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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 June 30, 2008

OR



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

For the transition period from  to

Commission File Number: 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   ̈

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



|                        |  |   |  |                           |  |  
|----------------------- |  | - |  | ------------------------- |  | -
|Large Accelerated Filer |  |  ̈ |  | Accelerated Filer         |  | x
|                        |  |   | 
|Non-accelerated filer   |  |  ̈ |  | Smaller Reporting Company |  |  ̈

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the
Exchange Act).    Yes   ̈    No  x

The number of shares outstanding of the Registrants common stock, $1.00 par value, on July 31, 2008 was 4,634,860 shares.









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##### Table of Contents

TABLE OF CONTENTS



|         |  |                                                                                               |  |              
|-------- |  | --------------------------------------------------------------------------------------------- |  | -------------
|         |  |                                                                                               |  | PageNumber(s)
|Part I.  |  | FINANCIAL INFORMATION                                                                         |  |              
|         |  |                                                                                              
|         |  | Item 1. Financial Statements (All Unaudited)                                                  |  |              
|         |  |                                                                                              
|         |  | Consolidated Balance Sheets                                                                   |  | 3            
|         |  | Consolidated Statements of Income                                                             |  | 4            
|         |  | Consolidated Statements of Changes in Shareholders Equity                                    |  | 5            
|         |  | Consolidated Statements of Cash Flow                                                          |  | 6            
|         |  | Notes to Consolidated Financial Statements                                                    |  | 7-10         
|         |  |                                                                                              
|         |  | Item 2. Managements Discussion and Analysis of Financial Condition and Results of
Operations |  | 11-25        
|         |  |                                                                                              
|         |  | Item 3. Quantitative and Qualitative Disclosures About Market Risk                            |  | 25-26        
|         |  |                                                                                              
|         |  | Item 4. Controls and Procedures                                                               |  | 26           
|         |  |                                                                                              
|Part II. |  | OTHER INFORMATION                                                                             |  |              
|         |  |                                                                                              
|         |  | Item 1. Legal Proceedings                                                                     |  | 27           
|         |  |                                                                                              
|         |  | Item 1A.Risk Factors                                                                          |  | 27           
|         |  |                                                                                              
|         |  | Item 2. Unregistered Sales of Equity Securities and Use of Proceeds                           |  | 27           
|         |  |                                                                                              
|         |  | Item 3. Defaults Upon Senior Securities                                                       |  | 27           
|         |  |                                                                                              
|         |  | Item 4. Submission of Matters to a Vote of Security Holders                                   |  | 27           
|         |  |                                                                                              
|         |  | Item 5. Other Information                                                                     |  | 27           
|         |  |                                                                                              
|         |  | Item 6. Exhibits                                                                              |  | 28           
|         |  |                                                                                              
|         |  | Signatures                                                                                    |  | 29           



2



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Balance Sheets (Unaudited)



(In thousands, except share data)



|                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|---------------------------------------------------------------------------------------------------------------------------------------------------------------- |  | ------------ | --------- | - | ---------------- | - | --------- | -
|                                                                                                                                                                 |  | June 30,2008 |           |   | December 31,2007 |  
|Assets                                                                                                                                                           |  |              |           |   |                  |   |           |  
|Cash and due from banks                                                                                                                                          |  | $            | 28,564    |   |                  | $ | 30,704    |  
|Securities available-for-sale                                                                                                                                    |  |              | 269,389   |   |                  |   | 272,713   |  
|Federal Home Loan Bank of New York (FLHB) and Federal Reserve Bank (FRB) stock                                                                               |  |              | 11,029    |   |                  |   | 9,507     |  
|Loans and leases held-for-sale                                                                                                                                   |  |              | 807       |   |                  |   | 3,163     |  
|Loans and leases, net of unearned income                                                                                                                         |  |              | 902,305   |   |                  |   | 895,533   |  
|Allowance for credit losses                                                                                                                                      |  |              | 8,651     |   |                  |   | 8,426     |  
|                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Net loans and leases                                                                                                                                             |  |              | 893,654   |   |                  |   | 887,107   |  
|                                                                                                                                                                 |  |             
|Premises and equipment, net                                                                                                                                      |  |              | 21,187    |   |                  |   | 21,560    |  
|Accrued interest receivable                                                                                                                                      |  |              | 4,377     |   |                  |   | 4,501     |  
|Bank-owned life insurance                                                                                                                                        |  |              | 24,447    |   |                  |   | 17,084    |  
|Assets held for sale                                                                                                                                             |  |              | 724       |   |                  |   | 801       |  
|Goodwill                                                                                                                                                         |  |              | 32,318    |   |                  |   | 32,187    |  
|Intangible assets, net                                                                                                                                           |  |              | 12,360    |   |                  |   | 13,183    |  
|Other assets                                                                                                                                                     |  |              | 12,904    |   |                  |   | 14,771    |  
|                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total assets                                                                                                                                                     |  | $            | 1,311,760 |   |                  | $ | 1,307,281 |  
|                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|                                                                                                                                                                 |  |             
|Liabilities and shareholders equity                                                                                                                             |  |              |           |   |                  |   |           |  
|Liabilities                                                                                                                                                      |  |              |           |   |                  |   |           |  
|Deposits:                                                                                                                                                        |  |              |           |   |                  |   |           |  
|Non-interest-bearing deposits                                                                                                                                    |  | $            | 137,177   |   |                  | $ | 138,846   |  
|Interest-bearing deposits                                                                                                                                        |  |              | 790,273   |   |                  |   | 805,367   |  
|                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total deposits                                                                                                                                                   |  |              | 927,450   |   |                  |   | 944,213   |  
|Borrowings                                                                                                                                                       |  |              | 224,636   |   |                  |   | 201,929   |  
|Accrued interest payable                                                                                                                                         |  |              | 4,129     |   |                  |   | 3,903     |  
|Other liabilities                                                                                                                                                |  |              | 14,529    |   |                  |   | 15,902    |  
|Junior subordinated obligations issued to unconsolidated subsidiary trusts                                                                                       |  |              | 25,774    |   |                  |   | 25,774    |  
|                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total liabilities                                                                                                                                                |  |              | 1,196,518 |   |                  |   | 1,191,721 |  
|                                                                                                                                                                 |  |             
|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, 4,904,672 and 4,889,297 shares issued; and 4,639,160 and
4,710,885 shares outstanding, respectively |  |              | 4,905     |   |                  |   | 4,889     |  
|Surplus                                                                                                                                                          |  |              | 41,025    |   |                  |   | 38,847    |  
|Undivided profits                                                                                                                                                |  |              | 78,114    |   |                  |   | 75,844    |  
|Accumulated other comprehensive income                                                                                                                           |  |              | 647       |   |                  |   | 1,205     |  
|Directors stock-based deferred compensation plan: 80,867 shares                                                                                                 |  |              | (1,992    | ) |                  |   |          |  
|Treasury stock, at cost: 265,512 and 178,412 shares, respectively                                                                                                |  |              | (7,457    | ) |                  |   | (5,225    | )
|                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total shareholders equity                                                                                                                                       |  |              | 115,242   |   |                  |   | 115,560   |  
|                                                                                                                                                                 |  |              |           |   |                  |   |           |  
|Total liabilities & shareholders equity                                                                                                                         |  | $            | 1,311,760 |   |                  | $ | 1,307,281 |  
|                                                                                                                                                                 |  |              |           |   |                  |   |           |  

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



3



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Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Income (Unaudited)





|                                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|-------------------------------------------------------------------------- |  | --------------------------------------------- | ------ | ------------------------ | - | ------ |  | ---- | ------ |  | - | ------
|                                                                           |  | Three months endedJune 30,                    |        | Six months endedJune 30,
|                                                                           |  | 2008                                          |        | 2007                     |   | 2008   |  | 2007
|                                                                           |  | (Dollars in thousands, except per share data)
|Interest income:                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Interest and fees on loans and leases                                      |  | $                                             | 13,682 |                          | $ | 14,662 |  | $    | 27,836 |  | $ | 29,223
|Federal funds sold and interest bearing deposits                           |  |                                               | 43     |                          |   |       |  |      | 89     |  |   | 3     
|Securities                                                                 |  |                                               | 3,255  |                          |   | 2,987  |  |      | 6,606  |  |   | 5,800 
|                                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Total interest income                                                      |  |                                               | 16,980 |                          |   | 17,649 |  |      | 34,531 |  |   | 35,026
|                                                                           |  |                                               |        |                         
|Interest expense:                                                          |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Deposits:                                                                  |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Savings accounts                                                           |  |                                               | 112    |                          |   | 114    |  |      | 218    |  |   | 224   
|Money market accounts                                                      |  |                                               | 1,130  |                          |   | 1,587  |  |      | 2,516  |  |   | 3,140 
|Time accounts                                                              |  |                                               | 3,896  |                          |   | 5,106  |  |      | 8,550  |  |   | 9,989 
|NOW accounts                                                               |  |                                               | 173    |                          |   | 230    |  |      | 387    |  |   | 413   
|                                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Total deposits                                                             |  |                                               | 5,311  |                          |   | 7,037  |  |      | 11,671 |  |   | 13,766
|Borrowings:                                                                |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Repurchase agreements                                                      |  |                                               | 374    |                          |   | 717    |  |      | 864    |  |   | 1,411 
|FHLB advances                                                              |  |                                               | 1,451  |                          |   | 1,353  |  |      | 2,962  |  |   | 2,740 
|Mortgagors escrow funds                                                   |  |                                               | 11     |                          |   | 6      |  |      | 19     |  |   | 9     
|Junior subordinated obligations issued to unconsolidated subsidiary trusts |  |                                               | 326    |                          |   | 487    |  |      | 741    |  |   | 970   
|                                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Total interest expense                                                     |  |                                               | 7,473  |                          |   | 9,600  |  |      | 16,257 |  |   | 18,896
|                                                                           |  |                                               |        |                         
|Net interest income                                                        |  |                                               | 9,507  |                          |   | 8,049  |  |      | 18,274 |  |   | 16,130
|Provision for credit losses                                                |  |                                               | 1,311  |                          |   | 700    |  |      | 2,677  |  |   | 1,450 
|                                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Net interest income after provision for credit losses                      |  |                                               | 8,196  |                          |   | 7,349  |  |      | 15,597 |  |   | 14,680
|                                                                           |  |                                               |        |                         
|Non-interest income:                                                       |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Investment management income                                               |  |                                               | 2,250  |                          |   | 2,281  |  |      | 4,538  |  |   | 4,498 
|Service charges on deposit accounts                                        |  |                                               | 1,257  |                          |   | 1,288  |  |      | 2,490  |  |   | 2,540 
|Card-related fees                                                          |  |                                               | 543    |                          |   | 489    |  |      | 1,045  |  |   | 935   
|Insurance agency income                                                    |  |                                               | 482    |                          |   | 459    |  |      | 820    |  |   | 856   
|Income from bank-owned life insurance                                      |  |                                               | 204    |                          |   | 157    |  |      | 363    |  |   | 313   
|Gain on the sale of loans                                                  |  |                                               | 136    |                          |   | 39     |  |      | 162    |  |   | 83    
|Gain on sale of securities available-for-sale                              |  |                                               |       |                          |   |       |  |      | 137    |  |   |      
|Rental income from operating leases                                        |  |                                               | 68     |                          |   | 50     |  |      | 134    |  |   | 126   
|Other non-interest income                                                  |  |                                               | 347    |                          |   | 373    |  |      | 784    |  |   | 804   
|                                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Total non-interest income                                                  |  |                                               | 5,287  |                          |   | 5,136  |  |      | 10,473 |  |   | 10,155
|                                                                           |  |                                               |        |                         
|Non-interest expense:                                                      |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Salaries and employee benefits                                             |  |                                               | 4,912  |                          |   | 4,563  |  |      | 9,917  |  |   | 8,997 
|Occupancy and equipment expense                                            |  |                                               | 1,674  |                          |   | 1,705  |  |      | 3,397  |  |   | 3,527 
|Communication expense                                                      |  |                                               | 204    |                          |   | 217    |  |      | 402    |  |   | 409   
|Stationery and supplies expense                                            |  |                                               | 129    |                          |   | 166    |  |      | 237    |  |   | 294   
|Marketing expense                                                          |  |                                               | 278    |                          |   | 426    |  |      | 569    |  |   | 716   
|Amortization of intangible assets                                          |  |                                               | 415    |                          |   | 435    |  |      | 823    |  |   | 884   
|Professional fees                                                          |  |                                               | 621    |                          |   | 727    |  |      | 1,362  |  |   | 1,427 
|Other non-interest expense                                                 |  |                                               | 1,397  |                          |   | 1,302  |  |      | 2,718  |  |   | 2,538 
|                                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Total non-interest expense                                                 |  |                                               | 9,630  |                          |   | 9,541  |  |      | 19,425 |  |   | 18,792
|                                                                           |  |                                               |        |                         
|Income before income tax expense                                           |  |                                               | 3,853  |                          |   | 2,944  |  |      | 6,645  |  |   | 6,043 
|Income tax expense                                                         |  |                                               | 966    |                          |   | 671    |  |      | 1,682  |  |   | 1,416 
|                                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Net income                                                                 |  | $                                             | 2,887  |                          | $ | 2,273  |  | $    | 4,963  |  | $ | 4,627 
|                                                                           |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Net income per common share                                                |  |                                               |        |                          |   |        |  |      |        |  |   |       
|Basic earnings per share                                                   |  | $                                             | 0.63   |                          | $ | 0.48   |  | $    | 1.09   |  | $ | 0.98  
|Diluted earnings per share                                                 |  | $                                             | 0.63   |                          | $ | 0.48   |  | $    | 1.07   |  | $ | 0.97  
|Cash dividends declared per share                                          |  | $                                             | 0.24   |                          | $ | 0.22   |  | $    | 0.48   |  | $ | 0.44  

