|                                                                                 
|---------------------------------------------------------------------------------
|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, 2007 | 
| | - | ----------------------------------------------------------------------------------------------------------------------------------------- | 
| |   | OR                                                                                                                                        | 
| | o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934                                                  | 
| |   | For the transition period from _________________ to ___________________                                                                   | 

|                                                      
|------------------------------------------------------
|Commission File Number: 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) 475-4478                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                        
|(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.
|                                                                                                                                                                                                                                                                                                                                                        
|YesxNoo                                                                                                                                                                                                                                                                                                                                                 
|                                                                                                                                                                                                                                                                                                                                                        
|Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, or a non-accelerated file (as defined in Rule 12b-2 of the Exchange Act).                                                                                                                                                                             
|Large accelerated filer o Accelerated filer x Non-accelerated filer o                                                                                                                                                                                                                                                                                   
|                                                                                                                                                                                                                                                                                                                                                        
|Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o   No x                                                                                                                                                                                                                           
|                                                                                                                                                                                                                                                                                                                                                        
|The number of shares outstanding of the Registrants common stock, $1.00 par value, on October 31, 2007 was 4,783,509 shares.                                                                                                                                                                                                                           

|
|



|TABLE OF CONTENTS
|-----------------
|                 

|Page Number(s)
|--------------
|              
|Part I.       
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|Part II.      
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|2
|-



|Alliance Financial Corporation and SubsidiariesConsolidated Balance Sheets (Unaudited)
|--------------------------------------------------------------------------------------
|                                                                                      
|(In thousands, except share data)                                                     
|                                                                                      

|                                                                                                                                                                                  | September 30, 2007 |           | December 31, 2006 |  
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------- | ------------------ | --------- | ----------------- | -
|
|
|Assets                                                                                                                                                                            |                    |           |                   |  
|Cash and due from banks                                                                                                                                                           | $                  | 28,160    |                   | $
|Securities available-for-sale                                                                                                                                                     |                    | 267,703   |                   |  
|Federal Home Loan Bank of New York and Federal Reserve Bank stock                                                                                                                 |                    | 9,228     |                   |  
|                                                                                                                                                                                  |                    |           |                   |  
|Loans and leases, net of unearned income                                                                                                                                          |                    | 891,368   |                   |  
|Less allowance for loan and lease losses                                                                                                                                          |                    | 7,863     |                   |  
|                                                                                                                                                                                  |                    |           |                   |  
|Net loans and leases                                                                                                                                                              |                    | 883,505   |                   |  
|
|Premises and equipment, net                                                                                                                                                       |                    | 18,210    |                   |  
|Accrued interest receivable                                                                                                                                                       |                    | 5,836     |                   |  
|Bank-owned life insurance                                                                                                                                                         |                    | 16,922    |                   |  
|Assets held for sale                                                                                                                                                              |                    | 2,866     |                   |  
|Goodwill                                                                                                                                                                          |                    | 33,501    |                   |  
|Intangible assets, net                                                                                                                                                            |                    | 13,593    |                   |  
|Other assets                                                                                                                                                                      |                    | 14,035    |                   |  
|                                                                                                                                                                                  |                    |           |                   |  
|Total assets                                                                                                                                                                      | $                  | 1,293,559 |                   | $
|                                                                                                                                                                                  |                    |           |                   |  
|
|Liabilities                                                                                                                                                                       |                    |           |                   |  
|Non-interest-bearing deposits                                                                                                                                                     | $                  | 128,835   |                   | $
|Interest-bearing deposits                                                                                                                                                         |                    | 815,233   |                   |  
|                                                                                                                                                                                  |                    |           |                   |  
|Total deposits                                                                                                                                                                    |                    | 944,068   |                   |  
|Borrowings                                                                                                                                                                        |                    | 189,135   |                   |  
|Accrued interest payable                                                                                                                                                          |                    | 3,442     |                   |  
|Other liabilities                                                                                                                                                                 |                    | 17,705    |                   |  
|Junior subordinated obligations issued to unconsolidated 
        subsidiary trusts                                                                                               |                    | 25,774    |                   |  
|                                                                                                                                                                                  |                    |           |                   |  
|Total liabilities                                                                                                                                                                 |                    | 1,180,124 |                   |  
|
|Shareholders equity                                                                                                                                                              |                    |           |                   |  
|Preferred stock (par value $25.00) 1,000,000 shares authorized, 
          none issued.                                                                                           |                    |          |                   |  
|Common stock (par value $1.00) 10,000,000 shares authorized, 
        4,909,821 and 4,894,994 shares issued; and 4,783,509 and
        4,800,512 shares outstanding, respectively |                    | 4,910     |                   |  
|Surplus                                                                                                                                                                           |                    | 39,386    |                   |  
|Undivided profits                                                                                                                                                                 |                    | 74,539    |                   |  
|Accumulated other comprehensive loss                                                                                                                                              |                    | (1,507    | )                 |  
|Treasury stock, at cost; 126,312 and 94,482 shares, respectively                                                                                                                  |                    | (3,893    | )                 |  
|                                                                                                                                                                                  |                    |           |                   |  
|Total shareholders equity                                                                                                                                                        |                    | 113,435   |                   |  
|                                                                                                                                                                                  |                    |           |                   |  
|                                                                                                                                                                                  |                    |           |                   |  
|Total liabilities & shareholders equity                                                                                                                                          | $                  | 1,293,559 |                   | $
|                                                                                                                                                                                  |                    |           |                   |  

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

|3
|-



|Alliance Financial Corporation and SubsidiariesConsolidated Statements of Income (Unaudited)
|--------------------------------------------------------------------------------------------
|                                                                                            
|                                                                                            

|                                                                     | Three months ended
      September 30, |           | Nine months ended
      September 30, |  
|-------------------------------------------------------------------- | -------------------------------------- | --------- | ------------------------------------- | -
|
|
|
|(Dollars in thousands, except share and per share data)             
|Interest income:                                                     |                                        |           |                                       |  
|Interest and fees on loans and leases                                | $                                      | 15,057    |                                       | $
|Federal funds sold and interest bearing deposits                     |                                        | 7         |                                       |  
|Securities                                                           |                                        | 2,964     |                                       |  
|                                                                     |                                        |           |                                       |  
|Total interest income                                                |                                        | 18,028    |                                       |  
|                                                                     |                                        |           |                                       |  
|Interest expense:                                                    |                                        |           |                                       |  
|Deposits:                                                            |                                        |           |                                       |  
|Savings accounts                                                     |                                        | 114       |                                       |  
|Money market accounts                                                |                                        | 1,533     |                                       |  
|Time accounts                                                        |                                        | 5,355     |                                       |  
|NOW accounts                                                         |                                        | 252       |                                       |  
|                                                                     |                                        |           |                                       |  
|                                                                     |                                        | 7,254     |                                       |  
|                                                                     |                                        |           |                                       |  
|Borrowings:                                                          |                                        |           |                                       |  
|Repurchase agreements                                                |                                        | 742       |                                       |  
|Federal Home Loan Board advances                                     |                                        | 1,331     |                                       |  
|Junior subordinated obligations                                      |                                        | 495       |                                       |  
|                                                                     |                                        |           |                                       |  
|Total interest expense                                               |                                        | 9,822     |                                       |  
|                                                                     |                                        |           |                                       |  
|Net interest income                                                  |                                        | 8,206     |                                       |  
|Provision for loan and lease losses                                  |                                        | 1,140     |                                       |  
|                                                                     |                                        |           |                                       |  
|Net interest income after provision for loan 
      and lease losses |                                        | 7,066     |                                       |  
|                                                                     |                                        |           |                                       |  
|Non-interest income:                                                 |                                        |           |                                       |  
|Investment management income                                         |                                        | 2,335     |                                       |  
|Service charges on deposit accounts                                  |                                        | 1,382     |                                       |  
|Card-related fees                                                    |                                        | 486       |                                       |  
|Insurance agency income                                              |                                        | 479       |                                       |  
|Income from bank-owned life insurance                                |                                        | 160       |                                       |  
|Gain on the sale of loans                                            |                                        | 46        |                                       |  
|Rental income from leases                                            |                                        |          |                                       |  
|Other non-interest income                                            |                                        | 619       |                                       |  
|                                                                     |                                        |           |                                       |  
|Total non-interest income                                            |                                        | 5,507     |                                       |  
|                                                                     |                                        |           |                                       |  
|Non-interest expense:                                                |                                        |           |                                       |  
|Salaries and employee benefits                                       |                                        | 4,634     |                                       |  
|Occupancy and equipment expense                                      |                                        | 1,560     |                                       |  
|Communication expense                                                |                                        | 174       |                                       |  
|Stationery and supplies expense                                      |                                        | 156       |                                       |  
|Marketing expense                                                    |                                        | 296       |                                       |  
|Amortization of intangible assets                                    |                                        | 435       |                                       |  
|Professional fees                                                    |                                        | 641       |                                       |  
|Other non-interest expense                                           |                                        | 1,529     |                                       |  
|                                                                     |                                        |           |                                       |  
|Total non-interest expense                                           |                                        | 9,425     |                                       |  
|                                                                     |                                        |           |                                       |  
|Income before income tax expense                                     |                                        | 3,148     |                                       |  
|Income tax expense                                                   |                                        | 738       |                                       |  
|                                                                     |                                        |           |                                       |  
|Net income                                                           | $                                      | 2,410     |                                       | $
|                                                                     |                                        |           |                                       |  
|                                                                    
|Share and per share data                                             |                                        |           |                                       |  
|Basic average shares outstanding                                     |                                        | 4,709,334 |                                       |  
|Diluted average shares outstanding                                   |                                        | 4,756,088 |                                       |  
|Basic earnings per share                                             | $                                      | 0.51      |                                       | $
|Diluted earnings per share                                           | $                                      | 0.51      |                                       | $
|Cash dividends declared                                              | $                                      | 0.22      |                                       | $

