UNITED
STATES
SECURITIES AND EXCHANGE COMMISSIONWashington,
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 June 30, 2007ORo
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
  THE SECURITIES EXCHANGE ACT OF 1934For 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. Yes x    
      
      No o  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 July 30, 2007 was 4,783,509 shares.     TABLE
OF CONTENTS

Page Number(s)Part
  I. FINANCIAL INFORMATIONItem 1.
Financial Statements (All Unaudited)Consolidated Balance
  Sheets

3Consolidated Statements
  of Income

4Consolidated Statements
  of Changes in Shareholders Equity

5Consolidated Statements
  of Cash Flow

6Notes to Consolidated
  Financial Statements

7-9Item 2.
Managements Discussion
  and Analysis of Financial Condition and Results of Operations

10-23Item 3.
Quantitative and
  Qualitative Disclosures About Market Risk

24Item 4.
Controls and Procedures

25Part II. OTHER
INFORMATIONItem 1.
Legal Proceedings

26Item 1A.
Risk Factors

26Item 2.
Unregistered Sales of
  Equity Securities and Use of Proceeds

26Item 3.
Defaults Upon Senior
  Securities

26Item 4.
Submission of Matters
  to a Vote of Security Holders

26Item 5.
Other Information

26Item 6.
Exhibits

27Signatures


282

Alliance Financial Corporation and SubsidiariesConsolidated Balance Sheets (Unaudited)(In thousands, except share data)June 30, 2007

December 31, 2006AssetsCash and due
from banks


$
29,124



$
27,398Securities
available-for-sale



248,027




254,002Federal Home
Loan Bank of New York and Federal Reserve Bank stock



9,233




7,985Total loans
and leases, net of unearned income



886,887




882,566Less allowance
for loan and lease losses



7,538




7,029Net loans
and leases



879,349




875,537Premises and
equipment, net



19,284




20,125Accrued
interest receivable



4,533




4,605Bank-owned
life insurance



16,762




16,449Assets held
for sale



2,367




2,367Goodwill



33,626




33,456Intangible
assets, net



14,028




14,912Other
assets



16,854




16,131Total
assets


$
1,273,187



$
1,272,967LiabilitiesNon-interest-bearing deposits


$
126,606



$
129,575Interest-bearing deposits



802,686




806,021Total
deposits



929,292




935,596Borrowings



186,309




179,650Accrued
interest payable



2,968




2,651Other
liabilities



18,528




19,790Junior
subordinated obligations issued tounconsolidated subsidiary
  trusts



25,774




25,774Total
liabilities



1,162,871




1,163,461Shareholders
equityPreferred
stock (par value $25.00) 1,000,000 sharesauthorized, none
  issued.








Common stock
(par value $1.00) 10,000,000 shares authorized, 4,909,821
  and 4,894,994 shares issued; and 4,783,509and 4,800,512 shares
  outstanding, respectively



4,910




4,895Surplus



39,287




38,986Undivided
profits



73,181




70,658Accumulated
other comprehensive loss



(3,169
)



(2,122
)Treasury
stock, at cost; 126,312 and 94,482 shares, respectively



(3,893
)



(2,911
)Total
shareholders equity



110,316




109,506Total
liabilities & shareholders
  equity


$
1,273,187



$
1,272,967The
accompanying notes are an integral part of the consolidated financial statements.

3

Alliance Financial Corporation and SubsidiariesConsolidated Statements of Income (Unaudited)Three months ended
  June 30,

Six months ended
  June 30,2007


2006


2007


2006(Dollars
  in thousands, except share and per share data)Interest income:Interest and
fees on loans and leases

$
14,662

$
10,781

$
29,223

$
20,769Federal funds
sold and interest bearing deposits





49


3


108Securities


2,987


2,635


5,800


5,297Total interest
income


17,649


13,465


35,026


26,174Interest expense:Deposits:Savings
accounts


114


79


224


151Money market
accounts


1,587


1,258


3,140


2,436Time
accounts


5,106


3,758


9,989


6,927NOW
accounts


230


118


413


2017,037


5,213


13,766


9,715Borrowings:Repurchase
agreements


717


596


1,411


1,172FHLB
advances


1,356


911


2,747


1,816Junior
subordinated obligations


490


205


972


3962,563


1,712


5,130


3,384Total interest
expense


9,600


6,925


18,896


13,099Net interest
income


8,049


6,540


16,130


13,075Provision for
loan and lease losses


700


417


1,450


1,417Net interest
income after provision for loan and lease losses


7,349


6,123


14,680


11,658Non-interest
income:Trust and
brokerage income


2,281


2,232


4,498


4,480Service
charges on deposit accounts


1,288


980


2,540


1,937Card-related
fees


489


287


935


558Insurance
agency income


459





856


Income from
bank-owned life insurance


157


100


313


198Gain on the
sale of loans


39


33


83


46Rental income
from leases


50


203


126


416Other
non-interest income


449


306


950


537Total non-interest
income


5,212


4,141


10,301


8,172Non-interest
expense:Salaries and employee
benefits


4,563


3,902


8,997


7,819Occupancy and
equipment expense


1,705


1,545


3,527


3,033Communication
expense


217


126


409


261Stationery and
supplies expense


166


104


294


211Marketing
expense


426


206


716


603Amortization
of intangible assets


435


126


884


252Professional
fees


727


641


1,427


1,389Other
non-interest expense


1,378


1,073


2,684


1,978Total
non-interest expense


9,617


7,723


18,938


15,546Income before
income tax expense


2,944


2,541


6,043


4,284Income tax
expense


671


569


1,416


872Net income

$
2,273

$
1,972

$
4,627

$
3,412Share and per share
dataBasic average
shares outstanding


4,709,334


3,487,279


4,716,944


3,491,336Diluted
average shares outstanding


4,771,091


3,638,442


4,785,445


3,633,035Basic earnings
per share

$
0.48

$
0.57

$
0.98

$
0.98Diluted
earnings per share

$
0.48

$
0.54

$
0.97

$
0.94Cash dividends
declared

$
0.22

$
0.22

$
0.44

$
0.44The 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

TotalBalance at December 31,
2005


3,565,012


$ 3,979


$ 11,185


$
(1,453
)


