reduced by a net decrease in borrowings of $37.7 million and
cash dividends of $3.6 million in the nine months ended September 30, 2009. Net cash from operating activities was primarily provided by net income in the amount of $8.0 million.

As a member of the FHLB, the Bank is eligible to borrow up to an established credit limit against certain residential mortgage loans and investment securities that have been pledged as collateral. As of
September 30, 2009, the Banks credit limit with the FHLB was $307.6 million. The total of the Banks outstanding borrowings from the FHLB on that date was $178.4 million.

The Company had a $132.5 million line of credit at September 30, 2009 with the Federal Reserve Bank of New York. The Company has pledged indirect loans and securities totaling $196.0 million and $5.0
million, respectively, at September 30, 2009. At September 30, 2009, the Company also had available $76.5 million of lines of credit with other financial institutions, none of which was in use at September 30, 2009.

Capital Resources

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

Shareholders equity was $124.8
million at September 30, 2009, compared with $144.5 million at December 31, 2008. Net income for the quarter increased shareholders equity by $3.0 million and was partially offset by common stock dividends declared of $1.3 million or
$0.28 per common share. In addition, accumulated other comprehensive income increased $3.1 million due to an increase in unrealized gains (net of taxes) on securities available-for-sale due primarily to changes in market conditions and interest
rates.

The Companys goal and related business plan 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 September 30, 2009, the Company exceeded all regulatory required minimum capital ratios and met the regulatory definition of a well-capitalized
institution. A more comprehensive analysis of regulatory capital requirements, including ratios for the Company, is included in Note 9 of this 2009 Quarterly Report on Form 10-Q.



33



---

##### Table of Contents

Application of Critical Accounting Estimates

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

The most significant accounting policies
followed by the Company are presented in Note 1 to the consolidated financial statements included in the Companys 2008 Annual Report on Form 10-K (the Consolidated Financial Statements). 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 loan and lease losses, accrued income taxes, and the fair value
analysis of the intangible asset 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.

The allowance for credit losses represents managements estimate of probable credit losses 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 in this Quarterly Report on Form 10-Q 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 accounts for income taxes using the
asset and liability approach. Under this approach, deferred tax assets and liabilities are established for the temporary differences between the financial reporting basis and the tax basis of the Companys assets and liabilities. Deferred tax
assets and liabilities are measured using enacted tax rates expected to be in effect when such amounts are realized or settled. The Company must assess the likelihood that a portion or all of the deferred tax assets will not be realized. In doing
so, judgments and estimates must be made regarding the projection of future taxable income. If necessary, a valuation allowance is established to reduce the deferred tax assets to the amount that is more likely than not to be realized.

In computing the income tax provision, estimates and assumptions must be made regarding the deductibility of certain expenses. It is possible that these
estimates and assumptions may be disallowed as part of an examination by the various taxing authorities that we are subject to, resulting in additional income tax expense in future periods. In addition, we maintain a reserve related to uncertain tax
positions. These uncertain tax positions are evaluated each reporting period to determine the level of reserve that is appropriate.

The
Company utilizes significance estimates and assumptions in determining the fair value of its 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 and costs of servicing.

Other Information

The long-standing Oneida Indian litigation, in which the Oneida Indian nation seeks possession of land in Madison and Oneida Counties, is described in Item 3 of the Companys Form 10-K for
the fiscal year ended December 31, 2008. Management continues to believe that this matter will be resolved without adversely affecting the Company.



34



---

##### Table of Contents

|Item 3. | Quantitative and Qualitative Disclosures About Market Risk
|------- | ----------------------------------------------------------

Qualitative Analysis. 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 rates. Interest rate risk is the primary market risk faced by the Company as other types of market risk do not arise in the normal course of our business activities.

The Banks Asset Liability 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 ALCO are reviewed and approved by the Companys Board of Directors. The primary tool used to assess our interest rate sensitivity is the income
simulation model.

Quantitative Analysis. Net Interest Income is affected by changes in the absolute level of interest rates and by
changes in the shape of the yield curve. The model requires management to make assumptions about how the Banks balance sheet is likely to evolve through time in different rate scenarios. The model assumes loan prepayment rates, reinvestment
rates and deposit decay rates based on historical experiences and current conditions. These assumptions change based on the varying rate scenarios.