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

|4
|-



|Alliance Financial Corporation and SubsidiariesConsolidated Statements of Changes in Shareholders Equity (Unaudited)
|---------------------------------------------------------------------------------------------------------------------
|                                                                                                                     
|(Dollars in thousands)                                                                                               
|                                                                                                                     

|                                                                                |  | Issued and
      Outstanding
      Common 
      Shares |           | Common
      Stock |   | Surplus |   | Unamortized
      Value of 
      Restricted 
      Stock |        | Undivided
      Profits |       | Accumulated 
      Other 
      Comprehensive
      Loss |   | Treasury
      Stock |        | Total |  
|------------------------------------------------------------------------------- |  | ------------------------------------------------------- | --------- | ------------------ | - | ------- | - | --------------------------------------------------------- | ------ | ----------------------- | ----- | -------------------------------------------------------- | - | -------------------- | ------ | ----- | -
|
|
|Balance at December 31, 2005                                                    |  |                                                         | 3,565,012 |                    | $ | 3,979   |   | $                                                         | 11,185 |                         | $     | (1,453                                                   | ) | $                    | 66,740 |       | $
|Comprehensive income                                                            | 
|Net income                                                                      |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      | 5,231  |       |  
|Other comprehensive income, net of taxes:                                       | 
|Change in unrealized appreciation in                                            | 
|available for sale securities, net of                                           | 
|reclassification adjustment                                                     |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      |       |       |  
|Change in minimum pension liability                                             |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      |       |       |  
|                                                                                | 
|Comprehensive income                                                            |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      |       |       |  
|Issuance of restricted stock                                                    |  |                                                         | 24,000    |                    |   | 24      |   |                                                           | 712    |                         |       | (736                                                     | ) |                      |       |       |  
|Forfeiture of restricted stock                                                  |  |                                                         | (16,495   | )                  |   | (17     | ) |                                                           | (490   | )                       |       | 432                                                      |   |                      |       |       |  
|Amortization of restricted stock                                                |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       | 252                                                      |   |                      |       |       |  
|Tax benefit of restricted stock plan                                            |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      | 16     |       |  
|Stock options exercised                                                         |  |                                                         | 26,304    |                    |   | 26      |   |                                                           | 565    |                         |       |                                                         |   |                      |       |       |  
|Tax benefit of stock-based compensation                                         |  |                                                         |          |                    |   |        |   |                                                           | 486    |                         |       |                                                         |   |                      |       |       |  
|Cash dividend, $.66 per share                                                   |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      | (2,357 | )     |  
|Treasury stock purchased                                                        |  |                                                         | (15,367   | )                  |   |        |   |                                                           |       |                         |       |                                                         |   |                      |       |       |  
|Reclassification of unearned restricted                                         | 
|stock awards to surplus in accordance                                           |  |                                                         |           |                    |   |         |   |                                                           |        |                         |       |                                                          |   |                      |        |       |  
|with SFAS No. 123R (75,875) shares                                              |  |                                                        |           |                    |  |         |   | (1,505                                                    | )      |                         | 1,505 |                                                          |   |                     |        |       | 
|                                                                               
|                                                                                |  |                                                         |           |                    |   |         |   |                                                           |        |                         |       |                                                          |   |                      |        |      
|Balance at September 30, 2006                                                   |  |                                                         | 3,583,454 |                    | $ | 4,012   |   | $                                                         | 10,953 |                         | $     |                                                         |   | $                    | 69,630 |       | $
|                                                                                |  |                                                         |           |                    |   |         |   |                                                           |        |                         |       |                                                          |   |                      |        |      
|                                                                                |  |                                                         |           |                    |   |         |   |                                                          
|Balance at December 31, 2006                                                    |  |                                                         | 4,800,512 |                    | $ | 4,895   |   | $                                                         | 38,986 |                         | $     |                                                         |   | $                    | 70,658 |       | $
|Comprehensive income                                                            | 
|Net income                                                                      |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      | 7,037  |       |  
|Other comprehensive income, net of taxes:                                       | 
|Change in unrealized appreciation in                                            | 
|available-for-sale securities, net of
              reclassification adjustment |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      |       |       |  
|Change in pension liability                                                     |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      |       |       |  
|                                                                                | 
|Comprehensive income                                                            |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      | 7,037  |       |  
|Issuance of restricted stock                                                    |  |                                                         | 16,950    |                    |   | 17      |   |                                                           | (17    | )                       |       |                                                         |   |                      |       |       |  
|Forfeiture of restricted stock                                                  |  |                                                         | (10,150   | )                  |   | (10     | ) |                                                           | (80    | )                       |       |                                                         |   |                      |       |       |  
|Amortization of restricted stock                                                |  |                                                         |          |                    |   |        |   |                                                           | 248    |                         |       |                                                         |   |                      |       |       |  
|Tax benefit of restricted stock plan                                            |  |                                                         |          |                    |   |        |   |                                                           | 19     |                         |       |                                                         |   |                      |       |       |  
|Stock options exercised                                                         |  |                                                         | 8,027     |                    |   | 8       |   |                                                           | 170    |                         |       |                                                         |   |                      |       |       |  
|Tax benefit of stock-based compensation                                         |  |                                                         |          |                    |   |        |   |                                                           | 60     |                         |       |                                                         |   |                      |       |       |  
|Cash dividend, $.66 per share                                                   |  |                                                         |          |                    |   |        |   |                                                           |       |                         |       |                                                         |   |                      | (3,156 | )     |  
|Treasury stock purchased                                                        |  |                                                         | (31,830   | )                  |   |        |   |                                                           |       |                         |       |                                                         |   |                      |       |       |  
|                                                                                |  |                                                         |           |                    |   |         |   |                                                           |        |                         |       |                                                          |   |                      |        |      
|Balance at September 30, 2007                                                   |  |                                                         | 4,783,509 |                    | $ | 4,910   |   | $                                                         | 39,386 |                         | $     |                                                         |   | $                    | 74,539 |       | $
|                                                                                |  |                                                         |           |                    |   |         |   |                                                           |        |                         |       |                                                          |   |                      |        |      

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

|-5-
|---



|Alliance Financial Corporation and SubsidiariesConsolidated Statements of Cash Flow (Unaudited)
|-----------------------------------------------------------------------------------------------
|                                                                                               
|(In thousands)                                                                                 
|                                                                                               