$ 66,740


$
(1,700
)


$ (9,180
)
$
69,571Comprehensive incomeNet
income
















3,412










3,412Other
comprehensive income, net of taxes:Change in
unrealized appreciation in available for sale securities, net of reclassification adjustment




















(1,706
)





(1,706
)Comprehensive
income



























1,706Issuance of
restricted stock


24,000


24


712



(736
)













Forfeiture of
restricted stock


(8,995
)

(9
)

(268
)


274














(3
)Amortization
of restricted stock












174














174Tax benefit of
restricted stock plan
















9










9Stock options
exercised


409





9


















9Tax benefit of
stock-based compensation








300


















300Cash dividend,
$.44 per share
















(1,569
)









(1,569
)Treasury stock
purchased


(15,367
)




















(496
)

(496
)Reclassification of unearned restricted stock awards to surplus in
  accordance with SFAS No. 123R (75,875) shares








(1,741
)


1,741














Balance at June 30,
2006


3,565,059


$ 3,994


$ 10,197


$




$ 68,592


$
(3,406
)


$ (9,676
)
$
69,701Balance at December 31,
2006


4,800,512


$ 4,895


$ 38,986


$




$ 70,658


$
(2,122
)


$ (2,911
)
$
109,506Comprehensive incomeNet
income
















4,627










4,627Other
comprehensive income, net of taxes:Change in
unrealized appreciation in available-for-sale Securities, net
  of reclassification adjustment




















(1,155
)





(1,155
)Change in
pension liability




















108






108Comprehensive
income
















4,627



(1,047
)





3,580Issuance of
restricted stock


16,950


17


(17
)

















Forfeiture of
restricted stock


(10,150
)

(10
)

(80
)

















(90
)Amortization
of restricted stock








167


















167Tax benefit of
restricted stock plan








13


















13Stock options
exercised


8,027


8


170


















178Tax benefit of
stock-based compensation








48


















48Cash dividend,
$.44 per share
















(2,104
)









(2,104
)Treasury stock
purchased


(31,830
)




















(982
)

(982
)Balance at June 30,
2007


4,783,509


$ 4,910


$ 39,287


$




$ 73,181


$
(3,169
)


$ (3,893
)
$
110,316The accompanying
    notes are an integral part of the consolidated financial statements.
  -5-

Alliance Financial Corporation and
  SubsidiariesConsolidated Statements of Cash
  Flow (Unaudited)(In thousands)Six
          months ended June 30,2007
      
      2006Operating
          activities:Net
          income
      
      
      $
      4,627
      
      $
      3,412Adjustments
          to reconcile net income to net cash provided by operating activities:Provision
          for loan and lease losses
      
      
      
      1,450
      
      
      1,417Depreciation
          expense
      
      
      
      1,304
      
      
      1,342Increase
          in surrender value of life insurance
      
      
      
      (313
      )
      
      (198
      )(Benefit)
          provision for deferred income taxes
      
      
      
      (85
      )
      
      1,081Accretion
          of investment security discounts and premiums, net
      
      
      
      (75
      )
      
      (61
      )Net
          loss (gain) on sale of premises and equipment
      
      
      
      9
      
      
      (8
      )Proceeds
          from the sale of mortgage loans
      
      
      
      5,920
      
      
      1,680Origination
          of loans held-for-sale
      
      
      
      (5,837
      )
      
      (1,634
      )Gain
          on sale of loans
      
      
      
      (83
      )
      
      (46
      )Amortization
          of capitalized servicing rights
      
      
      
      146
      
      
      38Amortization
          of intangible assets
      
      
      
      884
      
      
      252Restricted
          stock expense
      
      
      
      77
      
      
      174Change
          in other assets and liabilities
      
      
      
      (955
      )
      
      (3,661
      )Net
          cash provided by operating activities
      
      
      
      7,069
      
      
      3,788Investing
          activities:Proceeds
          from maturities, redemptions, calls and principal repayments of investment
          securities, available-for-sale
      
      
      
      42,705
      
      
      35,088Purchase
          of investment securities available-for-sale
      
      
      
      (38,503
      )
      
      (16,973
      )Purchase
          of Federal Home Loan Bank (FHLB) and Federal Reserve Bank
          (FRB) stock
      
      
      
      (14,191
      )
      
      (4,382
      )Redemption
          of FHLB stock
      
      
      
      12,943
      
      
      5,457Net
          increase in loans and leases
      
      
      
      (5,328
      )
      
      (31,523
      )Purchases
          of premises and equipment
      
      
      
      (809
      )
      
      (998
      )Proceeds
          from the sale of premises and equipment
      
      
      
      337
      
      
      126Net
          cash used in lending and investing activities
      
      
      
      (2,846
      )
      
      (13,205
      )Financing
          activities:Net
          decrease in demand deposits, NOW and savings accounts
      
      
      
      (4,689
      )
      
      (2,652
      )Net
          (decrease) increase in time deposits
      
      
      
      (1,615
      )
      
      35,022Net
          decrease in short-term borrowings
      
      
      
      (3,341
      )
      
      (10,289
      )Payments
          on long-term borrowings
      
      
      
      (10,000
      )
      
      (35,000
      )Proceeds
          from long-term borrowings
      
      
      
      20,000
      
      
      25,000Proceeds
          from the exercise of stock options
      
      
      
      178
      
      
      9Treasury
          stock purchased
      
      
      
      (982
      )
      
      (496
      )Tax
          benefit of stock-based compensation
      
      
      
