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 March 31, 2007ORo
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
  THE SECURITIES EXCHANGE ACT OF 1934For the transition period from ____________________
  to _______________________ Commission File
Number: 000-15366 ALLIANCE
  FINANCIAL CORPORATION(Exact name of
  Registrant as specified in its charter)New
  York

16-1276885(State or Other
  Jurisdiction of Incorporation or

(IRS Employer
  Identification Number)Organization)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. Yesx
Noo Indicate by check mark whether the Registrant is a
large accelerated filer, an accelerated filer, or a non-accelerated file (as
defined in Rule 12b-2 of the Exchange Act).Large accelerated fileroAccelerated
filerxNon-accelerated
filero Indicate by check mark whether the Registrant is a
shell company (as defined in Rule 12b-2 of the Exchange Act). YesoNo
x The number of shares outstanding of the Registrants
common stock on April 30, 2007: Common Stock, $1.00 Par Value  4,782,559
shares.    TABLE
OF CONTENTS

Part I.
FINANCIAL INFORMATIONItem 1.
Financial Statements (All Unaudited)Consolidated Balance SheetsConsolidated Statements of IncomeConsolidated Statements of Changes in
  Shareholders EquityConsolidated Statements of Cash FlowsNotes to Consolidated Financial
  StatementsItem 2.
Managements Discussion and Analysis
  of Financial Condition and Results of OperationsItem 3.
Quantitative and Qualitative
  Disclosures About Market RiskItem 4.
Controls and ProceduresPart II.
OTHER INFORMATIONItem 1.
Legal ProceedingsItem 1A.
Risk FactorsItem 2.
Unregistered Sales of Equity
  Securities and Use of ProceedsItem 3.
Defaults Upon Senior SecuritiesItem 4.
Submission of Matters to a Vote of
  Security HoldersItem 5.
Other InformationItem 6.
ExhibitsSignatures2

Alliance Financial Corporation and
  SubsidiariesConsolidated Balance Sheets (Unaudited)(In thousands, except share data)March 31,
  2007

December
  31, 2006AssetsCash and due
from banks

$
25,770

$
27,398Securities
available-for-sale


261,661


254,002Federal Home
Loan Bank of New York (FHLB) and Federal Reserve Bank
  (FRB) stock


9,311


7,985Loans and
leases, net of unearned income


885,076


882,566Allowance for
loan and lease losses


7,333


7,029Net loans and
leases


877,743


875,537Premises and
equipment, net


19,565


20,125Accrued
interest receivable


5,208


4,605Bank-owned
life insurance


16,605


16,449Assets held
for sale


2,367


2,367Goodwill


33,632


33,456Intangible
assets, net


14,463


14,912Other
assets


16,975


16,131Total
assets

$
1,283,300

$
1,272,967Liabilities and
shareholders equityLiabilitiesDeposits:Non-interest-bearing deposits

$
125,819

$
129,575Interest-bearing deposits


808,716


806,021Total
deposits


934,535


935,596Borrowings


190,817


179,650Accrued
interest payable


3,008


2,651Other
liabilities


18,854


19,790Junior
subordinated obligations issued to unconsolidated subsidiary
  trusts


25,774


25,774Total
liabilities


1,172,988


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





Common stock
(par value $1.00) 10,000,000 shares authorized, 4,908,871
  and 4,894,994 issued, and 4,782,559 and 4,800,512 shares outstanding,
  respectively


4,909


4,895Surplus


39,167


38,986Undivided
profits


71,960


70,658Accumulated
other comprehensive loss


(1,831
)

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


(3,893
)

(2,911
)Total
shareholders equity


110,312


109,506Total
liabilities & shareholders equity

$
1,283,300

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

3

Alliance Financial Corporation and SubsidiariesConsolidated
  Statements of Income (Unaudited)(Dollars in thousands, except per share data)Three
  months ended
  March 31,2007
  