|                                                                                                                          | Nine months ended
      September 30, |        
|------------------------------------------------------------------------------------------------------------------------- | ------------------------------------- | -------
|
|
|Operating activities:                                                                                                     |                                       |        
|                                                                                                                          |                                       |        
|Net income                                                                                                                | $                                     | 7,037  
|                                                                                                                          |                                       |        
|Adjustments to reconcile net income to net cash provided by 
    operating activities:                                    |                                       |        
|Provision for loan and lease losses                                                                                       |                                       | 2,590  
|Depreciation expense                                                                                                      |                                       | 1,884  
|Increase in surrender value of life insurance                                                                             |                                       | (473   
|Deferred income tax benefit                                                                                               |                                       | (85    
|Accretion of investment security discounts and premiums, net                                                              |                                       | (211   
|Net loss (gain) on sale of premises and equipment                                                                         |                                       | 13     
|Proceeds from the sale of mortgage loans                                                                                  |                                       | 8,449  
|Origination of loans held-for-sale                                                                                        |                                       | (8,320 
|Gain on sale of loans                                                                                                     |                                       | (129   
|Amortization of capitalized servicing rights                                                                              |                                       | 221    
|Amortization of intangible assets                                                                                         |                                       | 1,319  
|Restricted stock expense                                                                                                  |                                       | 158    
|Change in other assets and liabilities                                                                                    |                                       | (421   
|                                                                                                                          |                                       |        
|Net cash provided by operating activities                                                                                 |                                       | 12,032 
|                                                                                                                          |                                       |        
|Investing activities:                                                                                                     |                                       |        
|Proceeds from maturities, redemptions, calls and principal 
    repayments of investment   securities, available-for-sale |                                       | 56,407 
|Purchase of investment securities available-for-sale                                                                      |                                       | (69,156
|Purchase of Federal Home Loan Bank (FHLB) and Federal 
    Reserve Bank (FRB) stock                                   |                                       | (20,471
|Redemption of FHLB stock                                                                                                  |                                       | 19,228 
|Net increase in loans and leases                                                                                          |                                       | (10,868
|Purchases of premises and equipment                                                                                       |                                       | (1,228 
|Proceeds from the sale of premises and equipment                                                                          |                                       | 640    
|Proceeds from the sale of assets held for sale                                                                            |                                       | 107    
|                                                                                                                          |                                       |        
|Net cash used in investing activities                                                                                     |                                       | (25,341
|                                                                                                                          |                                       |        
|Financing activities:                                                                                                     |                                       |        
|Net increase in demand deposits, NOW and savings accounts                                                                 |                                       | 8,179  
|Net increase in time deposits                                                                                             |                                       | 293    
|Net increase in short-term borrowings                                                                                     |                                       | 5,185  
|Proceeds on long-term borrowings                                                                                          |                                       | 20,000 
|Payments on long-term borrowings                                                                                          |                                       | (15,700
|Net increase in junior subordinated obligations issued to 
    unconsolidated subsidiary trusts                           |                                       |       
|Proceeds from the exercise of stock options                                                                               |                                       | 178    
|Treasury stock purchased                                                                                                  |                                       | (982   
|Tax benefit of stock-based compensation                                                                                   |                                       | 79     
|Cash dividends                                                                                                            |                                       | (3,161 
|                                                                                                                          |                                       |        
|Net cash provided by financing activities                                                                                 |                                       | 14,071 
|Net increase in cash and cash equivalents                                                                                 |                                       | 762    
|                                                                                                                          |                                       |        
|Cash and cash equivalents at beginning of period                                                                          |                                       | 27,398 
|Cash and cash equivalents at end of period                                                                                | $                                     | 28,160 
|                                                                                                                          |                                       |        
|                                                                                                                          |                                       |        
|Supplemental disclosures of cash flow information:                                                                        |                                       |        
|Interest received during the period                                                                                       | $                                     | 51,823 
|Interest paid during the period                                                                                           |                                       | 27,929 
|Income taxes                                                                                                              |                                       | 1,056  
|Non-cash investing activities:                                                                                            |                                       |        
|Transfer of premises and equipment to assets held for sale                                                                |                                       | 606    
|Transfers of loans to other real estate and repossessed assets                                                            |                                       | 310    
|Non-cash financing activities:                                                                                            |                                       |        
|Dividend declared and unpaid                                                                                              |                                       | 1,052  

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

|-6-
|---



|ALLIANCE FINANCIAL CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS
A.           Basis of Presentation
|-----------------------------------------------------------------------------------------------------------
|                                                                                                           

|   | 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, 2006
  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, 2006. 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 three and nine months ended September
  30, 2007 and 2006.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|B. | Earnings Per Share                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
|   | Basic and diluted net income per common share calculations are as follows:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                
|   |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

|                                                                                                | For three months ended
      September 30,       |           | For nine months ended
      September 30, |  
|----------------------------------------------------------------------------------------------- | ------------------------------------------------ | --------- | ----------------------------------------- | -
|
|
|
|                                                                                                | (Dollars in thousands, except per share amounts) |          
|Basic:                                                                                          |                                                  |           |                                           |  
|Net Income                                                                                      | $                                                | 2,410     |                                           | $
|                                                                                                |                                                  |           |                                           |  
|Average common shares outstanding                                                               |                                                  | 4,709,334 |                                           |  
|Net income per common share  basic                                                             | $                                                | 0.51      |                                           | $
|                                                                                                |                                                  |           |                                           |  
|                                                                                                |                                                  |           |                                           |  
|Diluted:                                                                                        |                                                  |           |                                           |  
|Net income                                                                                      | $                                                | 2,410     |                                           | $
|                                                                                                |                                                  |           |                                           |  
|Average common shares outstanding                                                               |                                                  | 4,709,334 |                                           |  
|Incremental shares from assumed 
       conversion of stock options and
       restricted stock |                                                  | 46,754    |                                           |  
|                                                                                                |                                                  |           |                                           |  
|Average common shares 
        outstanding  diluted                                            |                                                  | 4,756,088 |                                           |  
|Net income per common share  diluted                                                           | $                                                | 0.51      |                                           | $
|                                                                                                |                                                  |           |                                           |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Basic earnings per share are computed by dividing net income by the weighted average number of common
shares outstanding during each period. Diluted earnings per share gives the effect to weighted average
shares which would be outstanding assuming the exercise of options and vesting of restricted stock
using the treasury stock method. For the three and nine months ended September 30, 2007, 1,000 anti-dilutive
stock options were excluded from the diluted weighted average common share calculations.
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     

|C. | Allowance for Loan and Lease Losses
|-- | -----------------------------------
|   |                                    

| | The allowance for loan and lease losses represents managements best estimate of probable loan
  and lease losses in the Companys loan portfolio. Managements quarterly evaluation of
  the allowance for loan and lease losses is a comprehensive analysis that builds a total reserve by
  evaluating the risks 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 a reserve 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,
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-7-
|---



|ALLIANCE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
|-------------------------------------------------------------------------
|                                                                         

| | losses, economic conditions, loan concentrations, policy changes, experience and ability of lending
  personnel, and current interest rates are likely to have. For commercial loan and lease pools, the
  Company establishes a specific reserve allocation for all loans and leases classified as being impaired
  in excess of $150,000, 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 a reserve 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 loan and lease
  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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                         
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           
| | Loans are charged off when they are considered a loss regardless of the delinquency status. From a
  delinquency standpoint, the policy of the Company is to charge off loans when they are 120 days past
  due unless extenuating circumstances are documented that attest to the ability to collect the loan.
  Special circumstances to include fraudulent loans and loans in bankruptcy will be charged off no
  later than 90 days of discovery or within 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 of repossession of collateral is assured and in process.                                                                                                                                                                                                                                                                       
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                           

| | D. | Retirement Plan and Post-Retirement Benefits
| | -- | --------------------------------------------
| |   

| | The Company has a noncontributory defined benefit pension plan which it assumed as part of the Bridge
  Street Financial Inc. (Bridge Street) acquisition on October 6, 2006. 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. The Company
  does not expect to make contributions to its pension plan in 2007.
| | ---------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
| | The Company provides post-retirement medical and life insurance benefits through an unfunded plan to
  qualifying employees. Benefits are available to full-time employees who have worked 15 years and
  attained age 55. Retirees and certain active employees with more than 20 years of service to the
  Company continue to receive benefits in accordance with plans that existed at the Companys
  predecessor banks, First National Bank of Cortland and Oneida Valley National Bank, respectively,
  prior to the merger of the banks in 1999.                                                                                                                                                                                                                                                                                                                                                 

|-8-
|---



|ALLIANCE FINANCIAL CORPORATION
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
The components of the plans net periodic cost for the periods indicated are as follows:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                  

|                             | Pension        |     
|---------------------------- | -------------- | ----
|
|
|
|
|
|                             | (In thousands) |     
|Service cost                 | $              |    
|Interest cost                |                | 60  
|Expected return on assets    |                | (100
|                             |                |     
|Net periodic pension benefit | $              | (40 
|                             |                |     

|
|

|                                                | Post-retirement |    
|----------------------------------------------- | --------------- | ---
|
|
|
|
|
|                                                | (In thousands)  |    
|Service cost                                    | $               | 44 
|Interest cost                                   |                 | 86 
|Amortization of unrecognized prior service cost |                 | 16 
|                                                |                 |    
|Net periodic post-retirement cost               | $               | 146
|                                                |                 |    

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|E.             Income Taxes
The Company has adopted the provisions of FASB Interpretation No. 48, Accounting for Uncertainty
in Income Taxes (FIN 48) effective January 1, 2007. There was no cumulative effect
of adoption of FIN 48.
As of January 1, 2007, the Companys gross unrecognized tax benefits totaled $134,000. Included
in this amount is $43,000 which would impact the Companys effective tax rate, if recognized
or reversed, and $69,000 which would affect goodwill. The Company does not anticipate that total
unrecognized tax benefits will significantly change due to the settlement of audits or the expiration
of statute of limitations prior to March 30, 2008. As of September 30, 2007, the Companys
gross unrecognized tax benefits totaled $206,000. During the first nine months of 2007, there were
additions of $72,000 for tax positions related to acquisition costs and adjusted through goodwill.
The Company or one of its subsidiaries files income tax returns in the U.S. federal jurisdiction and
various state jurisdictions.
As of January 1, 2007, the Company has accrued $11,000 of interest related to uncertain tax positions.
As of September 30, 2007, the total amount of accrued interest was $13,000. The Company accounts
for interest and penalties related to uncertain tax positions as part of its provision for federal
and state income taxes.