      61
      
      
      300Cash
          dividends
      
      
      
      (2,109
      )
      
      (1,538
      )Net
          cash (used) provided by deposit and financing activities
      
      
      
      (2,497
      )
      
      10,356Net
          increase in cash and cash equivalents
      
      
      
      1,726
      
      
      939Cash
          and cash equivalents at beginning of period
      
      
      
      27,398
      
      
      22,878Cash
          and cash equivalents at end of period
      
      
      $
      29,124
      
      $
      23,817Supplemental
          disclosures of cash flow information:Interest
          received during the period
      
      
      $
      35,098
      
      $
      26,710Interest
          paid during the period
      
      
      
      18,581
      
      
      13,409Income
          taxes
      
      
      
      928
      
      
      850Non-cash
          investing activities:Change
          in unrealized loss on available-for-sale securities
      
      
      
      (1,848
      )
      
      (2,706
      )Transfers
          of loans to other real estate and repossessed assets
      
      
      
      66
      
      
      13Non-cash
          financing activities:Dividend
          declared and unpaid
      
      
      
      1,052
      
      
      785The accompanying notes are an integral part of the
consolidated financial statements.

-6-

ALLIANCE FINANCIAL CORPORATIONNOTES TO CONSOLIDATED FINANCIAL STATEMENTS

A.
Basis of PresentationThe 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 six months ended June
  30, 2007 and 2006.B.
Earnings Per ShareBasic and diluted net income per common share
  calculations are as follows:For three
  months ended

For six
  months endedJune 30,

June 30,2007

2006

2007

2006(Dollars in thousands,
  except per share amounts)Basic:Net Income

$
2,273

$
1,972

$
4,627

$
3,412Average common shares outstanding


4,709,334


3,487,279


4,716,944


3,491,336Net income per common share  basic

$
0.48

$
0.57

$
0.98

$
0.98Diluted:Net income

$
2,273

$
1,972

$
4,627

$
3,412Average common shares outstanding


4,709,334


3,487,279


4,716,944


3,491,336Incremental
  shares from assumed conversion of stock options and restricted stock


61,757


151,163


68,501


141,699Average common
  shares outstanding  diluted


4,771,091


3,638,442


4,785,445


3,633,035Net income per
  common share  diluted

$
0.48

$
0.54

$
0.97

$
0.94Basic 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.

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

PensionThree months ended 
June 30,

Six months ended 
June 30,2007

2006

2007

2006(In thousands)Service cost

$


$  


$


$  Interest
  cost


60





120

Expected
  return on assets


(100
)




(200
)
Net periodic
  pension benefit

$
(40
)
$  


$
(80
)
$  Post-retirementThree months ended 
June 30,

Six months ended 
June 30,2007

2006

2007

2006(In thousands)Service cost

$
44

$
30

$
88

$
60Interest
  cost


86


72


173


141Amortization
  of unrecognized prior service cost


16


20


31


39Net periodic
  post-retirement cost

$
146

$
122

$
292

$
240E.
Income TaxesThe 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.

The Company or one of its subsidiaries files income tax returns in the
U.S. federal jurisdiction and various state jurisdictions. The Company is no
longer subject to U.S. federal or state income tax examinations by tax
authorities for tax years prior to 2003.

As of January 1, 2007, the Company has accrued $11,000 of interest
related to uncertain tax positions. As of June 30, 2007, the total amount of
accrued interest was $15,000. 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 following discussion presents material changes in the Companys
results of operations and financial condition during the three and six months
ended June 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 filingsOperating
results for the three months and six months ended June 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 SIX MONTHS ENDED JUNE 30, 2007

Earnings Summary and Executive Overview

Net income was $2.3 million, or $0.48 per diluted share in the second
quarter of 2007, an increase of $301,000, or 15.3% compared to net income of
$2.0 million or $0.54 per diluted share for the same period in 2006. The return
on average assets and return on average shareholders equity were 0.71% and
8.22%, respectively, for the three months ended June 30, 2007, compared with
0.80% and 11.30%, respectively, for the second quarter of 2006.

Net income was $4.6 million or $0.97 per diluted share for the six
months ended June 30, 2007, an increase of $1.2 million or 35.6% compared with
$3.4 million or $0.94 per diluted share for the six months ended June 30, 2006.
The return on average assets and return on average shareholders equity were
0.73% and 8.40%, respectively, for the six months ended June 30, 2007, compared
with 0.69% and 9.74%, respectively, for the same period in 2006.

The changes in net income and earnings per share in the three months
and six months ended June 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 and the increase in shares issued
and outstanding that resulted from the acquisition.

Analysis of Net Interest Income and the Net
Interest Margin

Net interest income totaled $8.0 million in
the three months ended June 30, 2007, an increase of $1.5 million compared with
the second quarter of 2006. Interest income increased $4.2 million or 31.1% in
the second quarter of 2007 compared with the year-ago quarter, while interest
expense increased $2.7 million or 38.6%.

The increase in net interest income resulted
primarily from an increase in average earning assets of $213.4 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 second quarter of 2007, compared with 72.4% in
the year-ago quarter. The higher portion 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 substantially offset an increase in
its cost of funds. The Companys tax-equivalent earning asset yield was 6.35%
in the second quarter of 2007, an increase of 38 basis points compared with
5.97% in the same quarter in 2006. The tax-equivalent earning asset yield was
6.30% in the first quarter of 2007.

The Companys cost of funds was 3.78% in the
second quarter of 2007, an increase of 39 basis points compared with 3.39% in
the second quarter of 2006. The Companys cost of funds was 3.67%
in the first 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. The average yield on the Companys time accounts in the second quarter
was 4.71% compared with 4.16% in the second quarter of 2006 and 4.60% in
the first quarter of 2007.