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



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Consolidated Statements of Changes in Shareholders Equity (Unaudited)



(Dollars in thousands)



|                                                                                                         |  |                                   |   |  |             |       |   |         |   |        |                  |  |   |                                            |   |  |                                      |        |   |               |   |        |       |  |   |        |   |  |   |         |  
|-------------------------------------------------------------------------------------------------------- |  | --------------------------------- | - |  | ----------- | ----- | - | ------- | - | ------ | ---------------- |  | - | ------------------------------------------ | - |  | ------------------------------------ | ------ | - | ------------- | - | ------ | ----- |  | - | ------ | - |  | - | ------- | -
|                                                                                                         |  | Issued andOutstandingCommonShares |   |  | CommonStock |       |   | Surplus |   |        | UndividedProfits |  |   | AccumulatedOtherComprehensive(Loss)/Income |   |  | DirectorsStock-basedCompensationPlan |        |   | TreasuryStock |   |        | Total | 
|Balance at December 31, 2006                                                                             |  | 4,800,512                         |   |  | $           | 4,895 |   |         | $ | 38,986 |                  |  | $ | 70,658                                     |   |  | $                                    | (2,122 | ) |               | $ |       |       |  | $ | (2,911 | ) |  | $ | 109,506 |  
|Comprehensive income                                                                                     |  |                                   |   |  |             |       |   |         |   |        |                  |  |   |                                            |   |  |                                      |        |   |               |   |        |       |  |   |        |   |  |   |         |  
|Net income                                                                                               |  |                                  |   |  |             |      |   |         |   |       |                  |  |   | 4,627                                      |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | 4,627   |  
|Other comprehensive income, net of taxes:                                                                |  |                                   |   |  |             |       |   |         |   |        |                  |  |   |                                            |   |  |                                      |        |   |               |   |        |       |  |   |        |   |  |   |         |  
|Change in unrealized gain in available-for-sale securities, net of reclassification adjustment           |  |                                  |   |  |             |      |   |         |   |       |                  |  |   |                                           |   |  |                                      | (1,155 | ) |               |   |       |       |  |   |       |   |  |   | (1,155  | )
|Change in accumulated unrealized losses and prior service costs for pension and post-retirement benefits |  |                                   |   |  |             |      |   |         |   |       |                  |  |   |                                           |   |  |                                      | 108    |   |               |   |       |       |  |   |       |   |  |   | 108     |  
|Comprehensive income                                                                                     |  |                                  |   |  |             |      |   |         |   |       |                  |  |   | 4,627                                      |   |  |                                      | (1,047 | ) |               |   |       |       |  |   |       |   |  |   | 3,580   |  
|Issuance of restricted stock                                                                             |  | 16,950                            |   |  |             | 17    |   |         |   | (17    | )                |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   |        |  
|Forfeiture of restricted stock                                                                           |  | (10,150                           | ) |  |             | (10   | ) |         |   | (80    | )                |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | (90     | )
|Amortization of restricted stock                                                                         |  |                                  |   |  |             |      |   |         |   | 167    |                  |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | 167     |  
|Tax benefit of restricted stock plan                                                                     |  |                                  |   |  |             |      |   |         |   | 13     |                  |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | 13      |  
|Stock options exercised                                                                                  |  | 8,027                             |   |  |             | 8     |   |         |   | 170    |                  |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | 178     |  
|Tax benefit of stock-based compensation                                                                  |  |                                  |   |  |             |      |   |         |   | 48     |                  |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | 48      |  
|Cash 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 | ) |  | $ | 110,316 |  
|                                                                                                         |  |                                   |   |  |             |       |   |         |   |        |                  |  |   |                                            |   |  |                                      |        |   |               |   |        |       |  |   |        |   |  |   |         |  
|                                                                                                         |  |                                   |   |  |             |       |   |        
|Balance at December 31, 2007                                                                             |  | 4,710,885                         |   |  | $           | 4,889 |   |         | $ | 38,847 |                  |  | $ | 75,844                                     |   |  | $                                    | 1,205  |   |               | $ |       |       |  | $ | (5,225 | ) |  | $ | 115,560 |  
|Comprehensive income                                                                                     |  |                                   |   |  |             |       |   |         |   |        |                  |  |   |                                            |   |  |                                      |        |   |               |   |        |       |  |   |        |   |  |   |         |  
|Net income                                                                                               |  |                                  |   |  |             |      |   |         |   |       |                  |  |   | 4,963                                      |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | 4,963   |  
|Other comprehensive income, net of taxes:                                                                |  |                                   |   |  |             |       |   |         |   |        |                  |  |   |                                            |   |  |                                      |        |   |               |   |        |       |  |   |        |   |  |   |         |  
|Change in unrealized gain in available-for-sale securities (net of tax)                                  |  |                                  |   |  |             |      |   |         |   |       |                  |  |   |                                           |   |  |                                      | (584   | ) |               |   |       |       |  |   |       |   |  |   | (584    | )
|Change in accumulated unrealized losses and prior service costs for pension and post-retirement benefits |  |                                  |   |  |             |      |   |         |   |       |                  |  |   |                                           |   |  |                                      | (1     | ) |               |   |       |       |  |   |       |   |  |   | (1      | )
|Comprehensive income                                                                                     |  |                                  |   |  |             |      |   |         |   |       |                  |  |   | 4,963                                      |   |  |                                      | (585   | ) |               |   |       |       |  |   |       |   |  |   | 4,378   |  
|Cumulative effect of change in pension measurement date                                                  |  |                                  |   |  |             |      |   |         |   |       |                  |  |   |                                           |   |  |                                      | 27     |   |               |   |       |       |  |   |       |   |  |   | 27      |  
|Cumulative effect of change in accounting for adoption of EITF 06-4                                      |  |                                  |   |  |             |      |   |         |   |       |                  |  |   | (462                                       | ) |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | (462    | )
|Issuance of restricted stock                                                                             |  | 15,500                            |   |  |             | 16    |   |         |   | (16    | )                |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   |        |  
|Forfeiture of restricted stock                                                                           |  | (125                              | ) |  |             |      |   |         |   | (2     | )                |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | (2      | )
|Amortization of restricted stock                                                                         |  |                                  |   |  |             |      |   |         |   | 185    |                  |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | 185     |  
|Tax benefit of restricted stock plan                                                                     |  |                                  |   |  |             |      |   |         |   | 17     |                  |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | 17      |  
|Tax benefit of stock-based compensation                                                                  |  |                                  |   |  |             |      |   |         |   | 2      |                  |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | 2       |  
|Cash dividend, $0.48 per share                                                                           |  |                                  |   |  |             |      |   |         |   |       |                  |  |   | (2,231                                     | ) |  |                                      |       |   |               |   |       |       |  |   |       |   |  |   | (2,231  | )
|Directors deferred stock plan stock purchases                                                           |  |                                  |   |  |             |      |   |         |   | 1,992  |                  |  |   |                                           |   |  |                                      |       |   |               |   | (1,992 | )     |  |   |       |   |  |   |        |  
|Treasury stock purchased                                                                                 |  | (87,100                           | ) |  |             |      |   |         |   |       |                  |  |   |                                           |   |  |                                      |       |   |               |   |       |       |  |   | (2,232 | ) |  |   | (2,232  | )
|                                                                                                         |  |                                   |   |  |             |       |   |         |   |        |                  |  |   |                                            |   |  |                                      |        |   |               |   |        |       |  |   |        |   |  |   |         |  
|Balance at June 30, 2008                                                                                 |  | 4,639,160                         |   |  | $           | 4,905 |   |         | $ | 41,025 |                  |  | $ | 78,114                                     |   |  | $                                    | 647    |   |               | $ | (1,992 | )     |  | $ | (7,457 | ) |  | $ | 115,242 |  
|                                                                                                         |  |                                   |   |  |             |       |   |         |   |        |                  |  |   |                                            |   |  |                                      |        |   |               |   |        |       |  |   |        |   |  |   |         |  

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



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Alliance Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flow (Unaudited)





|                                                                                                                  |  |                           |         |   |      |   |         |  
|----------------------------------------------------------------------------------------------------------------- |  | ------------------------- | ------- | - | ---- | - | ------- | -
|                                                                                                                  |  | Six months ended June 30, |        
|                                                                                                                  |  | 2008                      |         |   | 2007 |  
|                                                                                                                  |  | (In thousands             |        
|Operating Activities:                                                                                             |  |                           |         |   |      |   |         |  
|Net Income                                                                                                        |  | $                         | 4,963   |   |      | $ | 4,627   |  
|                                                                                                                  |  |                          
|Adjustments to reconcile net income to net cash provided by operating activities:                                 |  |                           |         |   |      |   |         |  
|Provision for credit losses                                                                                       |  |                           | 2,677   |   |      |   | 1,450   |  
|Depreciation expense                                                                                              |  |                           | 1,265   |   |      |   | 1,304   |  
|Increase in surrender value of life insurance                                                                     |  |                           | (363    | ) |      |   | (313    | )
|Benefit for deferred income taxes                                                                                 |  |                           |        |   |      |   | (85     | )
|Amortization (accretion) of investment security discounts and premiums, net                                       |  |                           | 127     |   |      |   | (75     | )
|Net gain on sale of securities available-for-sale                                                                 |  |                           | (137    | ) |      |   |        |  
|Net loss on sale of premises and equipment                                                                        |  |                           | 2       |   |      |   | 9       |  
|Proceeds from the sale of loans and leases held-for-sale                                                          |  |                           | 21,720  |   |      |   | 5,920   |  
|Origination of loans held-for-sale                                                                                |  |                           | (8,543  | ) |      |   | (5,837  | )
|Gain on sale of loans held-for-sale                                                                               |  |                           | (42     | ) |      |   | (29     | )
|Write-down of leases transferred to held-for-sale                                                                 |  |                           | 160     |   |      |   |        |  
|Gain on sale of assets held-for-sale                                                                              |  |                           | (99     | ) |      |   |        |  
|Gain on foreclosed real estate                                                                                    |  |                           | (30     | ) |      |   |        |  
|Amortization of capitalized servicing rights                                                                      |  |                           | 142     |   |      |   | 146     |  
|Amortization of intangible assets                                                                                 |  |                           | 823     |   |      |   | 884     |  
|Restricted stock expense                                                                                          |  |                           | 185     |   |      |   | 77      |  
|Change in other assets and liabilities                                                                            |  |                           | 2,375   |   |      |   | (1,009  | )
|                                                                                                                  |  |                           |         |   |      |   |         |  
|Net cash provided by operating activities                                                                         |  |                           | 25,225  |   |      |   | 7,069   |  
|                                                                                                                  |  |                          
|Lending and Investing Activities:                                                                                 |  |                           |         |   |      |   |         |  
|Proceeds from maturities, redemptions, calls and principal repayments of investment securities
available-for-sale |  |                           | 59,494  |   |      |   | 42,705  |  
|Proceeds from sales of investment securities available-for-sale                                                   |  |                           | 6,299   |   |      |   |        |  
|Purchase of investment securities available-for-sale                                                              |  |                           | (63,410 | ) |      |   | (38,503 | )
|Purchase of FHLB and FRB stock                                                                                    |  |                           | (10,068 | ) |      |   | (14,191 | )
|Redemption of FHLB stock                                                                                          |  |                           | 8,545   |   |      |   | 12,943  |  
|Net increase in loans and leases                                                                                  |  |                           | (20,283 | ) |      |   | (5,328  | )
|Purchases of premises and equipment                                                                               |  |                           | (919    | ) |      |   | (809    | )
|Proceeds from the sale of premises and equipment                                                                  |  |                           | 25      |   |      |   | 337     |  
|Proceeds from disposition of foreclosed assets                                                                    |  |                           | 291     |   |      |   |        |  
|Proceeds from assets held-for-sale                                                                                |  |                           | 176     |   |      |   |        |  
|Purchase of bank-owned life insurance                                                                             |  |                           | (7,000  | ) |      |   |        |  
|                                                                                                                  |  |                           |         |   |      |   |         |  
|Net cash used in lending and investing activities                                                                 |  |                           | (26,850 | ) |      |   | (2,846  | )
|                                                                                                                  |  |                          
|Deposit and Financing Activities:                                                                                 |  |                           |         |   |      |   |         |  
|Net increase (decrease) in demand deposits, NOW and savings accounts                                              |  |                           | 20,304  |   |      |   | (4,689  | )
|Net decrease in time deposits                                                                                     |  |                           | (37,067 | ) |      |   | (1,615  | )
|Net decrease in short-term borrowings                                                                             |  |                           | (12,293 | ) |      |   | (3,341  | )
|Proceeds from long-term borrowings                                                                                |  |                           | 50,000  |   |      |   | 20,000  |  
|Payments on long-term borrowings                                                                                  |  |                           | (15,000 | ) |      |   | (10,000 | )
|Proceeds from the exercise of stock options                                                                       |  |                           |        |   |      |   | 178     |  
|Treasury stock purchased                                                                                          |  |                           | (2,232  | ) |      |   | (982    | )
|Tax benefit of stock-based compensation                                                                           |  |                           | 17      |   |      |   | 61      |  
|Purchase of shares for directors deferred stock-based plan                                                       |  |                           | (1,992  | ) |      |   |        |  
|Cash dividends                                                                                                    |  |                           | (2,252  | ) |      |   | (2,109  | )
|                                                                                                                  |  |                           |         |   |      |   |         |  
|Net cash provided by deposit and financing activities                                                             |  |                           | (515    | ) |      |   | (2,497  | )
|                                                                                                                  |  |                           |         |   |      |   |         |  
|Net (decrease) increase in cash and cash equivalents                                                              |  |                           | (2,140  | ) |      |   | 1,726   |  
|Cash and cash equivalents at beginning of period                                                                  |  |                           | 30,704  |   |      |   | 27,398  |  
|                                                                                                                  |  |                           |         |   |      |   |         |  
|Cash and cash equivalents at end of period                                                                        |  | $                         | 28,564  |   |      | $ | 29,124  |  
|                                                                                                                  |  |                           |         |   |      |   |         |  
|                                                                                                                  |  |                          
|Supplemental Disclosures of Cash Flow Information:                                                                |  |                           |         |   |      |   |         |  
|Interest received during the period                                                                               |  | $                         | 34,655  |   |      | $ | 35,098  |  
|Interest paid during the period                                                                                   |  |                           | 16,031  |   |      |   | 18,581  |  
|Income taxes                                                                                                      |  |                           | 273     |   |      |   | 928     |  
|Non-cash investing activities:                                                                                    |  |                           |         |   |      |   |         |  
|Change in unrealized gain/loss on available-for-sale securities                                                   |  |                           | (952    | ) |      |   | (1,848  | )
|Transfer of leases to held-for-sale                                                                               |  |                           | 10,819  |   |      |   |        |  
|Transfer of loans to other real estate and repossessed assets                                                     |  |                           | 240     |   |      |   | 66      |  
|Non-cash financing activities:                                                                                    |  |                           |         |   |      |   |         |  
|Dividend declared and unpaid                                                                                      |  |                           | 1,114   |   |      |   | 1,052   |  