|-9-
|---



|Item 2.    Managements Discussion and Analysis of Financial Condition and Results
of Operations
General
Throughout this analysis, the term the Company 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 respective operating subsidiaries of these two holding companies merged on April 16, 1999 to
form Alliance Bank, N.A.
The following discussion presents material changes in the Companys results of operations and
financial condition during the three and nine months ended September 30, 2007, 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, that are less favorable than expected,
  resulting in, among other things, a deterioration in credit quality;
| |   |                                                                                                                                                                            
| |  | changes in business conditions and inflation;                                                                                                                              
| |   |                                                                                                                                                                            
| |  | changes in the securities markets;                                                                                                                                         
| |   |                                                                                                                                                                            
| |  | changes in technology used in the banking business;                                                                                                                        
| |   |                                                                                                                                                                            
| |  | our ability to maintain and increase market share and control expenses;                                                                                                    
| |   |                                                                                                                                                                            
| |  | the possibility that the Companys investment management business will fail to perform as currently anticipated;                                                           
| |   |                                                                                                                                                                            
| |  | changes in key management personnel may adversely impact our operations; and                                                                                               
| |   |                                                                                                                                                                            
| |  | other factors detailed from time to time in the Companys Securities and Exchange Commission filings                                                                       

|                                                                                                                                                                                         
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Operating results for the three months and nine months ended September 30, 2007 are not necessarily
indicative of the results that may be expected for the year ending December 31, 2007.

|-10-
|----



|RESULTS OF OPERATIONS FOR THE THREE MONTHS AND NINE MONTHS ENDED SEPTEMBER 30, 2007
Earnings Summary and Executive Overview
Net income was $2.4 million, or $0.51 per diluted share in the third quarter of 2007, an increase of
$591,000, or 32.5% compared to net income of $1.8 million or $0.51 per diluted share for the same
period in 2006. The return on average assets and return on average shareholders equity were
0.75 % and 8.65%, respectively, for the three months ended September 30, 2007, compared with 0.72%
and 10.27%, respectively, for the third quarter of 2006.
Net income was $7.0 million or $1.47 per diluted share for the nine months ended September 30, 2007,
an increase of $1.8 million or 34.5% compared with $5.2 million or $1.47 per diluted share for the
nine months ended September 30, 2006. The return on average assets and return on average shareholders
equity were 0.74% and 8.48%, respectively, for the nine months ended September 30, 2007, compared
with 0.70% and 9.92%, respectively, for the same period in 2006.
The changes in net income in the three months and nine months ended September 30, 2007 reflect, in
large part, the impact of the acquisition of Bridge Street Financial, Inc. (Bridge Street),
a $219.3 million bank holding company, in October 2006.
Analysis of Net Interest Income and the Net Interest Margin
Net interest income totaled $8.2 million in the three months ended September 30, 2007, an increase
of $1.7 million or 27.0% compared with the third quarter of 2006. Interest income increased $4.0
million or 28.2% in the third quarter of 2007 compared with the year-ago quarter, while interest
expense increased $2.2 million or 29.2%.
The increase in net interest income resulted primarily from an increase in average earning assets of
$205.3 million compared with the year-ago quarter. The acquisition of Bridge Street and growth in
the Companys lease portfolio in the second half of 2006 were the primary contributors to the
earning asset growth. Loans and leases comprised 77.0% of average earning assets in the third quarter
of 2007, compared with 74.1% in the year-ago quarter. The higher proportion of earning assets in
loans and leases, combined with general upward repricing of the Companys earning-assets, contributed
to an increase in the Companys tax-equivalent earning asset yield which offset an increase
in its cost of funds. The Companys tax-equivalent earning asset yield was 6.43% in the third
quarter of 2007, an increase of 31 basis points compared with 6.12% in the same quarter in 2006.
The tax-equivalent earning asset yield was 6.35% in the second quarter of 2007.
The Companys cost of funds was 3.86% in the third quarter of 2007, an increase of 20 basis points
compared with 3.66% in the third quarter of 2006. The Companys cost of funds was 3.78% in the
second quarter of 2007. The increase in the cost of funds compared with the year-ago quarter resulted
primarily from higher short-term interest rates and highly competitive pricing for time accounts
and municipal deposits in our market area.
Intense competition for commercial loans and slow economic growth in our market area have contributed
to a slowing of growth in our commercial loan portfolio in 2007. Average commercial loans outstanding
in the third quarter of 2007 was virtually unchanged compared with the average outstanding in the
first two quarters of 2007. Commercial loans outstanding at September 30, 2007 have decreased $9.4
million compared with the balance outstanding at December 31, 2006 due, in large part, to unanticipated
prepayments and seasonal use of lines of credit. Commercial lending continues to be an important
part of our growth strategy, however, its growth will likely continue to be constrained for the foreseeable
future as a result of the soft economic conditions in our markets and significant competition among
financial institutions. The Company intends to continue to maintain its sound credit underwriting
standards which may negatively impact our ability to increase earning assets in the current operating
environment.
Average residential mortgages outstanding increased $5.9 million in the third quarter of 2007 compared
with the average in the second quarter of 2007, as we expanded our mortgage origination operations
in an effort to increase our market share. This growth has come entirely from conventional mortgages
originated in our lending area. The Company does not originate and has no sub-prime, Alt-A, negative
amortizing or other higher risk residential mortgages in its portfolio.
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-11-
|----



|Average deposits increased $174.3 million in the third quarter of 2007 compared with the third quarter
of 2006 due primarily to the acquisition of Bridge Street, and were up $4.6 million compared with
the second quarter of 2007. Increases in average time deposits of $8.1 million and average demand
and savings accounts of $6.1 million in the third quarter of 2007 compared with the second quarter
of 2007 offset a $9.6 million decline in average money market accounts during the same period. Average
time accounts represented 46.8% of average deposits in the third quarter of 2007, compared with 48.4%
in the year ago quarter and 46.2% in the second quarter of 2007. Average money market accounts were
20.0% of average deposits in the third quarter, compared with 20.8% in the third quarter of 2006
and 21.2% in the second quarter of 2007. Average demand deposits were 24.2% of average deposits in
the third quarter of 2007, compared with 23.7% in the third quarter of 2006, and 23.4% in the second
quarter of 2007.
Our tax-equivalent net interest margin was 3.04% in the quarter ended September 30, 2007, compared
with 2.93% from the third quarter of 2006. The tax-equivalent net interest margin was 3.01% in the second quarter
of 2007.
Net interest income was $24.3 million for the nine months ended September 30, 2007, an increase of
$4.8 million or 24.6% compared with the nine months ended September 30, 2006. Interest income increased
$12.8 million or 31.8% in the first nine months of 2007 compared with the year-ago period, while
interest expense increased $8.0 million or 38.7%.
The increase in net interest income resulted primarily from an increase in average earning assets of
$212.2 million compared with the year-ago period. Changes in average earning assets and average deposits
and borrowings for the nine months ended September 30, 2007 compared with the year ago period showed
trends similar to those for the third quarter of 2007 compared to the third quarter of 2006.
Our tax-equivalent net interest margin was 3.03% in the nine months ended September 30, 2007, compared
with 3.0% in the year ago period.
Average Balance Sheet and Non-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.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-12-
|----