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 the
first half of 2007. Average commercial loans outstanding in the second quarter
of 2007 decreased $426,000 compared with the average outstanding in the first
quarter of 2007. Prepayments on several commercial relationships totaling
approximately $6.3 in the second quarter contributed to a $2.6 million decrease
in the balance at June 30, 2007 compared with March 31, 2007. Commercial loans
outstanding at June 30, 2007 have decreased $1.9 million compared with the
balance outstanding at December 31, 2006. 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 $4.3 million in the second quarter
of 2007 compared with the average in the first quarter of 2007, as we expanded
our mortgage origination operations in an effort to increase our

-11-

market share. This growth has come entirely from conventional mortgages
originated in our lending area. The Company has no exposure to sub-prime,
Alt-A, negative amortizing or other higher risk residential mortgages, as we do
not originate these types of loans.

Average deposits increased $170.9 million in the second quarter of 2007
compared with the second quarter of 2006 due primarily to the acquisition of
Bridge Street, and were up $7.3 million compared with the first quarter of
2007. Increases in average time deposits of $8.4 million and average demand and
savings accounts of $899,000 in the second quarter of 2007 compared with the
first quarter of 2007 offset a $2.0 million decline in average money market
accounts during the same period. Average time accounts represented 46.2% of
average deposits in the second quarter of 2007, compared with 47.1% in the year
ago quarter and 45.7% in the first quarter of 2007. Average savings and money
market accounts were 30.3% of average deposits in the second quarter, compared
with 29.9% in the second quarter of 2006 and 30.6% in the first quarter of
2007. Average demand deposits were 23.5% of average deposits in the second
quarter of 2007, compared with 23.0% in the second quarter of 2006, and 23.7%
in the first quarter of 2007.

Our tax-equivalent net interest margin was 3.01% in the quarter ended
June 30, 2007, which was unchanged from the second quarter of 2006. The
tax-equivalent net interest margin was 3.04% in the first quarter of 2007.

Net interest income was $16.1 million for the six months ended June 30,
2007, an increase of $3.1 million or 23.4% compared with the six months ended
June 30, 2006. Interest income
increased $8.9 million or 33.8% in the first half of 2007 compared with the
year-ago period, while interest expense increased $5.8 million or 44.3%.

The increase in net interest income resulted
primarily from an increase in average earning assets of $215.9 million compared
with the year-ago period. Changes in average earning assets and
average deposits and borrowings for the six months ended June 30, 2007 compared
with the year ago period showed trends similar to those for the second quarter
of 2007 compared the second quarter of 2006.

Our tax-equivalent net interest margin was 3.02% in the six months
ended June 30, 2007, compared with 3.03% in the year ago period.

We expect that the highly competitive loan and deposit pricing in our
markets will continue to influence our net interest margin in coming quarters.
However, based upon the weighted average yield of our time accounts in the
second quarter of 2007 and our current offering rates, it is likely that the
magnitude of upward repricing on our time deposits will be less than that was
experienced throughout 2006, absent an unforseen change in the Treasury yield
curve, competitive pricing or funding needs of the Company. As stated above,
the average yield on our time accounts was 4.71% in the second quarter of 2007,
which was slightly above the annual percentage yield being offered by the
Company for twelve month retail time accounts at June 30, 2007. This compares
with an average yield of 4.16% on time accounts in the second quarter of 2006,
which was slightly below the annual percentage yield being offered by the
Company for twelve month retail time accounts at June 30, 2006.

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 June 30,2007

2006Average
  Balance

Interest
  Earned/
  Paid

Yield
  Rate

Average
  Balance

Interest
  Earned/
  Paid

Yield
  Rate(Dollars in thousands)Assets:Interest earning
  assets:Federal funds
  sold


$




$






%


$
3,569



$
49




5.49
%Taxable
  investment securities



170,497




1,906




4.47
%



176,835




1,809




4.09
%Nontaxable
  investment securities



85,282




1,344




6.30
%



72,437




1,139




6.29
%FHLB and FRB
  stock



8,783




193




8.79
%



5,670




74




5.22
%Real estate
  loans



259,751




3,874




5.97
%



189,762




2,875




6.06
%Commercial
loans



212,776




4,265




8.02
%



157,774




3,219




8.16
%Nontaxable
  commercial loans



8,692




155




7.11
%



7,142




117




6.53
%Taxable leases
  (net of unearned discount)



111,526




1,964




7.04
%



54,740




940




6.87
%Nontaxable
leases
  (net of unearned discount)



20,210




297




5.88
%



21,056




258




4.89
%Indirect auto
  loans



180,782




2,445




5.41
%



179,734




2,219




4.94
%Consumer
loans



91,093




1,816




7.97
%



67,269




1,281




7.62
%Total
  Interest-earning assets


$
1,149,392



$
18,259




6.35
%


$
935,988



$
13,980




5.97
%Non-interest
  earning assets:Other
Assets



132,813














62,261Less: Allowance
  for loan and lease losses



(7,512
)













(5,114
)Net unrealized
  losses on securities available-for-sale



(1,863
)













(4,165
)Total
Assets


$
1,272,830













$
988,970Liabilities
  and shareholders equity:Interest bearing
  liabilities:Demand
deposits


$
95,575



$
230




0.96
%


$
83,021



$
118




0.57
%Savings
deposits



85,437




114




0.53
%



55,758




79




0.57
%MMDA
deposits



198,490




1,587




3.20
%



173,635




1,258




2.90
%Time
deposits



433,410




5,106




4.71
%



361,379




3,758




4.16
%Borrowings(1)



177,521




2,073




4.67
%



131,928




1,507




4.57
%Junior
  subordinated obligations issued to unconsolidated trusts



25,774




490




7.60
%



10,310




205




7.95
%Total
  interest-bearing liabilities


$
1,016,207



$
9,600




3.78
%


$
816,031



$
6,925




3.39
%Non-interest
  bearing liabilities:Demand deposits



125,239














93,507Other
  liabilities



20,708














9,646Shareholders
  equity



110,676














69,786Total
  liabilities and shareholders equity


$
1,272,830













$
988,970Net interest
  income (tax equivalent)