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



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##### Table of Contents

Alliance Financial Corporation and Subsidiaries

Notes 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, 2007 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, 2007. 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, 2008 and 2007.



|B. | Earnings Per Share
|-- | ------------------

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



|                                                                                 |  |                                                  |           |                              |   |           |  |      |           |  |   |          
|-------------------------------------------------------------------------------- |  | ------------------------------------------------ | --------- | ---------------------------- | - | --------- |  | ---- | --------- |  | - | ---------
|                                                                                 |  | For three months endedJune 30,                   |           | For six months endedJune 30,
|                                                                                 |  | 2008                                             |           | 2007                         |   | 2008      |  | 2007
|                                                                                 |  | (Dollars in thousands, except per share amounts)
|Basic:                                                                           |  |                                                  |           |                              |   |           |  |      |           |  |   |          
|Net Income                                                                       |  | $                                                | 2,887     |                              | $ | 2,273     |  | $    | 4,963     |  | $ | 4,627    
|                                                                                 |  |                                                  |           |                              |   |           |  |      |           |  |   |          
|Average common shares outstanding                                                |  |                                                  | 4,556,157 |                              |   | 4,709,334 |  |      | 4,567,092 |  |   | 4,716,944
|Net income per common share  basic                                              |  | $                                                | 0.63      |                              | $ | 0.48      |  | $    | 1.09      |  | $ | 0.98     
|                                                                                 |  |                                                  |           |                              |   |           |  |      |           |  |   |          
|                                                                                 |  |                                                  |           |                             
|Diluted:                                                                         |  |                                                  |           |                              |   |           |  |      |           |  |   |          
|Net income                                                                       |  | $                                                | 2,887     |                              | $ | 2,273     |  | $    | 4,963     |  | $ | 4,627    
|                                                                                 |  |                                                  |           |                              |   |           |  |      |           |  |   |          
|Average common shares outstanding                                                |  |                                                  | 4,556,157 |                              |   | 4,709,334 |  |      | 4,567,092 |  |   | 4,716,944
|Incremental shares from assumed conversion of stock options and restricted stock |  |                                                  | 57,569    |                              |   | 61,757    |  |      | 57,768    |  |   | 68,501   
|                                                                                 |  |                                                  |           |                              |   |           |  |      |           |  |   |          
|Average common shares outstanding  diluted                                      |  |                                                  | 4,613,726 |                              |   | 4,771,091 |  |      | 4,624,860 |  |   | 4,785,445
|Net income per common share  diluted                                            |  | $                                                | 0.63      |                              | $ | 0.48      |  | $    | 1.07      |  | $ | 0.97     
|                                                                                 |  |                                                  |           |                              |   |           |  |      |           |  |   |          

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 give 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 six months ended June 30, 2008, 66,055 and 1,000, respectively, anti-dilutive stock options were excluded from the diluted weighted average common share calculations.



|C. | Allowance for Credit Losses
|-- | ---------------------------

The
allowance for credit losses represents managements best estimate of probable credit losses in the Companys loan portfolio. Managements quarterly evaluation of the allowance for credit 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, 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,



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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 or repossession of collateral is assured and is in process.



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

The 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 2008.

Prior to
September 30, 2007, post-retirement medical and life insurance benefits were available to full-time employees who had worked 15 years and attained age 55. Subsequent to the acquisition of Bridge Street, benefits for the Bridge Street active
participants were converted to those under the Companys plan. Retirees and certain active employees with more than 20 years of service to the Company continue to receive benefits in accordance with plans that existed at First National Bank of
Cortland and Oneida Valley National Bank, prior to the merger of the banks in 1998. At September 30, 2007, the Company settled (the Settlement) the post-retirement benefits for certain active participants that met age and service
criteria at that time. In addition, a negative plan amendment (Negative Amendment) was adopted for all other active participants who did not meet the age and service criteria. The Settlement and the Negative Amendment eliminated
post-retirement benefits for all active employees. The only remaining participants in the plan after September 30, 2007 are retired participants and their spouses, if applicable.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





The components of the plans net periodic cost for the periods indicated are as follows:



|                                                          |  |                            |      |   |                          |   |      |      |  |   |      |   |  |   |      |  
|--------------------------------------------------------- |  | -------------------------- | ---- | - | ------------------------ | - | ---- | ---- |  | - | ---- | - |  | - | ---- | -
|                                                          |  | Pension                    |     
|                                                          |  | Three months endedJune 30, |      |   | Six months endedJune 30, |  
|                                                          |  | 2008                       |      |   | 2007                     |   |      | 2008 |  |   | 2007 |  
|                                                          |  | (In thousands)             |     
|Interest cost                                             |  | $                          | 64   |   |                          | $ | 60   |      |  | $ | 128  |   |  | $ | 120  |  
|Expected return on assets                                 |  |                            | (108 | ) |                          |   | (100 | )    |  |   | (216 | ) |  |   | (200 | )
|                                                          |  |                            |      |   |                          |   |      |      |  |   |      |   |  |   |      |  
|Net periodic pension benefit                              |  | $                          | (44  | ) |                          | $ | (40  | )    |  | $ | (88  | ) |  | $ | (80  | )
|                                                          |  |                            |      |   |                          |   |      |      |  |   |      |   |  |   |      |  
|                                                          | 
|                                                          |  | Post-retirement            |     
|                                                          |  | Three months endedJune 30, |      |   | Six months endedJune 30, |  
|                                                          |  | 2008                       |      |   | 2007                     |   |      | 2008 |  |   | 2007 |  
|                                                          |  | (In thousands)             |     
|Service cost                                              |  | $                          |     |   |                          | $ | 44   |      |  | $ |     |   |  | $ | 88   |  
|Interest cost                                             |  |                            | 60   |   |                          |   | 86   |      |  |   | 120  |   |  |   | 173  |  
|Amortization of unrecognized prior service cost (benefit) |  |                            | (11  | ) |                          |   | 16   |      |  |   | (22  | ) |  |   | 31   |  
|                                                          |  |                            |      |   |                          |   |      |      |  |   |      |   |  |   |      |  
|Net periodic post-retirement cost                         |  | $                          | 49   |   |                          | $ | 146  |      |  | $ | 98   |   |  | $ | 292  |  
|                                                          |  |                            |      |   |                          |   |      |      |  |   |      |   |  |   |      |  



|E. | Fair Value Measurements
|-- | -----------------------

Effective
January 1, 2008, the Company adopted Statement of Financial Accounting Standards (SFAS) No. 157, Fair Value Measurements (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value under
accounting principles generally accepted in the United States (GAAP) and enhances disclosures about fair value measurements. Fair value is defined under SFAS 157 as the exchange price that would be received for an asset or paid to transfer a
liability in the principal or most advantageous market in an orderly transaction between market participants at the measurement date. There was no cumulative effect adjustment in adopting SFAS 157.

In February 2008, the FASB issued FASB Staff Position (FSP) No. FAS 157-2, Effective Date of FASB Statement No. 157. This FSP delays the
effective date of FAS 157 for all nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value on a recurring basis (at least annually) to fiscal years beginning after November 15, 2008, and
interim periods within those fiscal years.

In February 2007, the FASB issued Statement No. 159, The Fair Value Option for Financial
Assets and Financial Liabilities. The standard provides companies with an option to report selected financial assets and liabilities at fair value and establishes presentation and disclosure requirements designed to facilitate comparisons between
companies that choose different measurement attributes for similar types of assets and liabilities. The new standard is effective for the Company on January 1, 2008. The Company did not elect the fair value option for any financial assets or
financial liabilities as of January 1, 2008.

SFAS 157 defines fair value as the exchange price that would be received for an asset or
paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. SFAS 157 also establishes a fair value hierarchy
which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

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

Level 2  Significant other observable inputs other than Level 1 prices, such as quoted prices for similar assets
or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.



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Alliance Financial Corporation and Subsidiaries

Notes to Consolidated Financial Statements





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

The Company used the following methods and
significant assumptions to estimate fair value:

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

Loans held-for-sale  The fair value of loans held-for-sale is determined, when possible, using quoted secondary-market prices. If no such quoted price exists, the fair value of a loan is
determined using quoted prices for a similar asset or assets, adjusted for the specific attributes of that loan.

Leases held-for-sale
 The fair value of leases held-for-sale is primarily determined using an unadjusted quoted price for those leases, when available. If no such quoted price exists, the fair value of a lease is determined using quoted prices for a similar asset
or assets, adjusted for the specific attributes of that lease.

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

Securities
available-for-sale are measured at fair value on a recurring basis. At June 30, 2008, $1.0 million and $279.4 million were measured using Level 1 and Level 2 inputs, respectively within the fair value hierarchy.



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##### Table of Contents

|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, 2008, 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 credit market conditions;
| | - |  | ------------------------------------



| |  |  | 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 six months ended June 30, 2008 are not necessarily indicative of the results that may be expected for the
year ending December 31, 2008.

Comparison of Operating Results for the Three and Six Months Ended June 30, 2008 and 2007

General

Net
income was $2.9 million, or $0.63 per diluted share in the second quarter of 2008, an increase of $614,000, or 27.0% compared to net income of $2.3 million or $0.48 per diluted share for the same period in 2007. The return on average assets and
return on average shareholders equity were 0.87% and 9.93%, respectively, for the three months ended June 30, 2008, compared with 0.71% and 8.22%, respectively, for the second quarter of 2007.