|                                                          |  | For the three months ended September 30, |          
|--------------------------------------------------------- |  | ---------------------------------------- | ---------
|
|
|
|
|
|                                                          |  | (Dollars in thousands)                   |          
|Assets:                                                   |  |                                          |          
|Interest earning assets:                                  |  |                                          |          
|Federal funds sold                                        |  | $                                        | 269      
|Taxable investment securities                             |  |                                          | 173,203  
|Nontaxable investment securities                          |  |                                          | 83,920   
|FHLB and FRB stock                                        |  |                                          | 8,713    
|Real estate loans                                         |  |                                          | 265,633  
|Commercial loans                                          |  |                                          | 212,899  
|Nontaxable commercial loans                               |  |                                          | 8,474    
|Taxable leases (net of unearned discount)                 |  |                                          | 112,261  
|Nontaxable leases (net of unearned discount)              |  |                                          | 18,319   
|Indirect auto loans                                       |  |                                          | 182,285  
|Consumer loans                                            |  |                                          | 91,579   
|                                                          |  |                                          |          
|Total Interest-earning assets                             |  |                                          | 1,157,555
|                                                         
|Non-interest earning assets:                              | 
|Other Assets                                              |  |                                          | 131,876  
|Less: Allowance for loan and lease losses                 |  |                                          | (7,792   
|Net unrealized losses on securities
   available-for-sale |  |                                          | (3,009   
|                                                          |  |                                          |          
|Total Assets                                              |  | $                                        | 1,278,630
|                                                          | 
|                                                         
|Liabilities and shareholders equity:                     | 
|Interest bearing liabilities:                             | 
|Demand deposits                                           |  | $                                        | 98,959   
|Savings deposits                                          |  |                                          | 83,923   
|MMDA deposits                                             |  |                                          | 188,892  
|Time deposits                                             |  |                                          | 441,531  
|Borrowings(1)                                             |  |                                          | 177,903  
|Junior subordinated obligations issued to                 | 
|unconsolidated trusts                                     |  |                                          | 25,774   
|                                                          |  |                                          |          
|Total interest-bearing liabilities                        |  |                                          | 1,016,982
|                                                         
|Non-interest bearing liabilities:                         | 
|Demand deposits                                           |  |                                          | 129,436  
|Other liabilities                                         |  |                                          | 20,747   
|Shareholders equity                                      |  |                                          | 111,465  
|                                                          |  |                                          |          
|Total liabilities and shareholders equity                |  | $                                        | 1,278,630
|                                                          |  |                                          |          
|                                                         
|Net interest income (tax equivalent)                      |  |                                          |          
|                                                          |  |                                          |          
|Net interest margin (tax equivalent)                      |  |                                          |          
|Net interest rate spread                                  |  |                                          |          
|Federal tax exemption on non-taxable                      | 
|investment securities, loans and leases                   | 
|included in interest income                               |  |                                          |          
|                                                          |  |                                          |          

|                                      
|--------------------------------------
|(1)  Includes mortgagors escrow funds

|-13-
|----



|                                             |  | For the nine months ended September 30, |          
|-------------------------------------------- |  | --------------------------------------- | ---------
|
|
|
|
|
|                                             |  | (Dollars in thousands)                  |          
|Assets:                                      |  |                                         |          
|Interest earning assets:                     |  |                                         |          
|Federal funds sold                           |  | $                                       | 184      
|Taxable investment securities                |  |                                         | 170,953  
|Nontaxable investment securities             |  |                                         | 84,978   
|FHLB and FRB Stock                           |  |                                         | 8,563    
|Real estate loans                            |  |                                         | 259,844  
|Commercial loans                             |  |                                         | 213,018  
|Nontaxable commercial loans                  |  |                                         | 8,587    
|Taxable leases (net of unearned discount)    |  |                                         | 111,335  
|Nontaxable leases (net of unearned discount) |  |                                         | 19,697   
|Indirect loans                               |  |                                         | 181,148  
|Consumer loans                               |  |                                         | 90,519   
|                                             |  |                                         |          
|Total interest-earning assets                |  |                                         | 1,148,826
|                                            
|Non-interest earning assets:                 |  |                                         |          
|Other assets                                 |  |                                         | 132,728  
|Less: Allowance for loan and lease losses    |  |                                         | (7,486   
|Net unrealized losses on securities          |  |                                         |          
|available-for-sale                           |  |                                         | (2,294   
|                                             |  |                                         |          
|Total assets                                 |  | $                                       | 1,271,774
|                                             |  |                                         |          
|                                            
|Liabilities and shareholders equity:        |  |                                         |          
|Interest bearing liabilities:                |  |                                         |          
|Demand deposits                              |  | $                                       | 97,004   
|Savings deposits                             |  |                                         | 84,728   
|MMDA deposits                                |  |                                         | 195,958  
|Time deposits                                |  |                                         | 433,242  
|Borrowings(1)                                |  |                                         | 178,524  
|Junior subordinated obligations issued to    |  |                                         |          
|unconsolidated trusts                        |  |                                         | 25,774   
|                                             |  |                                        
|Total interest-bearing liabilities           |  |                                         | 1,015,230
|                                            
|Non-interest bearing liabilities:            |  |                                         |          
|Demand deposits                              |  |                                         | 126,304  
|Other liabilities                            |  |                                         | 19,613   
|Shareholders equity                         |  |                                         | 110,627  
|                                             |  |                                         |          
|Total liabilities and shareholders equity   |  | $                                       | 1,271,774
|                                             |  |                                         |          
|                                            
|Net interest income (tax equivalent)         |  |                                         |          
|                                             |  |                                         |          
|Net interest margin (tax equivalent)         |  |                                         |          
|Net interest rate spread                     |  |                                         |          
|Federal tax exemption on non-taxable         |  |                                         |          
|investment securities, loans and leases      |  |                                         |          
|included in interest income                  |  |                                         |          
|                                             |  |                                         |          

|                                     
|-------------------------------------
|(1) Includes mortgagors escrow funds

|-14-
|----



|The following table sets forth the dollar volume of increase (decrease) in interest income and interest
expense resulting from changes in the volume of earning assets and interest-bearing liabilities,
and from changes in rates 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 equally between the volume and rate variances.
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                              

|                                                                          | For the three months ended
      September 30, 2007 
      compared to 
      September 30, 2006 |       | For the nine months ended
      September 30, 2007 
      compared to 
      September 30, 2006 |  
|------------------------------------------------------------------------- | ------------------------------------------------------------------------------------------------ | ----- | ----------------------------------------------------------------------------------------------- | -
|
|
|
|
|
|(In thousands)                                                           
|Federal funds sold                                                        | $                                                                                                | 2     |                                                                                                 | $
|Taxable investment securities                                             |                                                                                                  | 42    |                                                                                                 |  
|Non-taxable investment securities                                         |                                                                                                  | 199   |                                                                                                 |  
|FHLB and FRB stock                                                        |                                                                                                  | 40    |                                                                                                 |  
|Real estate loans                                                         |                                                                                                  | 1,087 |                                                                                                 |  
|Commercial loans                                                          |                                                                                                  | 1,134 |                                                                                                 |  
|Non-taxable commercial loans                                              |                                                                                                  | 23    |                                                                                                 |  
|Taxable leases (net of unearned income)                                   |                                                                                                  | 559   |                                                                                                 |  
|Non-taxable leases (net of unearned income)                               |                                                                                                  | 4     |                                                                                                 |  
|Indirect loans                                                            |                                                                                                  | (6    | )                                                                                               |  
|Consumer loans                                                            |                                                                                                  | 510   |                                                                                                 |  
|                                                                          |                                                                                                  |       |                                                                                                 |  
|Total interest-earning assets                                             | $                                                                                                | 3,594 |                                                                                                 | $
|                                                                          |                                                                                                  |       |                                                                                                 |  
|                                                                          |                                                                                                  |       |                                                                                                 |  
|Interest-bearing demand deposits                                          | $                                                                                                | 27    |                                                                                                 | $
|Savings deposits                                                          |                                                                                                  | 41    |                                                                                                 |  
|MMDA deposits                                                             |                                                                                                  | 223   |                                                                                                 |  
|Time deposits                                                             |                                                                                                  | 816   |                                                                                                 |  
|Borrowings                                                                |                                                                                                  | 362   |                                                                                                 |  
|Junior subordinated obligations issuedto unconsolidated subsidiary trusts |                                                                                                  | 274   |                                                                                                 |  
|                                                                          |                                                                                                  |       |                                                                                                 |  
|Total interest-bearing liabilities                                        | $                                                                                                | 1,743 |                                                                                                 | $
|                                                                          |                                                                                                  |       |                                                                                                 |  
|                                                                         
|Net interest income tax equivalent                                        | $                                                                                                | 1,851 |                                                                                                 | $
|                                                                          |                                                                                                  |       |                                                                                                 |  