$
8,659













$
7,055Net interest
  margin (tax equivalent)













3.01
%













3.01
%Net interest
  rate spread













2.57
%













2.58
%Federal tax
  exemption on non-taxable investment securities, loans and leases included in
  interest income







$
610













$
515(1)          Includes mortgagors escrow funds

-13-

For the six months ended June 30,2007

2006Average
  Balance

Interest 
  Earned
  /Paid

Yield
  Rate

Average
  Balance

Interest
  Earned
  /Paid

Yield
  Rate(Dollars in thousands)Assets:Interest earning
  assets:Federal funds
  sold


$
141



$
3




4.26
%


$
4,358



$
108




4.96
%Taxable
  investment securities



169,828




3,736




4.40
%



181,225




3,651




4.03
%Nontaxable
  investment securities



85,507




2,661




6.22
%



72,731




2,271




6.25
%FHLB and FRB
  Stock



8,488




307




7.23
%



5,880




147




5.00
%Real estate
  loans



257,588




7,735




6.01
%



188,241




5,674




6.03
%Commercial
loans



213,037




8,474




7.96
%



155,834




6,051




7.77
%Nontaxable
  commercial loans



8,644




306




7.08
%



6,749




224




6.65
%Taxable leases
  (net of unearned discount)



111,058




3,943




7.10
%



50,916




1,707




6.71
%Nontaxable
  leases (net of unearned discount)



20,380




597




5.86
%



20,302




502




4.94
%Indirect
loans



181,214




4,852




5.35
%



176,569




4,324




4.90
%Consumer
loans



90,892




3,624




7.97
%



68,037




2,534




7.45
%Total
  interest-earning assets


$
1,146,777



$
36,238




6.32
%


$
930,842



$
27,193




5.84
%Non-interest
  earning assets:Other
assets



130,840














62,509Less: Allowance
  for loan and lease losses



(7,333
)













(5,056
)Net unrealized
  losses on securities available-for-sale



(1,937
)













(3,283
)Total assets


$
1,268,347













$
985,012Liabilities
  and shareholders equity:Interest bearing
  liabilities:Demand
deposits


$
96,027



$
413




0.86
%


$
84,451



$
201




0.48
%Savings
deposits



85,130




224




0.53
%



55,591




151




0.54
%MMDA
deposits



199,491




3,140




3.15
%



176,190




2,436




2.77
%Time
deposits



429,097




9,989




4.60
%



351,711




6,927




3.94
%Borrowings(1)



178,835




4,158




4.65
%



134,973




2,988




4.43
%Junior
  subordinated obligations issued to unconsolidated trusts



25,774




972




7.54
%



10,310




396




7.68
%Total
  interest-bearing liabilities


$
1,014,354



$
18,896




3.73
%


$
813,226



$
13,099




3.22
%Non-interest
  bearing liabilities:Demand
deposits



124,738














91,990Other
  liabilities



19,047














9,713Shareholders
  equity



110,208














70,083Total
  liabilities and shareholders equity


$
1,268,347













$
985,012Net interest
  income (tax equivalent)







$
17,342













$
14,094Net interest
  margin (tax equivalent)













3.02
%













3.03
%Net interest
  rate spread













2.59
%













2.62
%Federal tax
  exemption on non-taxable investment securities, loans and leases included in
  interest income







$
1,212













$
1,019(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
  June 30, 2007 compared to
  June 30, 2006
  Increase/(Decrease Due To

For the six months ended
  June 30, 2007 compared to
  June 30, 2006
  Increase/(Decrease) Due ToVolume

Rate

Net
  Change

Volume

Rate

Net
  Change(In thousands)Federal funds sold

$
(49
)
$


$
(49
)
$
(97
)
$
(8
)
$
(105
)Taxable investment
securities


(68
)

165


97


(240
)

325


85Non-taxable investment
securities


203


2


205


398


(8
)

390FHLB and FRB stock


55


64


119


80


80


160Real estate loans


1,051


(52
)

999


2,086


(25
)

2,061Commercial loans


1,112


(66
)

1,046


2,248


175


2,423Non-taxable commercial
loans


26


12


38


68


14


82Taxable leases (net of unearned
income)


988


36


1,024


2,076


160


2,236Non-taxable leases (net of
unearned income)


(12
)

51


39


2


93


95Indirect loans


14


212


226


119


409


528Consumer loans


465


70


535


881


209


1,090Total
interest-earning assets

$
3,785

$
494

$
4,279

$
7,621

$
1,424

$
9,045Interest-bearing demand
deposits

$
24

$
88

$
112

$
39

$
173

$
212Savings deposits


41


(6
)

35


79


(6
)

73MMDA deposits


189


140


329


344


360


704Time deposits


800


548


1,348


1,712


1,350


3,062Borrowings


527


39


566


995


175


1,170Junior subordinated obligations
issued to
  unconsolidated subsidiary trusts


301


(16
)

285


589


(13
)