Net income was $5.0 million or $1.07 per diluted share for the six months ended June 30, 2008, an increase of $336,000 or 7.3 % compared with
$4.6 million or $0.97 per diluted share for the six months ended June 30, 2007. The return on average assets and return on average shareholders equity were 0.75% and 8.54%, respectively, for the six months ended June 30, 2008,
compared with 0.73% and 8.40%, respectively, for the same period in 2007.

The changes in net income and earnings per share in the three
months and six months ended June 30, 2008 reflect higher net interest income which offset higher credit costs, and tight control of expenses.

Net Interest Income



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Net interest income totaled $9.5 million in the three months ended June 30, 2008, an increase of
$1.5 million compared with the second quarter of 2007. Interest income decreased $669,000 or 3.8% in the second quarter of 2008 compared with the year-ago quarter, and interest expense decreased $2.1 million or 22.2%.

The Companys tax-equivalent net interest margin increased 38 basis points in the second quarter compared with the year-ago quarter, and was up 24
basis points compared with the first quarter of 2008. The net interest margin on a tax-equivalent basis was 3.39% in the second quarter of 2008, compared with 3.01% in the second quarter of 2007 and 3.15% in the first quarter of 2008. The increase
in the Companys net interest margin was the result of a decrease in the Companys cost of funds by 96 basis points in the second quarter compared with the year-ago quarter, which was partly offset by a decrease in the tax-equivalent
earning asset yield of 46 basis points over the same period.

Average interest-earning assets increased $44.9 million in the second quarter
compared with the year-ago period, due primarily to growth in the securities and residential mortgage portfolios. Loans and leases comprised 75.4% of average interest-earning assets in the second quarter, compared with 77.0% in the second quarter of
2007. The slightly lower proportion of earning assets in loans and leases, combined with general downward repricing of the Companys earning-assets as a result of lower short-term interest rates, contributed to a decrease in the Companys
tax-equivalent earning asset yield to 5.89% in 2008, compared with 6.35% in the year-ago quarter and 6.12% in the first quarter of 2008. The yield on consumer loans has been most affected by the drop in short-term interest rates. Home equity lines
of credit comprised approximately $55.6 million or 62% of the average consumer loan portfolio in the second quarter. The rates on these accounts, which are indexed to the prime rate and adjust monthly, have decreased 300 basis points since the
fourth quarter of 2007 due to the drop in the federal funds rate during this period.

The Companys cost of funds was 2.82% in the
second quarter, compared with 3.78% in the year-ago quarter and 3.35% in the first quarter of 2008. The Companys wholesale funding costs have dropped considerably in the second quarter due to lower market interest rates. The Company has also
been actively managing its deposit costs by lowering offering rates on most demand, money market and time account products. As a result of these deposit pricing strategies and lower market interest rates, the Company has significantly reduced its
deposit costs in the second quarter of 2008 compared with the year-ago quarter, including a 76 basis point reduction in time deposit yields and a 122 basis point reduction in the yield on money market accounts.

The growth in average interest-earning assets was funded by higher interest-bearing demand and money market accounts and borrowings. Average time
accounts decreased $38.9 million compared with the second quarter of 2007 and comprised 37.3% of total average interest-bearing liabilities in the second quarter, compared with 42.6% in the year-ago quarter. Much of the decrease in time deposits
occurred in the first quarter of 2008, as retention of maturing retail time deposits in the first quarter was lower than the first quarter of 2007 due in large part to the significant difference between the rates on accounts which matured or
repriced during this period and the Companys current offering rates. During the first quarter, the net decrease in retail time deposits (excluding brokered time deposits) totaled $31.7 million, or 30.0% of total balances that matured, and were
comprised in large part of rate-sensitive customers who typically had few other relationships with the bank. Approximately $105.9 million of retail time accounts matured or repriced in the first quarter of 2008 at an average rate of 4.59%. By way of
comparison, the Companys weekly average offering rate on its one year time account was 2.98% in the first quarter of 2008.

The
Company expanded its utilization of longer term wholesale funding (brokered time accounts and borrowings) in the first quarter of 2008 as a cost-effective alternative to short term rate sensitive retail time accounts. As a result, average brokered
time accounts represented 26.5% of average time accounts in the second quarter of 2008, compared with 17.6% in the second quarter of 2007. Together, brokered time deposits and borrowings totaled 30.5% of total interest-bearing liabilities in the
second quarter of 2008, compared with 25.0% in the year-ago period.

The retention rates for the Companys time accounts have returned
to more normal levels in the second quarter. Approximately $62.4 million of retail time accounts matured or repriced in the second quarter of 2008, at an average rate of 4.14%. During the second quarter, the net decrease in retail time deposits
(excluding brokered time deposits) totaled $11.6, or 18.6% of total balances that matured. The Companys weekly average offering rate on its one year time account was 2.23% in the second quarter of 2008.

Net interest income for the six months ended June 30, 2008 totaled $18.3 million, an increase of 13.3% compared with $16.1 million in the year-ago
period. Average earning assets increased $43.6 million in the first half of 2008



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##### Table of Contents

compared with the year-ago period. The tax-equivalent net interest margin was 3.27% in the first half of 2008, compared with 3.02% in the first half of 2007.
A decrease of 32 basis points in the Companys tax-equivalent earning assets yield in the first half of 2008 compared with the same period in 2007 was offset by a 65 basis point decrease in its cost of funds over the same period.

Changes in net interest income and net interest margin for the first half of 2008 compared with the same period in 2007 were driven largely by the same
factors in the analysis of the second quarter of 2008 to the second quarter of 2007 discussed above.

The magnitude of increase in our net
interest margin is expected to slow considerably in the third quarter. The opportunity for continued improvement in our net interest margin will be significantly impacted by a number of factors, including the amount and composition of earning
assets, competition for deposits, the Companys liquidity position and the fluctuation of market interest rates.

Average Balance
Sheet and Net Interest Analysis

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



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|                                                                                                         |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|-------------------------------------------------------------------------------------------------------- |  | ----------------------------------- | --------- | - | ------------------- | - | --------- |  | ---- | -------------- |  | - | ------------------- | - | --------- | - | ------ |  | ---- | -
|                                                                                                         |  | For the three months ended June 30, |          
|                                                                                                         |  | 2008                                |           |   | 2007                |  
|                                                                                                         |  | AverageBalance                      |           |   | InterestEarned/Paid |   | YieldRate |  |      | AverageBalance |  |   | InterestEarned/Paid |   | YieldRate |  
|                                                                                                         |  | (Dollars in thousands)              |          
|Assets:                                                                                                  |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Interest earning assets:                                                                                 |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Federal funds sold                                                                                       |  | $                                   | 6,829     |   |                     | $ | 43        |  | 2.52 | %              |  | $ |                    |   |           | $ |       |  |     | %
|Taxable investment securities                                                                            |  |                                     | 186,937   |   |                     |   | 2,159     |  | 4.62 | %              |  |   | 170,497             |   |           |   | 1,906  |  | 4.47 | %
|Nontaxable investment securities                                                                         |  |                                     | 88,663    |   |                     |   | 1,371     |  | 6.19 | %              |  |   | 85,282              |   |           |   | 1,344  |  | 6.30 | %
|FHLB and FRB stock                                                                                       |  |                                     | 10,847    |   |                     |   | 191       |  | 7.04 | %              |  |   | 8,783               |   |           |   | 193    |  | 8.79 | %
|Real estate loans(1)                                                                                     |  |                                     | 289,101   |   |                     |   | 4,241     |  | 5.87 | %              |  |   | 259,751             |   |           |   | 3,874  |  | 5.97 | %
|Commercial loans                                                                                         |  |                                     | 211,766   |   |                     |   | 3,590     |  | 6.78 | %              |  |   | 212,776             |   |           |   | 4,265  |  | 8.02 | %
|Nontaxable commercial loans                                                                              |  |                                     | 8,327     |   |                     |   | 138       |  | 6.62 | %              |  |   | 8,692               |   |           |   | 155    |  | 7.11 | %
|Taxable leases (net of unearned discount)(1)                                                             |  |                                     | 106,864   |   |                     |   | 1,678     |  | 6.28 | %              |  |   | 111,526             |   |           |   | 1,964  |  | 7.04 | %
|Nontaxable leases (net of unearned discount)                                                             |  |                                     | 17,831    |   |                     |   | 262       |  | 5.88 | %              |  |   | 20,210              |   |           |   | 297    |  | 5.88 | %
|Indirect auto loans                                                                                      |  |                                     | 177,112   |   |                     |   | 2,482     |  | 5.61 | %              |  |   | 180,782             |   |           |   | 2,445  |  | 5.41 | %
|Consumer loans                                                                                           |  |                                     | 89,979    |   |                     |   | 1,428     |  | 6.35 | %              |  |   | 91,093              |   |           |   | 1,816  |  | 7.97 | %
|                                                                                                         |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Total Interest-earning assets                                                                            |  | $                                   | 1,194,256 |   |                     | $ | 17,583    |  | 5.89 | %              |  | $ | 1,149,392           |   |           | $ | 18,259 |  | 6.35 | %
|                                                                                                         |  |                                     |           |   |                     |  
|Non-interest earning assets:                                                                             |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Other Assets                                                                                             |  |                                     | 134,353   |   |                     |   |           |  |      |                |  |   | 132,813             |   |           |   |        |  |      |  
|Less: Allowance for credit losses                                                                        |  |                                     | (8,387    | ) |                     |   |           |  |      |                |  |   | (7,512              | ) |           |   |        |  |      |  
|Net unrealized gains (losses) on securities available-for-sale                                           |  |                                     | 3,444     |   |                     |   |           |  |      |                |  |   | (1,863              | ) |           |   |        |  |      |  
|                                                                                                         |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Total Assets                                                                                             |  | $                                   | 1,323,666 |   |                     |   |           |  |      |                |  | $ | 1,272,830           |   |           |   |        |  |      |  
|                                                                                                         |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Liabilities and shareholders equity:                                                                    |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Interest bearing liabilities:                                                                            |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Demand deposits                                                                                          |  | $                                   | 106,487   |   |                     | $ | 173       |  | 0.65 | %              |  | $ | 95,575              |   |           | $ | 230    |  | 0.96 | %
|Savings deposits                                                                                         |  |                                     | 85,446    |   |                     |   | 112       |  | 0.52 | %              |  |   | 85,437              |   |           |   | 114    |  | 0.53 | %
|MMDA deposits                                                                                            |  |                                     | 228,124   |   |                     |   | 1,130     |  | 1.98 | %              |  |   | 198,490             |   |           |   | 1,587  |  | 3.20 | %
|Time deposits                                                                                            |  |                                     | 394,558   |   |                     |   | 3,896     |  | 3.95 | %              |  |   | 433,410             |   |           |   | 5,106  |  | 4.71 | %
|Borrowings                                                                                               |  |                                     | 218,258   |   |                     |   | 1,836     |  | 3.36 | %              |  |   | 177,521             |   |           |   | 2,076  |  | 4.68 | %
|Junior subordinated obligations issued to unconsolidated trusts                                          |  |                                     | 25,774    |   |                     |   | 326       |  | 5.06 | %              |  |   | 25,774              |   |           |   | 487    |  | 7.56 | %
|                                                                                                         |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Total interest-bearing liabilities                                                                       |  | $                                   | 1,058,647 |   |                     | $ | 7,473     |  | 2.82 | %              |  | $ | 1,016,207           |   |           | $ | 9,600  |  | 3.78 | %
|                                                                                                         |  |                                     |           |   |                     |  
|Non-interest bearing liabilities:                                                                        |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Demand deposits                                                                                          |  |                                     | 131,689   |   |                     |   |           |  |      |                |  |   | 125,239             |   |           |   |        |  |      |  
|Other liabilities                                                                                        |  |                                     | 17,058    |   |                     |   |           |  |      |                |  |   | 20,708              |   |           |   |        |  |      |  
|Shareholders equity                                                                                     |  |                                     | 116,272   |   |                     |   |           |  |      |                |  |   | 110,676             |   |           |   |        |  |      |  
|                                                                                                         |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Total liabilities and shareholders equity                                                               |  | $                                   | 1,323,666 |   |                     |   |           |  |      |                |  | $ | 1,272,830           |   |           |   |        |  |      |  
|                                                                                                         |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Net interest income (tax equivalent)                                                                     |  |                                     |           |   |                     | $ | 10,110    |  |      |                |  |   |                     |   |           | $ | 8,659  |  |      |  
|                                                                                                         |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Net interest margin (tax equivalent)                                                                     |  |                                     |           |   |                     |   |           |  | 3.39 | %              |  |   |                     |   |           |   |        |  | 3.01 | %
|Net interest rate spread                                                                                 |  |                                     |           |   |                     |   |           |  | 3.07 | %              |  |   |                     |   |           |   |        |  | 2.57 | %
|Federal tax exemption on non-taxable investment securities, loans and leases included in interest income |  |                                     |           |   |                     | $ | 603       |  |      |                |  |   |                     |   |           | $ | 610    |  |      |  
|                                                                                                         |  |                                     |           |   |                     |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  