|-15-
|----



|Analysis of Asset Quality and the Provision and Allowance for Loan and Lease Losses
We establish provisions for loan and lease losses, which are charged or credited to operations, in
order to maintain the allowance for loan and lease losses at a level management considers adequate
to absorb probable credit losses in the current loan and lease portfolio. The amount of the allowance
is based on estimates and the ultimate losses may vary from such estimates as more information becomes
available or later events occur. Management assesses the allowance for loan and lease losses on a
quarterly basis and makes provisions for loan and lease losses in order to adjust the allowance,
when necessary.
Nonperforming assets were $4.8 million or 0.37% of total assets at September 30, 2007, compared with
$5.5 million or 0.43% of total assets and $2.6 million or 0.21% of total assets at June 30, 2007
and December 31, 2006, respectively. Commercial loans on nonaccrual status decreased $924,000 in
the third quarter due largely to the return to performing status of one commercial loan during the
quarter.
At September 30, 2007, delinquent loans and leases (30 days or more, including nonperforming loans
and leases) totaled $12.9 million or 1.45% of total loans and leases, compared with $12.7 million
or 1.43% at June 30, 2007 and $16.3 million or 1.85% at December 31, 2006. Delinquencies at December
31, 2006 were impacted by the acquisition of the Bridge Street loan portfolio. The Company has no
sub-prime, Alt-A, negative amortizing or other higher risk residential mortgages in its portfolio.
The provision for loan and lease losses was $1.1 million and $2.6 million in the quarter and nine months
ended September 30, 2007, compared with $550,000 and $2.0 million, respectively, in the year-ago
periods. Net charge-offs were $815,000 and $1.8 million in the quarter and nine months ended September
30, 2007, compared with $318,000 and $1.5 million in the respective year-ago periods. The increased
provisions were largely the result of higher net charge-offs and managements expectations
of weakening economic and credit conditions.
The allowance for loan and lease losses was $7.9 million at September 30, 2007, compared with $7.5
million and $7.0 million at June 30, 2007 and December 31, 2006, respectively. The ratio of the allowance
for loan and lease losses to nonperforming loans and leases was 176.1% at September 30, 2007, compared
with 139.3% and 266.4% at June 30, 2007 and December 31, 2006, respectively. The ratio of the allowance
for loan and lease losses to total loans and leases was 0.88% at September 30, 2007, compared with
0.85% and 0.80% at June 30, 2007 and December 31, 2006, respectively.
In addition to the nonperforming loans summarized in the following table, the Company has identified
approximately $11.1 million in potential problem loans at September 30, 2007, as compared to $8.3
million at June 30, 2007 and $6.7 million at December 31, 2006. The average balance of such potential
problem loans was $309,000, $376,000 and $267,000 at September 30, 2007, June 30, 2007 and December
31, 2006, respectively. Potential problem loans are loans that are currently performing, but operating
performance or other relevant factors could result in potential credit problems thus causing management
to have concerns as to the ability of the borrowers to comply with the loan repayment terms. Such
loans may become nonperforming at some time in the future. At the Company, potential problem loans
are typically loans that are performing but are classified by our loan rating system as substandard.
At September 30, 2007, potential problem loans primarily consisted of commercial real estate and
commercial loans. There can be no assurance that additional loans will not become nonperforming,
require restructuring, or require increased provision for loan losses.
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-16-
|----



|The following tables present a summary of non-performing assets for the periods indicated and a summary
of the changes in the allowance for loan and lease losses arising from loans and leases charged off
and recoveries on loans and leases previously charged off and additions to the allowance, which have
been charged to expense for the periods indicated.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                   

|                                                     | September 30, 2007 |       | June 30, 2007 |   | December 31, 2006 | 
|---------------------------------------------------- | ------------------ | ----- | ------------- | - | ----------------- | 
|
|(In thousands)                                      
|Non-accruing loans and leases:                       |                    |       |               |   |                   | 
|Residential real estate loans                        | $                  | 294   |               | $ | 295               | 
|Commercial loans                                     |                    | 2,562 |               |   | 3,486             | 
|Leases                                               |                    | 347   |               |   | 350               | 
|Indirect loans                                       |                    | 43    |               |   | 40                | 
|Other consumer loans                                 |                    | 138   |               |   | 231               | 
|                                                     |                    |       |               |   |                   | 
|Total non-accruing loans and leases                  |                    | 3,384 |               |   | 4,402             | 
|Accruing loans and leases delinquent 90 days or more |                    | 1,080 |               |   | 1,009             | 
|                                                     |                    |       |               |   |                   | 
|Total Non-performing loans and leases                |                    | 4,464 |               |   | 5,411             | 
|Other real estate and repossessed assets             |                    | 326   |               |   | 66                | 
|                                                     |                    |       |               |   |                   | 
|Total non-performing assets                          | $                  | 4,790 |               | $ | 5,477             | 
|                                                     |                    |       |               |   |                   | 
|                                                     |                    |       |               |   |                   | 

|                                                         | Three months ended
      September 30, |       | Nine months ended
      September 30, |  
|-------------------------------------------------------- | -------------------------------------- | ----- | ------------------------------------- | -
|
|
|
|(In thousands)                                          
|Allowance for loan and lease losses, beginning of period | $                                      | 7,538 |                                       | $
|                                                         |                                        |       |                                       |  
|Loans and leases charged-off                             |                                        | (924  | )                                     |  
|Recoveries of loans and leases previously charged-off    |                                        | 109   |                                       |  
|                                                         |                                        |       |                                       |  
|Net loans and leases charged-off                         |                                        | (815  | )                                     |  
|                                                         |                                        |       |                                       |  
|Provision for loan and lease losses                      |                                        | 1,140 |                                       |  
|                                                         |                                        |       |                                       |  
|Allowance for loan and lease losses, end of period       | $                                      | 7,863 |                                       | $
|                                                         |                                        |       |                                       |  

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

|                                                                               | For three months
      ended
      September 30, |       | For nine months 
      ended
      September 30, | 
|------------------------------------------------------------------------------ | ------------------------------------------------ | ----- | ------------------------------------------------ | 
|
|
|
|
|Net loans and leases charged-off to average loans 
   and leases, annualized   |                                                  | 0.37  | %                                                | 
|Provision for loan and lease losses to average loans 
  and leases, annualized |                                                  | 0.51  | %                                                | 
|Allowance for loan and lease losses to period-end loans 
   and leases         |                                                  | 0.88  | %                                                | 
|Allowance for loan and lease losses to non-performing loans 
  and leases      |                                                  | 176.1 | %                                                | 
|Non-performing loans and leases to period-end loans 
   and leases             |                                                  | 0.50  | %                                                | 
|Non-performing assets to period-end assets                                     |                                                  | 0.37  | %                                                | 

|-17-
|----



|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, |  
|------------------------------------- | -------------------------------- | ----- | ------------------------------- | -
|
|
|
|
|
|
|Investment management income          | $                                | 2,335 |                                 | $
|Service charges on deposit accounts   |                                  | 1,382 |                                 |  
|Card-related fees                     |                                  | 486   |                                 |  
|Insurance agency income               |                                  | 479   |                                 |  
|Income from bank-owned life insurance |                                  | 160   |                                 |  
|Gain on the sale of loans             |                                  | 46    |                                 |  
|Rental income from operating leases   |                                  |      |                                 |  
|Other non-interest income             |                                  | 619   |                                 |  
|                                      |                                  |       |                                 |  
|Total non-interest income             | $                                | 5,507 |                                 | $
|                                      |                                  |       |                                 |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Non-interest income was $5.5 million in the third quarter of 2007, which was an increase of $1.3 million
or 32.1% compared with $4.2 million in the third quarter of 2006. Non-interest income was $15.8 million
in the nine months ended September 30, 2007, which was an increase of $3.5 million or 28.1% compared
with the year-ago period. The increases in non-interest income are due primarily to the effect of
the Bridge Street acquisition, growth in investment management income, and organic growth in customer
service charges and transaction fees. Rental income from leases decreased $185,000 or 100% in the
third quarter due to the decrease in operating lease activity. Non-interest income comprised 40.2%
of total revenue (non-interest income, net of realized gains and losses on securities, and net interest
income) in the third quarter of 2007 compared with 39.2% in the year-ago quarter and 39.3% in the
second quarter of 2007.
Non-interest Expenses
The following table sets forth certain information on operating expenses for the periods indicated,
dollars in thousands:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

|                                  | For three months ended September 30, |       | For nine months ended September 30, |  
|--------------------------------- | ------------------------------------ | ----- | ----------------------------------- | -
|
|
|
|
|
|
|Salaries and employee benefits    | $                                    | 4,634 |                                     | $
|Occupancy and equipment expense   |                                      | 1,560 |                                     |  
|Communication expense             |                                      | 174   |                                     |  
|Stationery and supplies expense   |                                      | 156   |                                     |  
|Marketing expense                 |                                      | 296   |                                     |  
|Amortization of intangible assets |                                      | 435   |                                     |  
|Professional fees                 |                                      | 641   |                                     |  
|Other operating expenses          |                                      | 1,529 |                                     |  
|                                  |                                      |       |                                     |  
|Total operating expenses          | $                                    | 9,425 |                                     | $
|                                  |                                      |       |                                     |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Non-interest expenses increased $1.7 million and $5.1 million in the three months and nine months ended
September 30, 2007 compared with the year-ago periods. Increases in all categories, except marketing,
resulted primarily from the incremental costs associated with the operation of the Bridge Street
branches and insurance agency, the costs associated with processing the increased volume of customer
transactions due to the Bridge Street acquisition and amortization of intangible assets recorded
in connection with the acquisition.
Marketing expense increased in the quarter and year-to-date periods ended September 30, 2007 compared
with 2006 due primarily to an overall increased level of marketing activities in 2007.