576Total interest-bearing
liabilities

$
1,882

$
793

$
2,675

$
3,758

$
2,039

$
5,797Net interest
income tax equivalent

$
1,903

$
(299
)
$
1,604

$
3,863

$
(615
)
$
3,248-15-

Analysis of Asset Quality and the Provision and Allowance for Loan
  and Lease LossesWe 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 $5.5 million or 0.43% of total assets at June 30, 2007, compared with
  $5.6 million or 0.44% of total assets and $2.6 million or 0.21% of total
  assets at March 31, 2007 and December 31, 2006, respectively. Three
  relationships comprised most of the increase in nonperforming assets which
  occurred in the first quarter of 2007, the largest of which is a $1.2 million
  short-term secured commercial loan. The other two are secured commercial
  relationships totaling $1.1 million which were acquired as part of the
  acquisition of Bridge Street.At June 30,
  2007, delinquent loans and leases (30 days or more, including nonperforming
  loans and leases) totaled $12.7 million or 1.43% of total loans and leases,
  compared with $10.9 million or 1.23% at March 31, 2007 and $16.3 million or
  1.85% at December 31, 2006. The Company has no exposure to sub-prime, Alt-A,
  negative amortizing or other higher risk residential mortgages.The
  provision for loan and lease losses was $700,000 in the quarter ended June
  30, 2007, compared with $417,000 in the second quarter of 2006. Net
  charge-offs were $495,000 in the three months ended June 30, 2007, compared
  with $293,000 in the year-ago quarter. The provision for loan and lease
  losses was $1.5 million for the six months ended June 30, 2007, compared with
  $1.4 million in the year-ago period.The
  allowance for loan and lease losses was $7.5 million at June 30, 2007,
  compared with $7.3 million and $7.0 million at March 31, 2007 and December
  31, 2006, respectively. The ratio of the allowance for loan and lease losses
  to nonperforming loans and leases was 139.3% at June 30, 2007, compared with
  132.7% and 266.4% at March 31, 2007 and December 31, 2006, respectively. The
  ratio of the allowance for loan and lease losses to total loans and leases
  was 0.85% at June 30, 2007, compared with 0.83% and 0.80% at March 31, 2007
  and December 31, 2006, respectively.In addition
  to the nonperforming loans summarized in the following table, the Company has
  identified approximately $8.3 million in potential problem loans at June 30,
  2007 as compared to $6.0 million at March 31, 2007 and $6.7 million at
  December 31, 2006. Potential problem loans are loans that are currently
  performing, but possible credit problems of the borrowers causes management
  to have concerns as to the ability of the borrowers to comply with the loan
  repayment terms, and 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 June 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.June 30,
  2007

March 31,
  2007

December
  31, 2006(In
  thousands)Non-accruing loans and
leases:Residential
real estate loans


$
295



$
297



$
298Commercial
loans



3,486




2,874




1,248Leases



350




228




99Indirect
loans



40




84




63Other consumer
loans



231




280




141Total
non-accruing loans and leases



4,402




3,763




1,849Accruing loans and leases
delinquent 90 days or more



1,009




1,763




790Total
Non-performing loans and leases



5,411




5,526




2,639Other real estate and
repossessed assets



66




66




Total
non-performing assets


$
5,477



$
5,592



$
2,639Three months ended
  June 30,

Six months ended
  June 30,2007

2006

2007

2006(In
  thousands)Allowance for loan and lease
losses, beginning of period


$7,333


$5,046


$ 7,029


$ 4,960Loans and leases
charged-off


(818
)

(441
)

(1,453
)

(1,511
)Recoveries of loans and leases
previously charged-off


323


148


512


304Net loans and leases
charged-off


(495
)

(293
)

(941
)

(1,207
)Provision for loan and lease
losses


700


417


1,450


1,417Allowance for loan and lease
losses, end of period


$7,538


$5,170


$ 7,538


$ 5,170The
following table presents certain asset quality ratios for the periods
indicated:

For three
  months ended 
  June 30,

For six
  months ended
  June 30,2007


2006

2007

2006Net loans and leases
charged-off to average loans and leases,
  annualized


0.22
%


0.17
%


0.21
%


0.36
%Provision for loan and lease
losses to average loans and leases,
  annualized


0.32
%


0.25
%


0.33
%


0.43
%Allowance for loan and lease
losses to period-end loans and leases


0.85
%


0.76
%


0.85
%


0.76
%Allowance for loan and lease
losses to non-performing loans and leases


139.3
%


623.9
%


139.3
%


623.9
%Non-performing loans and leases
to period-end loans and leases


0.61
%


0.12
%


0.61
%


0.12
%Non-performing assets to
period-end assets


0.43
%


0.09
%


0.43
%


0.09
%-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 June 30,

Six months
  ended June 30,Change





Change2007

2006

$

%

2007

2006

$

%Trust and brokerage
income


$2,281


$2,232

$
49


2.20
%


$  4,498


$4,480

$
18


0.40
%Service charges on deposit
accounts


1,288


980


308


31.43
%


2,540


1,937


603


31.13
%Card-related fees


489


287


202


70.38
%


935


558


377


67.56
%Insurance agency
income


459





459


100.0
%


856





856


100.0
%Income from bank- owned life
insurance


157


100


57


57.00
%


313


198


115


58.08
%Gain on the sale of
loans


39


33


6


18.18
%


83


46


37


80.43
%Rental income from operating
leases


50


203


(153
)

(75.37
)%


126


416


(290
)

(69.71
)%Other non-interest
income


449


306


143


46.73
%


950


537


413


76.91
%Total non-interest
Income


$5,212


$4,141

$
1,071


25.86
%


$10,301


$8,172

$
2,129


26.05
%Non-interest
  income increased $1.1 million and $2.1 million in the three months and six
  months ended June 30, 2007 compared with the year-ago periods primarily as a
  result of the acquisition of Bridge Street. Rental income from leases
  decreased in the quarterly and semi-annual periods ended June 30, 2006
  compared with the year ago periods due to the declining balances in our
  operating leases. We ceased originating operating leases in early 2004, and
  as a result, rental income will continue to decline in the second half of
  2007, during which time substantially all of the remaining rental income from
  these leases will be recognized. Non-interest income (excluding gains and
  losses on sales of securities and disposal of assets) comprised 39.3% and
  39.0%, respectively, of revenue in the three months and six months ended June
  30, 2007 compared with 38.8% and 38.5%, respectively, in the year-ago
  periods.Non-interest ExpensesThe
  following table sets forth certain information on operating expenses for the
  periods indicated, dollars in thousands:For three
  months ended June 30,