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



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##### Table of Contents

|                                                                                                         |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|-------------------------------------------------------------------------------------------------------- |  | --------------------------------- | --------- | - | -------------------- | - | --------- |  | ---- | -------------- |  | - | ------------------- | - | --------- | - | ------ |  | ---- | -
|                                                                                                         |  | For the six months ended June 30, |          
|                                                                                                         |  | 2008                              |           |   | 2007                 |  
|                                                                                                         |  | AverageBalance                    |           |   | InterestEarned /Paid |   | YieldRate |  |      | AverageBalance |  |   | InterestEarned/Paid |   | YieldRate |  
|                                                                                                         |  | (Dollars in thousands)            |          
|Assets:                                                                                                  |  |                                   |           |  
|Interest earning assets:                                                                                 |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Federal funds sold                                                                                       |  | $                                 | 6,950     |   |                      | $ | 89        |  | 2.59 | %              |  | $ | 141                 |   |           | $ | 3      |  | 4.26 | %
|Taxable investment securities                                                                            |  |                                   | 188,221   |   |                      |   | 4,437     |  | 4.71 | %              |  |   | 169,828             |   |           |   | 3,736  |  | 4.40 | %
|Nontaxable investment securities                                                                         |  |                                   | 87,841    |   |                      |   | 2,700     |  | 6.15 | %              |  |   | 85,507              |   |           |   | 2,661  |  | 6.22 | %
|FHLB and FRB Stock                                                                                       |  |                                   | 10,602    |   |                      |   | 387       |  | 7.30 | %              |  |   | 8,488               |   |           |   | 307    |  | 7.23 | %
|Real estate loans(1)                                                                                     |  |                                   | 283,852   |   |                      |   | 8,411     |  | 5.93 | %              |  |   | 257,588             |   |           |   | 7,735  |  | 6.01 | %
|Commercial loans                                                                                         |  |                                   | 210,989   |   |                      |   | 7,404     |  | 7.02 | %              |  |   | 213,037             |   |           |   | 8,474  |  | 7.96 | %
|Nontaxable commercial loans                                                                              |  |                                   | 8,277     |   |                      |   | 279       |  | 6.74 | %              |  |   | 8,644               |   |           |   | 306    |  | 7.08 | %
|Taxable leases (net of unearned discount)(1)                                                             |  |                                   | 109,316   |   |                      |   | 3,488     |  | 6.38 | %              |  |   | 111,058             |   |           |   | 3,943  |  | 7.10 | %
|Nontaxable leases (net of unearned discount)                                                             |  |                                   | 17,917    |   |                      |   | 527       |  | 5.89 | %              |  |   | 20,380              |   |           |   | 597    |  | 5.86 | %
|Indirect loans                                                                                           |  |                                   | 175,567   |   |                      |   | 4,976     |  | 5.67 | %              |  |   | 181,214             |   |           |   | 4,852  |  | 5.35 | %
|Consumer loans                                                                                           |  |                                   | 90,835    |   |                      |   | 3,024     |  | 6.66 | %              |  |   | 90,892              |   |           |   | 3,624  |  | 7.97 | %
|                                                                                                         |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Total interest-earning assets                                                                            |  | $                                 | 1,190,367 |   |                      | $ | 35,722    |  | 6.00 | %              |  | $ | 1,146,777           |   |           | $ | 36,238 |  | 6.32 | %
|                                                                                                         |  |                                   |           |   |                      |  
|Non-interest earning assets:                                                                             |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Other assets                                                                                             |  |                                   | 131,921   |   |                      |   |           |  |      |                |  |   | 130,840             |   |           |   |        |  |      |  
|Less: Allowance for loan and lease losses                                                                |  |                                   | (8,530    | ) |                      |   |           |  |      |                |  |   | (7,333              | ) |           |   |        |  |      |  
|Net unrealized losses on securities available-for-sale                                                   |  |                                   | 3,512     |   |                      |   |           |  |      |                |  |   | (1,937              | ) |           |   |        |  |      |  
|                                                                                                         |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Total assets                                                                                             |  | $                                 | 1,317,270 |   |                      |   |           |  |      |                |  | $ | 1,268,347           |   |           |   |        |  |      |  
|                                                                                                         |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|                                                                                                         |  |                                   |           |   |                      |  
|Liabilities and shareholders equity:                                                                    |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Interest bearing liabilities:                                                                            |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Demand deposits                                                                                          |  | $                                 | 106,723   |   |                      | $ | 387       |  | 0.73 | %              |  | $ | 96,027              |   |           | $ | 413    |  | 0.86 | %
|Savings deposits                                                                                         |  |                                   | 83,648    |   |                      |   | 218       |  | 0.52 | %              |  |   | 85,130              |   |           |   | 224    |  | 0.53 | %
|MMDA deposits                                                                                            |  |                                   | 219,480   |   |                      |   | 2,516     |  | 2.29 | %              |  |   | 199,491             |   |           |   | 3,140  |  | 3.15 | %
|Time deposits                                                                                            |  |                                   | 404,176   |   |                      |   | 8,550     |  | 4.23 | %              |  |   | 429,097             |   |           |   | 9,989  |  | 4.60 | %
|Borrowings                                                                                               |  |                                   | 214,248   |   |                      |   | 3,845     |  | 3.59 | %              |  |   | 178,835             |   |           |   | 4,160  |  | 4.65 | %
|Junior subordinated obligations issued to unconsolidated trusts                                          |  |                                   | 25,774    |   |                      |   | 741       |  | 5.75 | %              |  |   | 25,774              |   |           |   | 970    |  | 7.53 | %
|                                                                                                         |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Total interest-bearing liabilities                                                                       |  | $                                 | 1,054,049 |   |                      | $ | 16,257    |  | 3.08 | %              |  | $ | 1,014,354           |   |           | $ | 18,896 |  | 3.73 | %
|                                                                                                         |  |                                   |           |   |                      |  
|Non-interest bearing liabilities:                                                                        |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Demand deposits                                                                                          |  |                                   | 128,971   |   |                      |   |           |  |      |                |  |   | 124,738             |   |           |   |        |  |      |  
|Other liabilities                                                                                        |  |                                   | 18,068    |   |                      |   |           |  |      |                |  |   | 19,047              |   |           |   |        |  |      |  
|Shareholders equity                                                                                     |  |                                   | 116,182   |   |                      |   |           |  |      |                |  |   | 110,208             |   |           |   |        |  |      |  
|                                                                                                         |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Total liabilities and shareholders equity                                                               |  | $                                 | 1,317,270 |   |                      |   |           |  |      |                |  | $ | 1,268,347           |   |           |   |        |  |      |  
|                                                                                                         |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|                                                                                                         |  |                                   |           |   |                      |  
|Net interest income (tax equivalent)                                                                     |  |                                   |           |   |                      | $ | 19,465    |  |      |                |  |   |                     |   |           | $ | 17,342 |  |      |  
|                                                                                                         |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  
|Net interest margin (tax equivalent)                                                                     |  |                                   |           |   |                      |   |           |  | 3.27 | %              |  |   |                     |   |           |   |        |  | 3.02 | %
|Net interest rate spread                                                                                 |  |                                   |           |   |                      |   |           |  | 2.92 | %              |  |   |                     |   |           |   |        |  | 2.59 | %
|Federal tax exemption on non-taxable investment securities, loans and leases included in interest income |  |                                   |           |   |                      | $ | 1,191     |  |      |                |  |   |                     |   |           | $ | 1,212  |  |      |  
|                                                                                                         |  |                                   |           |   |                      |   |           |  |      |                |  |   |                     |   |           |   |        |  |      |  



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



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##### Table of Contents

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 proportionally between the volume and rate variances.



|                                                                           |  |                                                                                            |        |   |                                                                                          |   |        |           |  |   |        |   |  |      |       |   |           |   |        |   |  |   |        |  
|-------------------------------------------------------------------------- |  | ------------------------------------------------------------------------------------------ | ------ | - | ---------------------------------------------------------------------------------------- | - | ------ | --------- |  | - | ------ | - |  | ---- | ----- | - | --------- | - | ------ | - |  | - | ------ | -
|                                                                           |  | For the three months endedJune 30, 2008 compared toJune 30, 2007Increase/(Decrease) Due To |        |   | For the six months endedJune 30, 2008 compared toJune 30, 2007Increase/(Decrease) Due To |  
|                                                                           |  | Volume                                                                                     |        |   | Rate                                                                                     |   |        | NetChange |  |   | Volume |   |  | Rate |       |   | NetChange |  
|                                                                           |  | (In thousands)                                                                             |       
|Federal funds sold                                                         |  | $                                                                                          | 43     |   |                                                                                          | $ |       |           |  | $ | 43     |   |  | $    | 91    |   |           | $ | (5     | ) |  | $ | 86     |  
|Taxable investment securities                                              |  |                                                                                            | 188    |   |                                                                                          |   | 65     |           |  |   | 253    |   |  |      | 422   |   |           |   | 279    |   |  |   | 701    |  
|Non-taxable investment securities                                          |  |                                                                                            | 155    |   |                                                                                          |   | (128   | )         |  |   | 27     |   |  |      | 117   |   |           |   | (78    | ) |  |   | 39     |  
|FHLB and FRB stock                                                         |  |                                                                                            | 165    |   |                                                                                          |   | (167   | )         |  |   | (2     | ) |  |      | 77    |   |           |   | 3      |   |  |   | 80     |  
|Real estate loans                                                          |  |                                                                                            | 764    |   |                                                                                          |   | (397   | )         |  |   | 367    |   |  |      | 960   |   |           |   | (284   | ) |  |   | 676    |  
|Commercial loans                                                           |  |                                                                                            | (20    | ) |                                                                                          |   | (655   | )         |  |   | (675   | ) |  |      | (81   | ) |           |   | (989   | ) |  |   | (1,070 | )
|Non-taxable commercial loans                                               |  |                                                                                            | (7     | ) |                                                                                          |   | (10    | )         |  |   | (17    | ) |  |      | (13   | ) |           |   | (14    | ) |  |   | (27    | )
|Taxable leases (net of unearned income)                                    |  |                                                                                            | (80    | ) |                                                                                          |   | (206   | )         |  |   | (286   | ) |  |      | (61   | ) |           |   | (394   | ) |  |   | (455   | )
|Non-taxable leases (net of unearned income)                                |  |                                                                                            | (36    | ) |                                                                                          |   | 1      |           |  |   | (35    | ) |  |      | (78   | ) |           |   | 8      |   |  |   | (70    | )
|Indirect loans                                                             |  |                                                                                            | (241   | ) |                                                                                          |   | 278    |           |  |   | 37     |   |  |      | (352  | ) |           |   | 476    |   |  |   | 124    |  
|Consumer loans                                                             |  |                                                                                            | (22    | ) |                                                                                          |   | (366   | )         |  |   | (388   | ) |  |      | (2    | ) |           |   | (598   | ) |  |   | (600   | )
|                                                                           |  |                                                                                            |        |   |                                                                                          |   |        |           |  |   |        |   |  |      |       |   |           |   |        |   |  |   |        |  
|Total interest-earning assets                                              |  |                                                                                            | 909    |   |                                                                                          |   | (1,585 | )         |  |   | (676   | ) |  |      | 1,080 |   |           |   | (1,596 | ) |  |   | (516   | )
|                                                                           |  |                                                                                            |        |   |                                                                                          |   |        |           |  |   |        |   |  |      |       |   |           |   |        |   |  |   |        |  
|Interest-bearing demand deposits                                           |  |                                                                                            | 141    |   |                                                                                          |   | (198   | )         |  |   | (57    | ) |  |      | 97    |   |           |   | (123   | ) |  |   | (26    | )
|Savings deposits                                                           |  |                                                                                            |       |   |                                                                                          |   | (2     | )         |  |   | (2     | ) |  |      | (4    | ) |           |   | (2     | ) |  |   | (6     | )
|MMDA deposits                                                              |  |                                                                                            | 1,232  |   |                                                                                          |   | (1,689 | )         |  |   | (457   | ) |  |      | 751   |   |           |   | (1,375 | ) |  |   | (624   | )
|Time deposits                                                              |  |                                                                                            | (431   | ) |                                                                                          |   | (779   | )         |  |   | (1,210 | ) |  |      | (560  | ) |           |   | (879   | ) |  |   | (1,439 | )
|Borrowings                                                                 |  |                                                                                            | 1,992  |   |                                                                                          |   | (2,232 | )         |  |   | (240   | ) |  |      | 1,618 |   |           |   | (1,931 | ) |  |   | (313   | )
|Junior subordinated obligations issued to unconsolidated subsidiary trusts |  |                                                                                            |       |   |                                                                                          |   | (161   | )         |  |   | (161   | ) |  |      |      |   |           |   | (231   | ) |  |   | (231   | )
|                                                                           |  |                                                                                            |        |   |                                                                                          |   |        |           |  |   |        |   |  |      |       |   |           |   |        |   |  |   |        |  
|Total interest-bearing liabilities                                         |  |                                                                                            | 2,934  |   |                                                                                          |   | (5,061 | )         |  |   | (2,127 | ) |  |      | 1,902 |   |           |   | (4,541 | ) |  |   | (2,639 | )
|                                                                           |  |                                                                                            |        |   |                                                                                          |   |        |           |  |   |        |   |  |      |       |   |           |   |        |   |  |   |        |  
|Net interest income tax equivalent                                         |  | $                                                                                          | (2,025 | ) |                                                                                          | $ | 3,476  |           |  | $ | 1,451  |   |  | $    | (822  | ) |           | $ | 2,945  |   |  | $ | 2,123  |  
|                                                                           |  |                                                                                            |        |   |                                                                                          |   |        |           |  |   |        |   |  |      |       |   |           |   |        |   |  |   |        |  



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##### Table of Contents

Asset Quality and the Allowance for Credit Losses

Loans and leases past due 30 days or more, which generally includes nonperforming and potential problem loans, totaled $11.3 million or 1.26% of total
loans and leases at June 30, 2008, compared with $10.9 million or 1.24% at March 31, 2008 and $16.4 million or 1.84% at December 31, 2007. The Companys delinquencies at June 30, 2008 are not concentrated in any one segment
of the loan and lease portfolio. Commercial loans and residential mortgages, the two largest segments of our loan and lease portfolio, comprised the largest portion of total delinquencies at 44.0% and 32.7%, respectively, of total delinquencies.