|-18-
|----



|The Companys efficiency ratio was 68.7% and 70.7% in the three months and nine months ended September
30, 2007, compared with 72.3% and 72.9% in the prior year periods. Expense control will continue
to be a high priority for us in this operating environment.
Income Taxes
The Companys effective tax rate was 23.4% for both the three months and nine months ended September
30, 2007, compared with 24.0% and 21.7% in the year-ago periods.
ANALYSIS OF FINANCIAL CONDITION
Loans
Total loans and leases (net of unearned income) were $891.4 million at September 30, 2007, compared
with $882.6 million at December 31, 2006. Residential mortgages totaled $268.8 million or 30.2% of
total loans and leases at September 30, 2007, reflecting an increase of $15.5 million compared with
December 31, 2006. The growth in residential mortgages has come entirely from conventional mortgages
originated in our local markets as the result of our long established plan to grow our mortgage origination
operations. The Company does not originate and has no sub-prime, Alt-A, negative amortizing or other
higher risk residential mortgages in its portfolio.
Commercial loans totaled $214.2 million or 24.1% of total loans and leases at September 30, 2007, compared
with $223.6 million or 25.4% of total loans and leases at December 31, 2006. Prepayments of several
commercial relationships totaling approximately $8.8 million in the second and third quarters of
2007, along with a $6.5 million decrease in line of credit utilization due largely to seasonal factors
offset otherwise modest growth during the first three quarters of 2007. The prepayments occurred
largely as a result of the Companys decision not to offer certain aggressive rate and credit
terms that would have been necessary to retain these relationships. Commercial loan growth will likely
continue to be constrained for the foreseeable future as a result of the soft economic growth in
our markets and significant competition among financial institutions.
Indirect loans totaled $182.1 million and were 20.5% of total loans and leases at September 30, 2007,
compared with $181.9 million or 20.7% of total loans and leases at December 31, 2006. We have managed
the rate of originations in this portfolio in response to highly aggressive competitive pricing for
indirect loans in our market which has diminished the profitability of indirect lending in light
of current funding costs.
The following table sets forth the composition of the Banks loan and lease portfolio at the dates
indicated, dollars in thousands:
|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    

|                                  | September 30, 2007 |         | Percent |  | December 31, 2006 |   | Percent |        
|--------------------------------- | ------------------ | ------- | ------- |  | ----------------- | - | ------- | -------
|
|
|Residential real estate loans     | $                  | 268,774 |         |  | 30.2              | % | $       | 253,289
|Commercial loans                  |                    | 214,217 |         |  | 24.1              | % |         | 223,600
|Leases (net of unearned income)   |                    | 130,224 |         |  | 14.7              | % |         | 131,048
|Indirect loans                    |                    | 182,104 |         |  | 20.5              | % |         | 181,929
|Other consumer loans              |                    | 92,997  |         |  | 10.5              | % |         | 90,438 
|                                  |                    |         |         |  |                   |   |         |        
|Total loans & leases              | $                  | 888,316 |         |  | 100.0             | % | $       | 880,304
|                                  |                    |         |         |  |                   |   |         |        
|(Less)                            |                    |         |         |  |                   |   |         |        
|Net deferred loan costs           |                    | 3,052   |         |  |                   |   |         | 2,262  
|Allowance for loan & lease losses |                    | (7,863  | )       |  |                   |   |         | (7,029 
|                                  |                    |         |         |  |                   |   |         |        
|Net loans and leases              | $                  | 883,505 |         |  |                   |   | $       | 875,537
|                                  |                    |         |         |  |                   |   |         |        

|-19-
|----



|Securities Available-for-sale
The following table sets forth the amortized cost and fair value for the Companys available-for-sale
investment securities portfolio, dollars in thousands:
|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|                                                                                                                                                                                          

|                                                    | September 30, 2007 |         | December 31, 2006 |  
|--------------------------------------------------- | ------------------ | ------- | ----------------- | -
|
|
|
|                                                   
|U.S. Treasury obligations                           | $                  | 7,044   |                   | $
|U.S. government-sponsored corporations              |                    | 71,008  |                   |  
|Mortgage-backed securities                          |                    | 101,456 |                   |  
|Obligations of states and political subdivisions    |                    | 86,184  |                   |  
|Other equity securities                             |                    | 2,934   |                   |  
|                                                    |                    |         |                   |  
|Total                                               | $                  | 268,626 |                   | $
|                                                    |                    |         |                   |  
|Net unrealized loss on available-for-salesecurities |                    | (923    | )                 |  
|                                                    |                    |         |                   |  
|Total carrying value                                | $                  | 267,703 |                   |  
|                                                    |                    |         |                   |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Our securities available-for-sale portfolio is predominately comprised of investment grade mortgage-backed
securities, securities issued by U.S. government sponsored corporations and municipal securities.
Our mortgage-backed securities portfolio is comprised of pass-through securities guaranteed by either
Fannie Mae, Freddie Mac or Ginnie Mae, and does not include any securities backed by subprime or
other high-risk mortgages. The decrease in unrealized losses on available-for-sale securities resulted
primarily from changes in market conditions and interest rates during the period.
Deposits
Total deposits were $944.1 million at September 30, 2007, an increase of $8.5 million from December
31, 2006. The Company did not experience any material changes in its deposit base in the first nine
months of 2007.
The following table sets forth the composition of the Banks deposits by business line at the
dates indicated, dollars in thousands:
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  

|                      | September 30, 2007 |         | December 31, 2006 |  
|--------------------- | ------------------ | ------- | ----------------- | -
|
|
|
|
|Non-interest checking | $                  | 35,370  |                   | $
|Interest checking     |                    | 77,329  |                   |  
|                      |                    |         |                   |  
|Total checking        |                    | 112,699 |                   |  
|                      |                    |         |                   |  
|Savings               |                    | 74,002  |                   |  
|Money market          |                    | 72,509  |                   |  
|Time deposits         |                    | 359,455 |                   |  
|                      |                    |         |                   |  
|Total deposits        | $                  | 618,665 |                   | $
|                      |                    |         |                   |  

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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
levels of liquidity. Management believes, as of September 30, 2007, that liquidity as measured by
the Bank is in compliance with its policy guidelines.

|-20-
|----



|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, 2007,
cash and cash equivalents increased by $762,000, as net cash provided by operating activities of
$12.0 million and net cash provided by financing activity of $14.1 million exceeded the net cash
used in investing activities of $25.3 million. Net cash from operating activities was primarily provided
by net income in the amount of $7.0 million. Net cash provided by financing activities principally
reflects an $8.5 million increase in deposits and a net increase in borrowings of $9.5 million, partly
reduced by cash dividends of $3.2 million and treasury share purchases of $982,000 in the nine months
ended September 30, 2007. Net cash used in investing activities primarily reflects a net increase
in investment securities of $12.7 million combined with a net increase in loans and leases of $10.9 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, 2007, the Banks credit limit with the FHLB was $­­­­205.5 million.
The total of the Banks outstanding borrowings from the FHLB on that date was $127.5 million,
providing $78.0 million in availability.
Capital Resources
Shareholders equity increased $3.9 million in the nine months ended September 30, 2007. Net income
of $7.0 million was partially offset by dividends declared totaling $3.2 million ($0.66 per share).
In addition, the Company completed its stock repurchase program in the first quarter of 2007 with
the purchase of 31,830 shares of its stock for a total cost of $982,000. The accumulated other comprehensive
loss decreased $615,000 primarily due to a decrease in unrealized losses on securities available-for-sale.
The decrease in unrealized losses resulted primarily from changes in market conditions and interest
rates during the period.
On March 11, 2005, the Federal Reserve Board (FRB) announced approval of its final rule that allows
the continued inclusion of outstanding and prospective issuances of trust preferred securities in
the Tier 1 capital of bank holding companies. Under the final rule, bank holding companies may continue
to treat trust preferred securities as Tier 1 capital up to the current 25% core capital limit until
March 31, 2009. After March 31, 2009, the 25% limit will be calculated net of goodwill (such goodwill
is determined net of any associated deferred tax liability).
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 following tables) of total and Tier 1 Capital (as defined in the regulations) to risk-weighted
assets (as defined) and of Tier 1 Capital (as defined) to average assets (as defined).
As of December 31, 2006, 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. To be categorized as well-capitalized, the Bank must maintain total
risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the tables below. Management
believes that, as of September 30, 2007, the Company and its subsidiary Bank met all capital adequacy
requirements to which they were subject.
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-21-
|----



|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                 |         | To be Well 
      Capitalized Under
      Prompt Corrective
      Action Provisions | 
|---------------------------------------- | ---------------------- | ------- | ----------------------------------------------------------------------------------- | 
|
|
|
|                                         | (Dollars in thousands) |        
|As of September 30, 2007                 |                        |         |                                                                                     | 
|Total Capital (to risk-weighted assets)  | $                      | 100,689 |                                                                                     | 
|Tier I Capital (to risk-weighted assets) |                        | 92,758  |                                                                                     | 
|Tier I Capital (to average assets)       |                        | 92,758  |                                                                                     | 
|As of December 31, 2006                  |                        |         |                                                                                     | 
|Total Capital (to risk-weighted assets)  | $                      | 95,510  |                                                                                     | 
|Tier I Capital (to risk-weighted assets) |                        | 88,215  |                                                                                     | 
|Tier I Capital (to average assets)       |                        | 88,215  |                                                                                     | 