For six
  months ended June 30,Change





Change2007

2006

$

%

2007

2006

$

%Salaries, wages and employee
benefits


$4,563


$3,902


$   661


16.94
%


$  8,997


$   7,819


$1,178


15.07
%Building, occupancy, and
equipment


1,705


1,545


160


10.36
%


3,527


3,033


494


16.29
%Communication expense


217


126


91


72.22
%


409


261


148


56.70
%Stationery and
supplies


166


104


62


59.62
%


294


211


83


39.34
%Marketing


426


206


220


106.80
%


716


603


113


18.74
%Amortization of intangible
assets


435


126


309


245.24
%


884


252


632


250.79
%Professional fees


727


641


86


13.42
%


1,427


1,389


38


2.74
%Other operating
expenses


1,378


1,073


305


28.42
%


2,684


1,978


706


35.69
%Total operating
expenses


$9,617


$7,723


$1,894


24.52
%


$18,938


$15,546


$3,392


21.82
%Non-interest
          expenses increased $1.9 million and $3.4 million in the three months
          and six months ended June 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.-18-

Marketing
expense increased in the quarter and year-to-date periods ended June 30, 2007
compared with 2006 due primarily to a higher proportion of 2007 marketing
related activities occurring in the second quarter, whereas 2006s expenses
were more concentrated in the first quarter.

The Companys
efficiency ratio was 72.5% and 71.7% in the three months and six months ended
June 30, 2007, compared with 72.3% and 73.2% in the prior year periods. Expense control will continue to be a high
priority for us in this operating environment. In excess of $4 million
of Bridge Streets pre-merger annualized expenses have been eliminated as a
result of its merger and integration into the Company, and we are continuing to focus our attention on further non-interest
expense reduction opportunities across our organization.

Income Taxes

The Companys
effective tax rate was 22.8% and 23.4% for the three months and six months
ended June 30, 2007, compared with 22.4% and 20.4% in the year-ago periods. The
higher effective tax rates in the current year periods was attributable to a
decrease in tax-exempt income as a percentage of total income due primarily to
the acquisition of Bridge Street. The differences from the statutory rate is
driven substantially by tax-exempt income.

ANALYSIS OF FINANCIAL CONDITION

Loans

Total loans
and leases (net of unearned income) were
$886.9 million at June 30, 2007, compared with $882.6 million at December 31,
2006. Commercial loans totaled $221.6 million or 25.0% of total loans
and leases at June 30, 2007, compared with $223.5 million or 25.3% of total
loans and leases at December 31, 2006. Prepayments of several commercial
relationships totaling $6.3 million in the second quarter offset otherwise
modest growth during the quarter. 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 $181.6 million and were 20.5% of total loans and leases at June 30,
2007, compared with $182.5 million or 20.7% of total loans and leases at
December 31, 2006. We have intentionally slowed 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:

June 30, 2007

Percent

December 31, 2006

PercentResidential
  real estate loans


$
262,911

29.6
%


$
253,825

28.8
%Commercial
  loans



221,649

25.0
%



223,527

25.3
%Leases (net
  of unearned income)



130,028

14.7
%



131,338

14.9
%Indirect
  loans



181,603

20.5
%



182,528

20.7
%Other
  consumer loans



90,696

10.2
%



91,348

10.3
%Total loans
& leases


$
886,887

100.0
%


$
882,566

100.0
%(Less)Allowance for
loan & lease losses



(7,538
)





(7,029
)Net loans and
leases


$
879,349





$
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:

June 30, 2007

December 31, 2006Amortized
  Cost

Fair
  Value

Amortized
  Cost

Fair
  ValueU.S. Treasury
obligations

$
6,974

$
6,320

$
6,839

$
6,420U.S. government-sponsored
corporations


61,102


60,299


62,178


61,452Mortgage-backed
securities


96,699


94,567


97,908


96,163Obligations of states and
political
  subdivisions


84,321


84,363


86,299


87,388Other equity
securities


2,443


2,478


2,442


2,579Total

$
251,539

$
248,027

$
255,666

$
254,002Net unrealized loss on
available-for-sale
  securities


(3,512
)




(1,664
)Total carrying value

$
248,027




$
254,002Our 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 increase in
unrealized losses on available-for-sale securities resulted
primarily from changes in market interest rates during the period.

Deposits

Total deposits
were $929.3 million at June 30, 2007, a decrease of $6.3 million from December
31, 2006. The Company did not experience any material changes in its deposit
base in the first half of 2007.