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



|                                                     |  |                |       |               |   |                  |  |   |      
|---------------------------------------------------- |  | -------------- | ----- | ------------- | - | ---------------- |  | - | -----
|                                                     |  | June 30,2008   |       | March 31,2008 |   | December 31,2007
|                                                     |  | (In thousands)
|Non-accruing loans and leases:                       |  |                |       |               |   |                  |  |   |      
|Residential real estate loans                        |  | $              | 1,221 |               | $ | 1,143            |  | $ | 1,118
|Commercial loans                                     |  |                | 2,525 |               |   | 2,568            |  |   | 4,988
|Leases                                               |  |                | 1,654 |               |   | 524              |  |   | 320  
|Indirect loans                                       |  |                | 115   |               |   | 59               |  |   | 83   
|Other consumer loans                                 |  |                | 261   |               |   | 157              |  |   | 158  
|                                                     |  |                |       |               |   |                  |  |   |      
|Total non-accruing loans and leases                  |  |                | 5,776 |               |   | 4,451            |  |   | 6,667
|Accruing loans and leases delinquent 90 days or more |  |                | 52    |               |   | 180              |  |   | 39   
|                                                     |  |                |       |               |   |                  |  |   |      
|Total non-performing loans and leases                |  |                | 5,828 |               |   | 4,631            |  |   | 6,706
|Other real estate and repossessed assets             |  |                | 138   |               |   | 158              |  |   | 229  
|                                                     |  |                |       |               |   |                  |  |   |      
|Total non-performing assets                          |  | $              | 5,966 |               | $ | 4,789            |  | $ | 6,935
|                                                     |  |                |       |               |   |                  |  |   |      

Nonperforming loans and leases increased $1.2 million or 25.8% in the second quarter to $5.8
million or 0.65% of total loans and leases at June 30, 2008, compared with $4.6 million or 0.52% at March 31, 2008 and $6.7 million or 0.75% of total loans and leases at December 31, 2007. The largest single nonperforming relationship
is a $1.5 million commercial lease that was less than 30 days delinquent at June 30, 2008. Subsequent to quarter end, the commercial lease became past due for two payments and was placed in non-accrual status effective June 30, 2008. The
Companys earnings release for the second quarter dated July 15, 2008 reported the amount of nonperforming assets as $4.3 million at the end of the second quarter as the information that led to the decision to place the lease in
non-accrual status became available after the earnings release date. Placing the lease in non-accrual status as of June 30, 2008 had no impact on the provision for credit losses and did not change the Companys assessment of the adequacy
of the allowance for credit losses at June 30, 2008. The next largest single nonperforming loan at the end of the second quarter is a commercial credit that was written down in the first quarter of 2008 to its estimated collectible amount of
$600,000. The decrease in nonperforming loans and leases compared with December 31, 2007 resulted largely from a $2.4 million decrease in nonperforming commercial loans during the first quarter of 2008, partly offset by the $1.5 million
commercial lease mentioned above. The decrease in the first quarter resulted primarily from principal paydowns, collateral liquidation and charge-offs with respect to the two largest nonperforming loans at that time.

As a recurring part of its portfolio management program, the Company has identified approximately $8.0 million in potential problem loans at
June 30, 2008, as compared to $9.8 million at March 31, 2008 and $5.4 million at December 31, 2007. The average balance of potential problem loans was $259,000 at June 30, 2008 compared with $289,000 and $208,000 at
March 31, 2008 and December 31, 2007, respectively. Potential problem loans are loans that are currently performing, but where the borrowers operating performance or other relevant factors could result in potential credit problems,
and are typically classified by our loan rating system as substandard. At June 30, 2008, 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.

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



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##### Table of Contents

The Banks policy is to place a loan or lease on non-accrual status and recognize income on a cash
basis when a loan or lease is more than 90 days past due, unless in the opinion of management, the loan or lease is well secured and in the process of collection. The Bank considers a loan or lease impaired when, based on current information and
events, it is probable that the Bank will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally
based upon the present value of future cash flows discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on fair value of the collateral. As of June 30,
2008, there was $1.6 million in impaired loans for which $522,000 in related allowance for credit losses was allocated. As of March 31, 2008 and December 31, 2007, there were $2.0 million and $4.2 million respectively in impaired loans for
which $804,000 and $1.3 million in related allowance for credit losses was allocated.

The allowance for credit losses represents
managements best estimate of probable incurred credit losses in the Banks loan and lease portfolio. Managements quarterly evaluation of the allowance for credit losses is a comprehensive analysis that builds a total reserve by
evaluating the risks within each product class. The Bank uses a general allocation methodology for all residential and consumer loan pools. This methodology estimates a reserve for each pool based on the most recent three-year loss rate, adjusted to
reflect the expected impact that current trends regarding loan growth, delinquency, losses, economic conditions, loan concentrations, policy changes and current interest rates are likely to have. For commercial loan and lease pools, the Bank
establishes a specific reserve allocation for all loans and leases in excess of $150,000 which are considered to be impaired and which have been risk rated under the Banks risk rating system as substandard, doubtful or loss. The specific
allocation is based on the most recent valuation of the loan or lease collateral. For all other commercial loans and leases, the Bank uses the general allocation methodology that establishes a reserve for each risk rating category. The general
allocation methodology for commercial loans and leases considers the same qualitative factors that are considered when evaluating residential mortgage and consumer loan pools. The combination of using both the general and specific allocation
methodologies reflects managements best estimate of the probable credit losses in the Banks loan and lease portfolio. Loans and leases are charged against the allowance for credit losses, in accordance with the Banks loan and lease
policy, when they are determined by management to be uncollectible. Recoveries on loans and leases previously charged off are credited to the allowance for credit losses when they are received. When management determines that the allowance for
credit losses is less than adequate to provide for potential losses, a direct charge to operating income is recorded.

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



|                                                      |  |                            |        |   |                          |   |       |      |  |   |        |   |  |   |        |  
|----------------------------------------------------- |  | -------------------------- | ------ | - | ------------------------ | - | ----- | ---- |  | - | ------ | - |  | - | ------ | -
|                                                      |  | Three months endedJune 30, |        |   | Six months endedJune 30, |  
|                                                      |  | 2008                       |        |   | 2007                     |   |       | 2008 |  |   | 2007   |  
|                                                      |  | (In thousands)             |       
|Allowance for credit losses, beginning of period      |  | $                          | 8,184  |   |                          | $ | 7,333 |      |  | $ | 8,426  |   |  | $ | 7,029  |  
|Loans and leases charged-off                          |  |                            | (1,076 | ) |                          |   | (818  | )    |  |   | (2,957 | ) |  |   | (1,453 | )
|Recoveries of loans and leases previously charged-off |  |                            | 232    |   |                          |   | 323   |      |  |   | 505    |   |  |   | 512    |  
|                                                      |  |                            |        |   |                          |   |       |      |  |   |        |   |  |   |        |  
|Net loans and leases charged-off                      |  |                            | (844   | ) |                          |   | (495  | )    |  |   | (2,452 | ) |  |   | (941   | )
|                                                      |  |                            |        |  
|Provision for credit losses                           |  |                            | 1,311  |   |                          |   | 700   |      |  |   | 2,677  |   |  |   | 1,450  |  
|                                                      |  |                            |        |   |                          |   |       |      |  |   |        |   |  |   |        |  
|Allowance for credit losses, end of period            |  | $                          | 8,651  |   |                          | $ | 7,538 |      |  | $ | 8,651  |   |  | $ | 7,538  |  
|                                                      |  |                            |        |   |                          |   |       |      |  |   |        |   |  |   |        |  

The provision for credit losses was $1.3 million and $2.7 million in the quarter and six months
ended June 30, 2008, respectively, compared with $700,000 and $1.5 million in the year-ago periods, respectively. Net charge-offs were $844,000 and $2.5 million in the three months and six months ended June 30, 2008, respectively, compared
with $495,000 and $941,000 in the year-ago periods, respectively. The increase in net charge-offs in 2008 was due largely to comprehensive liquidation strategies implemented in the first quarter on the two largest non-performing commercial
relationships at that time, which resulted in charge-offs of $1.2 million or 65% of the first quarters total gross charge-offs. The increased level of provisions in 2008 is a reflection of marginally higher levels of loan delinquencies and
increases in charge-offs and levels of classified loans in 2008, and managements assessment of the potential impact on the Companys portfolio of macroeconomic factors and credit market conditions affecting the financial sector generally.
The Company has no direct exposure to the various types of high risk residential mortgages currently impacting the financial sector. The provision for credit losses as a percentage of net charge-offs



-18-



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##### Table of Contents

was 155.3% and 109.2%, respectively, in the quarter and six months ended June 30, 2008, compared with 141.4% and 154.1%, respectively, in the year-ago
periods.

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



|                                                                         |  |                                |   |  |                              |   |  |       |   |  |       |  
|------------------------------------------------------------------------ |  | ------------------------------ | - |  | ---------------------------- | - |  | ----- | - |  | ----- | -
|                                                                         |  | For three months endedJune 30, |   |  | For six months endedJune 30, |  
|                                                                         |  | 2008                           |   |  | 2007                         |   |  | 2008  |   |  | 2007  |  
|Net loans and leases charged-off to average loans and leases, annualized |  | 0.37                           | % |  | 0.22                         | % |  | 0.55  | % |  | 0.21  | %
|Provision for credit losses to average loans and leases, annualized      |  | 0.58                           | % |  | 0.32                         | % |  | 0.60  | % |  | 0.33  | %
|Allowance for credit losses to period-end loans and leases               |  | 0.96                           | % |  | 0.85                         | % |  | 0.96  | % |  | 0.85  | %
|Allowance for credit losses to non-performing loans and leases           |  | 148.4                          | % |  | 139.3                        | % |  | 199.2 | % |  | 139.3 | %
|Non-performing loans and leases to period-end loans and leases           |  | 0.65                           | % |  | 0.61                         | % |  | 0.48  | % |  | 0.61  | %
|Non-performing assets to period-end assets                               |  | 0.45                           | % |  | 0.43                         | % |  | 0.34  | % |  | 0.43  | %