|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                            
|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|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 2006 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 loan and lease losses represents managements estimate of probable loan and
lease losses in the loan and lease portfolio. Determining the amount of the allowance for loan and
lease 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 C to the Consolidated Financial Statements in this Quarterly Report
on Form 10-Q describes the methodology used to determine the allowance for loan and lease losses,
and a discussion of the factors driving changes in the amount of the allowance for loan and lease
losses is included in this report.
The Company estimates its tax expense based on the amount it expects to owe the respective tax authorities.
Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In
estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax
treatment of transactions, taking into account statutory, judicial and regulatory guidance in the
context of the Companys tax position. If the

|-22-
|----



|final resolution of taxes payable differs from the Companys estimates due to regulatory determination or legislative or judicial actions or any other reason, adjustments to tax expense may be required.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        
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|The Company utilizes significance estimates and assumptions in determining the fair value of its intangible asset 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.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                 
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|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 the Companys Form 10-K for the fiscal year ended December 31, 2006. On May 21, 2007, the U.S. District Court issued a decision dismissing the possessory land claims. The Courts decision has been appealed. Although management cannot predict the timing of the resolution of this matter,
it continues to believe that this matter will be resolved without adversely affecting the Company.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|New Accounting Pronouncements                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                     
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|In February 2007, the FASB issued SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities - Including an Amendment of FASB Statement No. 115. This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. This option is available to all entities, including not-for-profit organizations. Most of the provisions in Statement 159 are elective; however,
the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities,
applies to all entities with available-for-sale and trading securities. Some requirements apply differently to entities that do not report net income. The FASBs stated objective in issuing this standard is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions.                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|The fair value option established by Statement 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings (or another performance indicator if the business entity does not report earnings) at each subsequent reporting date. A not-for-profit organization will report unrealized gains and losses in its statement of activities or similar statement.
The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments.                                                                                                                                                                                                                                                                                                                                                                                    
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|This Statement is effective for the Company as of January 1, 2008. The Company is currently analyzing the effects of this statement and the impact on the Companys financial conditions or results of operations has not yet been determined.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                    
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|In September 2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement defines fair value, establishes methods for measuring fair value and expands disclosures about fair value measurements. While this Statement does not require any new fair value measurements, it is intended to increase consistency and comparability in fair value measurements, and expand disclosures about fair value measurements among companies.
This Statement is effective for the Company beginning January 1, 2008. The Company is currently evaluating the impact this will have on the Companys current practice of measuring fair value and any additional disclosures required in our financial statements.                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                          
|                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                  
|In September 2006, the Financial Accounting Standards Board ratified the consensus reached in the Emerging Issues Task Force (Task Force) Issue No. 06-4, Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements (Issue). Issue 06-4 requires the recognition of a liability and related compensation costs for endorsement split-dollar life insurance arrangements that provide a benefit to an employee that extends to postretirement periods.
The Task Force reached a consensus that for an endorsement split-dollar life insurance arrangement within the scope of this Issue, an employer should recognize a liability for future benefits in accordance with Statement 106 (if, in substance, a postretirement
  benefit plan exists) or Opinion 12 (if the arrangement is, in substance, an individual deferred compensation contract) based on the substantive agreement with the employee. The consensus reached in this Issue is effective for January 1, 2008. The Company is currently analyzing the effects of the Issue and the impact on the Companys financial conditions or results of operations has not yet been determined.

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|Item 3.    Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss in a financial instru­ment arising from adverse changes in market
conditions, rates or prices such as interest rates, foreign currency exchange rates, commodity prices,
and equity prices. The Companys market risk arises principally from interest rate risk in its
lending, deposit and borrowing activities. Other types of market risks do not arise in the normal
course of the Companys business activities.
The 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.
Interest rate risk is monitored primarily through the use of two complementary measures: earnings simulation
modeling and net present value estimation. Both measures are highly assumption-dependent and change
regularly as the balance sheet and business mix evolve; however, the Company believes that taken
together they represent a reasonably comprehensive view of the magnitude of interest rate risk, the
distribution of risk along the yield curve, the level of risk through time, and the amount of exposure
to changes in certain interest rate relationships. The key assumptions employed by these measures
are analyzed regularly and reviewed by ALCO.
Earnings Simulation Modeling
Net interest income is affected by changes in the absolute level of interest rates and by changes in
the shape of the yield curve. In general, a flattening of the yield curve would result in a decline
in earnings due to the compression of earning asset yields and funding rates, while a steepening
of the yield curve would result in increased earnings as investment margins widen. The model requires
management to make assumptions about how the Banks balance sheet is likely to evolve through
time in different interest rate environments. Loan and deposit growth rate assumptions are derived
from historical analysis and managements outlook, as are the assumptions used to project yields
and rates for new loans and deposits. Securities portfolio maturities and prepayments are assumed
to be reinvested in similar instruments. Mortgage loan prepayment assumptions are developed from
industry median estimates of prepayment speeds in conjunction with the historical prepayment performance
of the Banks own loans. Non-contractual deposit growth rates and pricing are modeled on historical
patterns. Interest rates of the various assets and liabilities on the balance sheet are assumed to
change proportionally, based on their historic relationship to short-term rates. The Banks
guidelines for risk management call for preventative measures to be taken if the simulation modeling
demonstrates that an instantaneous 2% increase or decrease in short-term rates over the next twelve
months would adversely affect net interest income over the same period by more than 15% when compared
to the stable rate scenario. At September 30, 2007, based on the results of the Banks simulation
model, and assuming that management does not take action to alter the outcome, the Bank would expect
net interest income to decline 13.12% if short term interest rates increase by 2%, and to increase
11.75% if short term interest rates decrease by 2%.
Net Present Value Estimation
The Net Present Value of Equity (NPV) measure is used for discerning levels of risk present in the
balance sheet that might not be taken into account in the earnings simulation model due to the shorter
time horizon used by that model. The NPV of the balance sheet, at a point in time, is defined as
the discounted present value of the asset cash flows minus the discounted value of liability cash
flows. Interest rate risk analysis using NPV involves changing the interest rates used in determining
the cash flows and in discounting the cash flows. The Banks NPV analysis models both an instantaneous
2% increasing and 2% decreasing interest rate scenario comparing the NPV in each scenario to the
NPV in the current rate scenario. The resulting percentage change in NPV is an indication of the
longer-term repricing risk and options risk embedded in the balance sheet. The NPV measure assumes
a static balance sheet versus the growth assumptions that are incorporated into the earnings simulation
measure, and an unlimited time horizon instead of the one-year horizon applied in the earnings simulation
model. As with earnings simulation modeling, assumptions about the timing and the variability of
balance sheet cash flows are critical in NPV analysis. Particularly important are assumptions driving
mortgage prepayments in both the loan and investment portfolios, and changes in the noncontractual
deposit portfolios. These assumptions are applied consistently in both models. Based on the September
30, 2007 NPV estimation, a 2% instantaneous increase in interest rates was estimated to decrease
NPV by 3.35%. NPV was estimated to decrease by 1.48% if rates immediately declined by 2%.
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|-24-
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|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, 2007, 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, 2007 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.
|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------

|-25-
|----



|PART II.        OTHER INFORMATION
Item 1.     Legal Proceedings
Not applicable.
|-------------------------------------------------------------------------------
|                                                                               

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

| | There are no material changes in the risk factors disclosed in the Companys 2006 Annual Report
  on Form 10-K for the fiscal year ended December 31, 2006.
| | -----------------------------------------------------------------------------------------------------------------------------------------------------------
| |                                                                                                                                                            

|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

|-26-
|----



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

| | Exhibits required by Item 601 of Regulation S-K:
| | ------------------------------------------------
| |                                                 

|Exhibit No. | Description
|----------- | -----------
|            |            
|           
|            | 3.1        
|            |            
|            | 3.2        
|            |            
|            | 4.1        
|            |            

| | 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                       

|-27-
|----



|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:  November 9, 2007 |  | /s/ Jack H. Webb                                                          
|                        |  |                                                                           
|                        |  | Jack H. Webb, Chairman of the Board, President and Chief Executive Officer
|                        |  |                                                                           
|DATE:  November 9, 2007 |  | /s/ J. Daniel Mohr                                                        
|                        |  |                                                                           
|                        |  | J. Daniel Mohr, Treasurer and Chief Financial Officer                     

|-28-
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