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

June 30, 2007

December 31, 2006Retail

Commercial

Municipal

Total

Percent

Retail

Commercial

Municipal

Total

PercentNon-interest   checking

$
34,149

$
89,165

$
3,292

$
126,606

13.6
%

$
34,236

$
90,667

$
4,672

$
129,575

13.9
%Interest checking


74,589


9,354


13,863


97,806

10.5
%


69,642


9,083


15,094


93,819

10.0
%Total checking


108,738


98,519


17,155


224,412

24.1
%


103,878


99,750


19,766


223,394

23.9
%Savings


76,954


6,221


1,790


84,965

9.2
%


77,888


6,436


1,701


86,025

9.2
%Money market


74,060


37,148


73,149


184,357

19.8
%


76,771


39,709


72,662


189,142

20.2
%Time deposits


361,893


22,665


51,000


435,558

46.9
%


367,614


27,876


41,545


437,035

46.7
%Total
deposits

$
621,645

$
164,553

$
143,094

$
929,292

100.0
%

$
626,151

$
173,771

$
135,674

$
935,596

100.0
%Liquidity

The Companys liquidity
primarily reflects the Banks ability to provide funds to meet loan and lease
requests, to accommodate possible outflows in deposits, to take advantage of
market interest rate opportunities, and to pay dividends to the company.
Funding loan and lease requests, providing for liability outflows, and managing
of interest rate fluctuations require continuous analysis in order to match the
maturities of specific categories of short-term loans and leases and
investments with specific types of deposits and borrowings. Liquidity is
normally considered in terms of the nature and mix of the Banks sources and
uses of funds. The Asset Liability Committee (ALCO) of the Bank is
responsible for implementing the policies and guidelines for the maintenance of
prudent levels of liquidity. Management believes, as of June 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 six months ended June 30, 2007, cash and cash
equivalents increased by $1.7 million, as net cash provided by operating
activities of $7.1 million exceeded the net cash used in lending and investing
and deposit and financing activities of $5.4 million. Net cash from operating
activities was primarily provided by net income in the amount of $4.6 million.
Net cash used in deposit and financing activities principally reflects a $6.3
million decrease in deposits, cash dividends of $2.1 million and treasury share
purchases of $982,000 in the six months ended June 30, 2007. The decreases were
partially offset by a net increase in borrowings of $6.7 million. Net cash used
in lending and investing activities primarily reflects a net increase in loans
and leases of $5.3 million, partly reduced by a net decrease in investment
securities of $3.0 million.

As a member of
the FHLB, the Bank is eligible to borrow up to an established credit limit
against certain residential mortgage loans and investment securities that have been
pledged as collateral. As of June 30, 2007, the Banks credit limit with the
FHLB was $200.4 million. The total of the Banks outstanding borrowings from
the FHLB on that date was $128.2 million.

Capital Resources

During the six
months ended June 30, 2007, shareholders equity increased $810,000. Net income
of $4.6 million was partially offset by dividends declared totaling $2.1
million ($0.44 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. Accumulated other
comprehensive loss increased $1.3 million due to an increase in unrealized
losses on securities available-for-sale. The increase in unrealized losses
resulted primarily from changes in market 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 (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 June 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 ProvisionsAmount

Ratio

Amount

Ratio(Dollars
  in thousands)As of June 30, 2007Total
  Capital (to risk-weighted assets)

$
98,405

11.29
%
$
87,177

>10.00
%Tier I
  Capital (to risk-weighted assets)


90,731

10.41
%

52,306

>6.00
%Tier I
  Capital (to average assets)


90,731

7.41
%

61,253

>5.00
%As of December 31, 2006Total
  Capital (to risk-weighted assets)

$
95,510

10.97
%
$
87,039

>10.00
%Tier I
  Capital (to risk-weighted assets)


88,215

10.14
%

52,223

>6.00
%Tier I
  Capital (to average assets)


88,215

7.34
%

60,103

>5.00
%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.

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.

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. Management 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.

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.

-23-

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 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 June
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 13.26% if short term interest rates
increase by 2%, and to increase 12.20% 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 June 30, 2007 NPV estimation, a 2% instantaneous increase in
interest rates was estimated to decrease NPV by 4.22%. NPV was estimated to
increase by 0.46% if rates immediately declined by 2%. Policy guidelines limit
the amount of the estimated increase/decline to 25% in a 2% rate change
scenario.

-24-

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 June
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 June 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
  applicableb)   Not
  applicablec)   Not
  applicableItem 3. Defaults Upon Senior Securities

Not
  applicable.Item 4. Submission of Matters to a Vote of
Security Holders

The Company
  held its Annual Meeting of Shareholders on May 15, 2007 (the Meeting).At the
  Meeting, each of the following persons was elected as a Class III Director
  whose term will expire at the 2010 Annual Meeting of Shareholders:VOTES
FOR
WITHHELD
NON-VOTESMary Pat
  Adams
4,023,501
66,622
691,436Samuel J.
  Lanzafame
4,023,454
66,669
691,436Lowell A.
  Seifter
4,053,631
36,492
691,436Jack H. Webb
4,019,162
70,961
691,436At the
  Meeting, the following person was elected as a Class II Director whose term
  will expire at the 2009 Annual Meeting of Shareholders:VOTES
FOR
WITHHELD
NON-VOTESDeborah F.
  Stanley
4,050,486
39,637
691,436Item 5. Other Information

Not
  applicable-26-

Item 6. Exhibits

Exhibits
  required by Item 601 of Regulation S-K:Exhibit No.

Description3.1

Amended and
  Restated Certificate of Incorporation of the Company (incorporated herein by
  reference to exhibit 3.1 to the Companys Registration Statement on Form S-4
  {Registration No. 333-62623} filed with the Commission on August 31, 1998, as
  amended)3.2

Amended and
  Restated Bylaws of the Company (incorporated herein by reference to exhibit
  3.2 to the Companys Current Report on Form 8-K {File No. 0-15366} filed with
  the Commission on September 3, 2004)4.1

Rights
  Agreement dated October 19, 2001 between Alliance Financial Corporation and
  American Stock Transfer & Trust Company, including the Certificate of
  Amendment to the companys Certificate of Incorporation, the form of Rights
  Certificate and the Summary of Rights attached thereto as Exhibits A, B, and
  C, respectively (incorporated herein by reference to exhibit 4.1 to the Companys
  Form 8-A12G filed with the Commission on October 25, 2001)31.1

Certification of Jack H. Webb, Chairman of the Board,
President and
  Chief Executive Officer of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley
  Act of 200231.2

Certification of J. Daniel Mohr, Treasurer and Chief
Financial
  Officer of the Registrant, pursuant to Section 302 of the Sarbanes-Oxley Act
  of 200232.1

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 200232.2

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 CORPORATIONDATE: August
  6, 2007
/s/ Jack H.
  WebbJack H.
  Webb, Chairman of the Board, Presidentand Chief Executive
  OfficerDATE: August
  6, 2007
/s/ J.
  Daniel MohrJ. Daniel
  Mohr, Treasurer and Chief Financial Officer.-28-