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 |  |   |     |   |  |       | Change |     
|                                              |  | 2008                        |       | 2007 |                           | $      |  |   | %   |   |  | 2008  |        | 2007 |   | $      |  |   | %      | 
|Investment management income                  |  | $                           | 2,250 |      | $                         | 2,281  |  | $ | (31 | ) |  | (1.4  | )%     |      | $ | 4,538  |  | $ | 4,498  |  | $ | 40  |   |  | 0.9   | % 
|Service charges on deposit accounts           |  |                             | 1,257 |      |                           | 1,288  |  |   | (31 | ) |  | (2.4  | )%     |      |   | 2,490  |  |   | 2,540  |  |   | (50 | ) |  | (2.0  | )%
|Card-related fees                             |  |                             | 543   |      |                           | 489    |  |   | 54  |   |  | 11.0  | %      |      |   | 1,045  |  |   | 935    |  |   | 110 |   |  | 11.8  | % 
|Insurance agency income                       |  |                             | 482   |      |                           | 459    |  |   | 23  |   |  | 5.0   | %      |      |   | 820    |  |   | 856    |  |   | (36 | ) |  | (4.2  | )%
|Income from bank-owned life insurance         |  |                             | 204   |      |                           | 157    |  |   | 47  |   |  | 29.9  | %      |      |   | 363    |  |   | 313    |  |   | 50  |   |  | 16.0  | % 
|Gain on the sale of loans                     |  |                             | 136   |      |                           | 39     |  |   | 97  |   |  | 248.7 | %      |      |   | 162    |  |   | 83     |  |   | 79  |   |  | 95.2  | % 
|Gain on sale of securities available-for-sale |  |                             |      |      |                           |       |  |   |    |   |  |      |        |      |   | 137    |  |   |       |  |   | 137 |   |  | 100.0 | % 
|Rental income from operating leases           |  |                             | 68    |      |                           | 50     |  |   | 18  |   |  | 36.0  | %      |      |   | 134    |  |   | 126    |  |   | 8   |   |  | 6.3   | % 
|Other non-interest income                     |  |                             | 347   |      |                           | 373    |  |   | (26 | ) |  | (7.0  | )%     |      |   | 784    |  |   | 804    |  |   | (20 | ) |  | (2.5  | )%
|                                              |  |                             |       |      |                           |        |  |   |     |   |  |       |        |      |   |        |  |   |        |  |   |     |   |  |       |   
|Total non-interest income                     |  | $                           | 5,287 |      | $                         | 5,136  |  | $ | 151 |   |  | 2.9   | %      |      | $ | 10,473 |  | $ | 10,155 |  | $ | 318 |   |  | 3.1   | % 
|                                              |  |                             |       |      |                           |        |  |   |     |   |  |       |        |      |   |        |  |   |        |  |   |     |   |  |       |   

Non-interest income was $5.3 million in the second quarter of 2008, which was an increase of
$151,000 or 2.9% from the second quarter of 2007. Non-interest income comprised 35.7% of total revenue in the second quarter of 2008 compared with 39.0% in the year-ago quarter and 36.3% in the first quarter of 2008. The decline in this ratio has
been driven entirely by the increase in net interest income in 2008.

Non-interest income totaled $10.5 million in the first six months of
2008, which is an increase from $10.2 million in the year-ago period. Approximately half of the increase in the first half of 2008 compared with 2007 resulted from securities gains and non-recurring income recorded in the first quarter of 2008, with
the balance of the increase resulting primarily from higher customer transaction fees.



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##### Table of Contents

Non-interest Expenses

The 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 |                               |       |  |   | Change |  
|                                   |  | 2008                            |       | 2007   |                               | $     |  |   | %      |   |  | 2008  |    | 2007 |   | $      |  |   | %      | 
|Salaries and benefits              |  | $                               | 4,912 |        | $                             | 4,563 |  | $ | 349    |   |  | 7.6   | %  |      | $ | 9,917  |  | $ | 8,997  |  | $ | 920  |   |  | 10.2  | % 
|Building, occupancy, and equipment |  |                                 | 1,674 |        |                               | 1,705 |  |   | (31    | ) |  | (1.8  | )% |      |   | 3,397  |  |   | 3,527  |  |   | (130 | ) |  | (3.7  | )%
|Communication expense              |  |                                 | 204   |        |                               | 217   |  |   | (13    | ) |  | (6.0  | )% |      |   | 402    |  |   | 409    |  |   | (7   | ) |  | (1.7  | )%
|Stationery and supplies            |  |                                 | 129   |        |                               | 166   |  |   | (37    | ) |  | (22.3 | )% |      |   | 237    |  |   | 294    |  |   | (57  | ) |  | (19.4 | )%
|Marketing                          |  |                                 | 278   |        |                               | 426   |  |   | (148   | ) |  | (34.7 | )% |      |   | 569    |  |   | 716    |  |   | (147 | ) |  | (20.5 | )%
|Amortization of intangible assets  |  |                                 | 415   |        |                               | 435   |  |   | (20    | ) |  | (4.6  | )% |      |   | 823    |  |   | 884    |  |   | (61  | ) |  | (6.9  | )%
|Professional fees                  |  |                                 | 621   |        |                               | 727   |  |   | (106   | ) |  | (14.6 | )% |      |   | 1,362  |  |   | 1,427  |  |   | (65  | ) |  | (4.6  | )%
|Other operating expenses           |  |                                 | 1,397 |        |                               | 1,302 |  |   | 95     |   |  | 7.3   | %  |      |   | 2,718  |  |   | 2,538  |  |   | 180  |   |  | 7.1   | % 
|                                   |  |                                 |       |        |                               |       |  |   |        |   |  |       |    |      |   |        |  |   |        |  |   |      |   |  |       |   
|Total operating expenses           |  | $                               | 9,630 |        | $                             | 9,541 |  | $ | 89     |   |  | 0.9   | %  |      | $ | 19,425 |  | $ | 18,792 |  | $ | 633  |   |  | 3.4   | % 
|                                   |  |                                 |       |        |                               |       |  |   |        |   |  |       |    |      |   |        |  |   |        |  |   |      |   |  |       |   

Non-interest expenses were $9.6 million in the quarter ended June 30, 2008, an increase of
0.9% compared to $9.5 million in the second quarter of 2007. Non-interest expenses decreased 1.7% from the first quarter of 2008.

Non-interest expenses were $19.4 million in the six months ended June 30, 2008, an increase of 3.4% compared with $18.8 million in the first half of 2007.

Salaries and benefits increased in the three months and six months ended June 30, 2008 compared with the year-ago periods due largely to normal salary increases and lower incentive-based compensation expense in
2007. Decreases in other expense categories were due largely to a heightened focus in 2008 on expense control.

The Companys
efficiency ratio improved to 65.1% in the second quarter of 2008, compared with 72.4% in the year-ago quarter and 71.1% in the first quarter of 2008. The Companys efficiency ratio was 68.0% in the six months ended June 30, 2008, compared
with 71.5% in the year-ago period.

Income Taxes

The Companys effective tax rate was 25.1% and 25.3%, respectively, for the quarter and six months ended June 30, 2008, compared with 22.8% and 23.4%, respectively, in the year-ago periods. The increase in
the effective tax rate in 2008 primarily reflects a decline in the percentage of non-taxable income to pre-tax income.



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##### Table of Contents

Comparison of Financial Condition at June 30, 2008 and December 31, 2007

General

Total assets were $1.3
billion at June 30, 2008, which increased slightly from December 31, 2007. Total loans and leases (net of unearned income) were $902.3 million at June 30, 2008, compared with $884.2 million and $895.5 million at March 31, 2008
and December 31, 2007, respectively.

Securities

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, 2008 |         | December 31, 2007
|                                                      |  | AmortizedCost |         | FairValue         |   | AmortizedCost |  | FairValue
|U.S. Treasury obligations                             |  | $             | 100     |                   | $ | 101           |  | $         | 100     |  | $ | 101    
|Obligations of U.S. government-sponsored enterprises  |  |               | 33,738  |                   |   | 33,938        |  |           | 60,902  |  |   | 60,942 
|Obligations of states and political subdivisions      |  |               | 88,749  |                   |   | 89,630        |  |           | 87,028  |  |   | 88,580 
|Mortgage-backed securities                            |  |               | 143,305 |                   |   | 142,777       |  |           | 120,258 |  |   | 120,155
|Other equity securities                               |  |               | 2,958   |                   |   | 2,943         |  |           | 2,934   |  |   | 2,935  
|                                                      |  |               |         |                   |   |               |  |           |         |  |   |        
|Total                                                 |  |               | 268,850 |                   | $ | 269,389       |  |           | 271,222 |  | $ | 272,713
|                                                      |  |               |         |                   |   |               |  |           |         |  |   |        
|Net unrealized gains on available-for-sale securities |  |               | 539     |                   |   |               |  |           | 1,491   |  |   |        
|                                                      |  |               |         |                   |   |               |  |           |         |  |   |        
|Total carrying value                                  |  | $             | 269,389 |                   |   |               |  | $         | 272,713 |  |   |        
|                                                      |  |               |         |                   |   |               |  |           |         |  |   |        

Our securities available-for-sale portfolio is predominately comprised of investment grade
mortgage-backed securities, securities issued by U.S. government sponsored enterprises 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 gains on available-for-sale securities resulted primarily from changes in interest rates and credit market conditions during the
period.

Loans and Leases

Total loans and leases (net of unearned income) were $898.6 million at June 30, 2008, compared with $892.3 million at December 31, 2007. Growth in the Companys consumer lending businesses in the second quarter outpaced
slight declines in commercial loans and leases.

Residential mortgages outstanding increased $20.5 million or 7.5% during the first six
months of 2008 and totaled $294.0 million at June 30, 2008. Alliance has increased its share of the local residential mortgage market in part due to closures or consolidation among non-bank mortgage originators and a focused expansion of the
Companys origination team in Central New York. The Company originates only conventional residential mortgages in its local markets, and has no direct exposure to sub-prime, Alt-A, negative amortizing or other higher risk residential mortgages.

Leases (net of unearned income) decreased $12.4 million or 9.4% in 2008 due primarily to the sale of a portion of the Companys
equipment lease portfolio and a slowing of originations.

Indirect auto loans increased $4.7 million or 2.7% in the first six months of
2008. Applications received through the Companys indirect lending program are subject to the same comprehensive underwriting criteria and procedures as its direct lending program. Approximately 85% of the indirect auto originations in 2008
were to borrowers with credit scores exceeding 700.



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##### Table of Contents

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



|                                |  |               |         |   |         |       |   |                   |   |         |         |  |       |  
|------------------------------- |  | ------------- | ------- | - | ------- | ----- | - | ----------------- | - | ------- | ------- |  | ----- | -
|                                |  | June 30, 2008 |         |   | Percent |       |   | December 31, 2007 |   |         | Percent | 
|Residential real estate loans   |  | $             | 293,952 |   |         | 32.7  | % |                   | $ | 273,465 |         |  | 30.6  | %
|Commercial loans                |  |               | 215,455 |   |         | 24.0  | % |                   |   | 217,136 |         |  | 24.4  | %
|Leases (net of unearned income) |  |               | 118,929 |   |         | 13.2  | % |                   |   | 131,300 |         |  | 14.7  | %
|Indirect loans                  |  |               | 180,791 |   |         | 20.1  | % |                   |   | 176,115 |         |  | 19.7  | %
|Other consumer loans            |  |               | 89,504  |   |         | 10.0  | % |                   |   | 94,246  |         |  | 10.6  | %
|                                |  |               |         |   |         |       |   |                   |   |         |         |  |       |  
|Total loans & leases            |  | $             | 898,631 |   |         | 100.0 | % |                   | $ | 892,262 |         |  | 100.0 | %
|                                |  |               |         |   |         |       |   |                   |   |         |         |  |       |  
|Net deferred loan costs         |  |               | 3,674   |   |         |       |   |                   |   | 3,271   |         |  |       |  
|Allowance for credit losses     |  |               | (8,651  | ) |         |       |   |                   |   | (8,426  | )       |  |       |  
|                                |  |               |         |   |         |       |   |                   |   |         |         |  |       |  
|Net loans and leases            |  | $             | 893,654 |   |         |       |   |                   | $ | 887,107 |         |  |       |  
|                                |  |               |         |   |         |       |   |                   |   |         |         |  |       |  

Deposits

Total deposits were $927.5 million at June 30, 2008, a decrease of $16.8 million from December 31, 2007. Time accounts decreased $37.1 million or 8.8% due largely to a decrease in retail time accounts
discussed previously in this Form 10-Q. The decrease in time accounts was partially offset by higher checking, savings and money market balances as a result of the Companys business development focus and incentive-based programs focused on
generating these lower cost transaction accounts. Also contributing to the increase in these accounts is the temporary movement of some matured time deposits due to the currently low rate environment.