The following table sets forth the results of the Companys net interest income simulation model as of September 30, 2009.



|                                        |  |                                             
|--------------------------------------- |  | --------------------------------------------
|Change in Interest Rates (basis points) |  | Percent change
in annual Net Interest Income
|+200bp                                  |  | (3.1)%                                      
|-100bp                                  |  | 0.6%                                        

The modeled net interest income reflects a gradual increase/decrease in rates over 12 months from a
flat rate scenario. The results of the income simulation show the change in net interest income that is well within the Companys policy limit. The Companys guideline for risk management calls for preventative measures to be taken if
simulation indicates net interest income would be adversely affected by more than 15%.

The net interest income table presented assumes that
the composition of our interest sensitive assets and liabilities existing at the beginning of the period remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the
yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. Moreover, modeling changes require the making of assumptions set forth above that may or may not reflect the manner in which actual yields and costs
respond to changes in market interest rates. Although the net interest income table provides an indication of our interest rate risk exposure at a particular point in time, such measurement is not intended to and does not provide a precise forecast
of the effect of changes in market interest rates on our net interest income and will differ from actual results.



|Item 4. | Controls and Procedures
|------- | -----------------------

The management
of the Company is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of September 30, 2009, an evaluation was
performed under the supervision of and with the participation of the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Companys disclosure controls and procedures. Based on that
evaluation, the CEO and the CFO concluded that the Companys disclosure controls and procedures as of September 30, 2009 were effective.

There has been no change in the Companys internal control over financial reporting that occurred during the most recent fiscal quarter that materially affected, or is reasonably likely to materially affect, the Companys internal
control over financial reporting.



35



---

##### Table of Contents

PART II. OTHER INFORMATION



|Item 1. | Legal Proceedings
|------- | -----------------

Not
applicable.



|Item 1A | Risk Factors
|------- | ------------

There has not been any
material change in the risk factors disclosure from that contained in the Companys 2008 Form 10-K for the fiscal year ended December 31, 2008 (filed with the SEC on March 11, 2009). In addition, given the current market and
industry conditions, the following risks and uncertainties should be considered.

Increases in FDIC deposit insurance premiums and
assessments could adversely affect our financial condition.

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

In September 2009, the FDIC announced a proposal that would require most FDIC-insured banks to prepay their projected
insurance assessments for the years 2010 through 2012 in December 2009. Based on a preliminary projection prepared for the Company by the FDIC, the Company expects to advance approximately $6.0 million of prepaid assessments. This projection
anticipates average insured deposit growth for the Company of 5% through 2012 and increases in assessment rates of approximately 22% from current rates. Prepaid assessments will be capitalized as an asset and amortized based on the expected period
in which the assessment would have been incurred.

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

We cannot predict the effect on our operations of recent legislative and regulatory initiatives that were enacted in
response to the ongoing financial crisis.

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

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



36



---

##### Table of Contents

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

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

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



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

a) Not applicable

b) Not applicable

c) Not applicable



|Item 3. | Defaults Upon Senior Securities
|------- | -------------------------------

Not applicable



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

Not applicable



|Item 5. | Other Information
|------- | -----------------

Not
applicable



37



---

##### Table of Contents

|Item 6. | Exhibits
|------- | --------

Exhibits
required by Item 601 of Regulation S-K:



|              |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|ExhibitNumber |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|              | 
|3.1           |  | Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to exhibit 3.1 to the Companys Registration Statement on Form S-4
(Registration No. 333-62623) filed with the Commission on August 27, 2009                                                                                                                                                                                                               
|              | 
|3.4           |  | 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)
|              | 
|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                                                                                                                                                                                                                                                            



38



---

##### Table of Contents

SIGNATURES

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



|                       |  |                                                                           
|---------------------- |  | --------------------------------------------------------------------------
|                       |  | ALLIANCE FINANCIAL CORPORATION                                            
|                       | 
|DATE: October 30, 2009 |  | /S/    JACK H.
WEBB                                                       
|                       |  | Jack H. Webb, Chairman of the Board, President and Chief Executive Officer
|                       | 
|DATE: October 30, 2009 |  | /S/    J. DANIEL
MOHR                                                     
|                       |  | J. Daniel Mohr, Treasurer and Chief Financial Officer                     



39