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



|                      |  |               |         |            |                   |           |  |       |         |         |   |         |        |       |            |  |           |         |       |   |         |  |   |         |  |   |         |  |       |  
|--------------------- |  | ------------- | ------- | ---------- | ----------------- | --------- |  | ----- | ------- | ------- | - | ------- | ------ | ----- | ---------- |  | --------- | ------- | ----- | - | ------- |  | - | ------- |  | - | ------- |  | ----- | -
|                      |  | June 30, 2008 |         |            | December 31, 2007 |          
|                      |  | Retail        |         | Commercial |                   | Municipal |  | Total |         | Percent |   |         | Retail |       | Commercial |  | Municipal |         | Total |   | Percent | 
|Non-interest checking |  | $             | 36,920  |            | $                 | 97,168    |  | $     | 3,089   |         | $ | 137,177 |        | 14.8  | %          |  | $         | 35,288  |       | $ | 100,598 |  | $ | 2,960   |  | $ | 138,846 |  | 14.7  | %
|Interest checking     |  |               | 82,191  |            |                   | 10,783    |  |       | 16,416  |         |   | 109,390 |        | 11.8  | %          |  |           | 77,368  |       |   | 9,636   |  |   | 14,789  |  |   | 101,793 |  | 10.8  | %
|                      |  |               |         |            |                   |           |  |       |         |         |   |         |        |       |            |  |           |         |       |   |         |  |   |         |  |   |         |  |       |  
|Total checking        |  |               | 119,111 |            |                   | 107,951   |  |       | 19,505  |         |   | 246,567 |        | 26.6  | %          |  |           | 112,656 |       |   | 110,234 |  |   | 17,749  |  |   | 240,639 |  | 25.5  | %
|                      |  |               |         |            |                   |           |  |       |         |        
|Savings               |  |               | 77,841  |            |                   | 6,707     |  |       | 3,099   |         |   | 87,647  |        | 9.5   | %          |  |           | 73,111  |       |   | 6,498   |  |   | 1,545   |  |   | 81,154  |  | 8.6   | %
|Money market          |  |               | 75,953  |            |                   | 43,637    |  |       | 91,367  |         |   | 210,957 |        | 22.7  | %          |  |           | 70,684  |       |   | 43,565  |  |   | 88,825  |  |   | 203,074 |  | 21.5  | %
|Time deposits         |  |               | 319,527 |            |                   | 20,956    |  |       | 41,796  |         |   | 382,279 |        | 41.2  | %          |  |           | 352,760 |       |   | 22,897  |  |   | 43,689  |  |   | 419,346 |  | 44.4  | %
|                      |  |               |         |            |                   |           |  |       |         |         |   |         |        |       |            |  |           |         |       |   |         |  |   |         |  |   |         |  |       |  
|Total deposits        |  | $             | 592,432 |            | $                 | 179,251   |  | $     | 155,767 |         | $ | 927,450 |        | 100.0 | %          |  | $         | 609,211 |       | $ | 183,194 |  | $ | 151,808 |  | $ | 944,213 |  | 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 that, as of June 30, 2008, liquidity as measured by the Bank is in compliance
with its policy guidelines.

The Banks principal sources of funds for operations are cash flows generated from earnings, deposits,
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, 2008, cash and cash equivalents decreased by $2.1
million, as net cash used in investing and financing activities of $27.4 million exceeded net cash provided by operating activities of $25.2 million. Net cash used in investing activities primarily resulted from the net increase in



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loans of $20.3 million. The net cash used in financing activities principally reflects a $16.8 million decrease in deposits, cash dividends of $2.3 million,
purchase of shares for the directors deferred stock-based plan of $2.0 million and treasury share purchases of $2.2 million in the six months ended June 30, 2008. The decreases were partially offset by a net increase in borrowings of
$22.7 million. Net cash from operating activities was primarily provided by net income in the amount of $5.0 million and proceeds from sale of loans and leases held-for-sale of $21.6 million, partly reduced by originations of loans held-for-sale of
$8.5 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, 2008, the Banks credit limit with the FHLB was $213.8 million. The total of the Banks outstanding borrowings from the FHLB on that date
was $167.5 million.

Capital Resources

During the six months ended June 30, 2008, shareholders equity decreased $318,000. Net income of $5.0 million was offset by dividends declared totaling $2.2 million ($0.48 per share) and treasury stock
purchased of $2.2 million. The Company continued its stock repurchase program in the first six months of 2008 with the purchase of 87,100 shares of its stock for average cost of the shares repurchased of $25.63 per share. In addition, accumulated
other comprehensive income decreased $558,000 due to a decrease in unrealized gains on securities available-for-sale due primarily to changes in market conditions and interest rates. The securities available-for-sale portfolio is predominantly
comprised of investment grade mortgage-backed securities, securities issued by U.S. government-sponsored enterprises 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 are backed by conventional residential mortgages. Our mortgage-based securities portfolio does not include any securities backed by sub-prime, Alt-A or other high-risk mortgages.

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, 2007, 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, 2008, the Company and its subsidiary Bank met all capital adequacy requirements to which they were subject.



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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 WellCapitalized UnderPrompt CorrectiveAction Provisions |  
|                                         |  | Amount                 |         | Ratio |                                                               |   | Amount |   | Ratio  | 
|                                         |  | (Dollars in thousands) |        
|As of June 30, 2008                      |  |                        |         |      
|Total Capital (to risk-weighted assets)  |  | $                      | 103,504 |       | 11.71                                                         | % |        | $ | 88,389 |  | 310.00 | %
|Tier I Capital (to risk-weighted assets) |  |                        | 94,812  |       | 10.73                                                         | % |        |   | 53,034 |  | 36.00  | %
|Tier I Capital (to average assets)       |  |                        | 94,812  |       | 7.41                                                          | % |        |   | 63,945 |  | 35.00  | %
|As of December 31, 2007                  |  |                        |         |       |                                                               |   |        |   |        |  |        |  
|Total Capital (to risk-weighted assets)  |  | $                      | 102,311 |       | 11.59                                                         | % |        | $ | 88,262 |  | 310.00 | %
|Tier I Capital (to risk-weighted assets) |  |                        | 93,885  |       | 10.64                                                         | % |        |   | 52,957 |  | 36.00  | %
|Tier I Capital (to average assets)       |  |                        | 93,885  |       | 7.53                                                          | % |        |   | 62,373 |  | 35.00  | %

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 2007 Annual Report on Form 10-K (the Consolidated Financial Statements). These policies, along with the disclosures presented in the
other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the
sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for loan and lease losses, accrued income taxes, and the fair value analysis
of the intangible asset to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new information becomes available.

The allowance for credit losses represents managements estimate of probable credit losses in the loan and lease portfolio. Determining the amount
of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans and leases, estimated
losses on pools of homogeneous loans and leases based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the
largest asset type on the consolidated balance sheet. Note C to the Consolidated Financial Statements in this Quarterly Report on Form 10-Q describes the methodology used to determine the allowance for credit losses, and a discussion of the factors
driving changes in the amount of the allowance for credit losses is included in this report.

The Company 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



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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, 2007. 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

The
FAS issued FASB Staff Position (FSP) FAS 157-1, Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification
or Measurement under Statement 13, and FSP FAS 157-2, Effective Date of FASB Statement No. 157. FSP FAS 157-1 excludes certain leasing transactions accounted for under FASB Statement No. 13, Accounting for
Leases, from the scope of Statement 157. FSP FAS 157-2 defers the effective date in FASB Statement No. 157, Fair Value Measurements, for one year (January 1, 2009 for the Company) for certain nonfinancial assets and
nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually). The Company is currently evaluating the impact this will have on the Companys current
practice of measuring fair value for these assets and does not anticipate a material effect on the financial statements.

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



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

Qualitative Analysis. Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices, and
equity rates. Interest rate risk is the primary market risk faced by the Company as other types of market risk do not arise in the normal course of our business activities.

The Asset Liability Committee (ALCO) is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and limit exposure to interest rate risk. The
policies and guidelines established by ALCO are reviewed and approved by the Companys Board of Directors. The primary tool used to assess our interest rate sensitivity is the income simulation model.

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

The following table sets
forth the results of our net interest income simulation model as of June 30, 2008.



|                                        |  |                                             |   
|--------------------------------------- |  | ------------------------------------------- | --
|Change in Interest Rates (basis points) |  | Percent change in annualNet Interest Income |   
|+200bp                                  |  | (0.63                                       | )%
|-100bp                                  |  | (0.21                                       | )%



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

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



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

The management of the Company is responsible for establishing and maintaining effective disclosure controls and procedures, as defined under Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934. As of June 30, 2008, 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, 2008 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.



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##### Table of Contents

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 2007 Annual Report on Form 10-K for the fiscal year ended December 31, 2007.



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



| | a) | Not applicable
| | -- | --------------



| | b) | Not applicable
| | -- | --------------



| | c) | The table below sets forth the information with respect to purchases made by the Company of our common stock during the quarter ended June 30, 2008:
| | -- | ----------------------------------------------------------------------------------------------------------------------------------------------------



|                 |  |                                |  |                             |       |                                                                  |        |                                                                    |       
|---------------- |  | ------------------------------ |  | --------------------------- | ----- | ---------------------------------------------------------------- | ------ | ------------------------------------------------------------------ | ------
|Period           |  | Total Numberof SharesPurchased |  | Average PricePaid Per Share |       | Total Number ofShares Purchasedas Part of PubliclyAnnounced Plan |        | Maximum Numberof Shares that MayYet be PurchasedUnder the Plan (1)
|4/1/08  4/30/08 |  | 2,550                          |  | $                           | 26.04 |                                                                  | 2,550  |                                                                    | 12,400
|5/1/08  5/31/08 |  | 2,700                          |  | $                           | 24.60 |                                                                  | 2,700  |                                                                    | 9,700 
|6/1/08  6/30/08 |  | 5,400                          |  | $                           | 23.65 |                                                                  | 5,400  |                                                                    | 4,300 
|                 |  |                                |  |                             |       |                                                                  |        |                                                                    |       
|Total            |  | 10,650                         |  | $                           | 24.47 |                                                                  | 10,650 |                                                                    |       
|                 |  |                                |  |                             |       |                                                                  |        |                                                                    |       



|(1) | On November 27, 2007, the Company announced that its Board of Directors had authorized the repurchase of up to 3% of the Companys outstanding common
stock, or approximately 143,500 shares, over a 12-month period. The preceding table provides information with respect to repurchases of the Companys common stock in accordance with the repurchase plan during the second quarter ended
June 30, 2008. The Company purchased the remaining 4,300 shares available under the plan in July 2008.
|--- | ------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------



|Item 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 13, 2008 (the Meeting).

At the Meeting, each of the following persons was elected as a Class I Director whose term will expire at the 2011 Annual Meeting of Shareholders:



|                  |  |           |  |          |  |          
|----------------- |  | --------- |  | -------- |  | ---------
|Votes             |  | For       |  | Withheld |  | Non-votes
|Donald S. Ames    |  | 3,937,192 |  | 54,444   |  | 659,874  
|John M. Endries   |  | 3,937,882 |  | 53,754   |  | 659,874  
|Margaret G. Ogden |  | 3,893,787 |  | 97,849   |  | 659,874  
|Paul M. Solomon   |  | 3,928,192 |  | 63,444   |  | 659,874  
|John H. Watt, Jr. |  | 3,927,335 |  | 64,301   |  | 659,874  



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

Not applicable



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##### Table of Contents

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

Exhibits required by Item 601 of Regulation S-K:



|               |  |                                                                                                                                                                                                                                                                                                                                                                                                                                                               
|-------------- |  | --------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------
|Exhibit Number |  | Exhibit                                                                                                                                                                                                                                                                                                                                                                                                                                                       
|3.1            |  | Amended and Restated Certificate of Incorporation of the Company (incorporated herein by reference to exhibit 3.1 to the Companys Registration Statement on Form S-4
(Registration No. 333-62623) filed with the Commission on August 31, 1998, as amended                                                                                                                                                                                                   
|               | 
|3.2            |  | Amended and Restated Bylaws of the Company (incorporated herein by reference to exhibit number 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)
|               | 
|10.1           |  | Alliance Financial Corporation Director Retirement Plan dated March 11, 2008 (incorporated herein by reference to exhibit 10.1 to the Companys Current Report on Form
8-K (File No. 000-15366) filed with the Commission on March 14, 2008)                                                                                                                                                                                                                  
|               | 
|10.2           |  | Alliance Bank Executive Incentive Retirement Plan dated March 11, 2008 (incorporated herein by reference to exhibit 10.2 to the Companys Current Report on Form 8-K
(File No. 000-15366) filed with the Commission on March 14, 2008)                                                                                                                                                                                                                        
|               | 
|10.3           |  | Alliance Financial Corporation Stock-Based Deferral Plan dated March 11, 2008 (incorporated herein by reference to exhibit 10.3 to the Companys Current Report on Form
8-K (File No. 000-15366) filed with the Commission on March 14, 2008)                                                                                                                                                                                                                 
|               | 
|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                                                                                                                                                                                                                                                            



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##### Table of Contents

SIGNATURES

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



|                      |  |                                                                           
|--------------------- |  | --------------------------------------------------------------------------
|                      |  | ALLIANCE FINANCIAL CORPORATION                                            
|                      | 
|DATE: August 11, 2008 |  | /s/ Jack H. Webb                                                          
|                      |  | Jack H. Webb, Chairman of the Board, President and Chief Executive Officer
|                      | 
|DATE: August 11, 2008 |  | /s/ J. Daniel Mohr                                                        
|                      |  | J. Daniel Mohr, Treasurer and Chief Financial Officer                     



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