  2006Interest incomeInterest and fees on loans and leases
  
  $
  14,561
  
  $
  9,989Federal funds sold and interest bearing deposits
  
  
  6
  
  
  61Securities
  
  
  2,810
  
  
  2,659Total interest income
  
  
  17,377
  
  
  12,709Interest expenseDeposits:Savings accounts
  
  
  110
  
  
  73Money market accounts
  
  
  1,552
  
  
  1,177Time accounts
  
  
  4,884
  
  
  3,170NOW accounts
  
  
  183
  
  
  83Total deposits
  
  
  6,729
  
  
  4,503Borrowings:Repurchase agreements
  
  
  709
  
  
  575FHLB advances
  
  
  1,369
  
  
  905Junior subordinated obligations issued to unconsolidated subsidiary
  trusts
  
  
  489
  
  
  191Total interest expense
  
  
  9,296
  
  
  6,174Net interest income
  
  
  8,081
  
  
  6,535Provision for loan and
  lease losses
  
  
  750
  
  
  1,000Net interest income after provision for loan and lease losses
  
  
  7,331
  
  
  5,535Non-interest incomeTrust & brokerage income
  
  
  2,218
  
  
  2,248Service charges on deposit accounts
  
  
  1,252
  
  
  957Card-related fees
  
  
  446
  
  
  271Insurance agency income
  
  
  397
  
  
  Income from bank-owned life insurance
  
  
  156
  
  
  98Gain on the sale of loans
  
  
  44
  
  
  13Rental income from operating leases
  
  
  76
  
  
  213Other non-interest income
  
  
  500
  
  
  231Total non-interest income
  
  
  5,089
  
  
  4,031Non-interest expenseSalaries and employee benefits
  
  
  4,434
  
  
  3,917Occupancy and equipment
  
  
  1,822
  
  
  1,488Communication expense
  
  
  192
  
  
  135Stationery and supplies expense
  
  
  129
  
  
  107Marketing expense
  
  
  289
  
  
  397Amortization of intangible assets
  
  
  449
  
  
  126Professional fees
  
  
  700
  
  
  746Other non-interest expenses
  
  
  1,306
  
  
  907Total non-interest expense
  
  
  9,321
  
  
  7,823Income before income tax
  expense
  
  
  3,099
  
  
  1,743Income tax expense
  
  
  745
  
  
  303Net income
  
  $
  2,354
  
  $
  1,440Net income per common shareBasic
  
  $
  0.50
  
  $
  0.40Diluted
  
  $
  0.49
  
  $
  0.40Dividends declared per
  share
  
  $
  0.22
  
  $
  0.22The accompanying notes are an
integral part of the consolidated financial statements.

4

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

CommonStock

Surplus

UnamortizedValue ofRestrictedStock

UndividedProfits

AccumulatedOtherComprehensiveIncome

TreasuryStock

TotalBalance at
December 31, 2005


3,565,012

$
3,979

$
11,185

$
(1,453
)
$
66,740

$
(1,700
)
$
(9,180
)
$
69,571Comprehensive
incomeNet
Income














1,440








1,440Other
comprehensive income, net of taxes:Change in
unrealized appreciation in available for sale securities,
  net of reclassification adjustment (net of tax)

















(482
)




(482
)Comprehensive
income














1,440


(482
)




958Issuance of
restricted stock


21,500


21


643


(664
)










Forfeiture of
restricted stock


(400
)




(11
)

14











3Amortization
of restricted stock











83











83Tax benefit of
restricted stock plan














6








6Stock options
exercised


409





9














9Tax benefit of
stock-based compensation








288














288Cash dividend,
$.22 per share














(781
)







(781
)Treasury stock
purchased


(15,367
)
















(496
)

(496
)Reclassification of unearned restricted stock awards to  surplus in accordance with SFAS No. 123R
  (83,875) shares








(2,020
)

2,020Balance at
March 31, 2006


3,571,154

$
4,000

$
10,094

$


$
67,405

$
(2,182
)
$
(9,676
)
$
69,641Balance at
December 31, 2006


4,800,512

$
4,895

$
38,986

$


$
70,658

$
(2,122
)
$
(2,911
)
$
109,506Comprehensive
incomeNet
Income














2,354








2,354Other
comprehensive income, net of taxes:Change in
unrealized appreciation in available-for-sale Securities
  (net of tax)

















161





161Change in
minimum pension liability

















130





130Comprehensive
income














2,354


291





2,645Issuance of
restricted stock


15,750


16


(16
)













Forfeiture of
restricted stock


(9,900
)

(10
)

(76
)













(86
)Amortization
of restricted stock








86














86Tax benefit of
restricted stock plan








6














6Stock options
exercised


8,027


8


170














178Tax benefit of
stock-based compensation








11














11Cash dividend,
$.22 per share














(1,052
)







(1,052
)Treasury stock
purchased


(31,830
)
















(982
)

(982
)Balance at
March 31, 2007


4,782,559

$
4,909

$
39,167

$


$
71,960

$
(1,831
)
$
(3,893
)
$
110,3125

Alliance
  Financial Corporation and SubsidiariesCondensed
  Consolidated Statements of Cash Flow (Unaudited)Three
  months ended March 31,2007

2006(In thousands)Operating Activities:Net
Income

$
2,354

$
1,440Adjustments to
reconcile net income to net cash provided by operating
  activities:Provision for
loan and lease losses


750


1,000Depreciation
expense


685


629Increase in
surrender value of life insurance


(156
)

(98
)Benefit for
deferred income taxes


(116
)

Accretion of
investment security discounts and premiums, net


(51
)

(21
)Net loss
(gain) on sale of premises and equipment


11


(7
)Proceeds from
the sale of mortgage loans


2,800


941Origination of
loans held-for-sale


(2,756
)

(928
)Gain on sale
of loans


(44
)

(13
)Amortization
of capitalized servicing rights


70


19Amortization
of intangible assets


449


126Restricted
stock expense





83Change in
other assets and liabilities


(2,063
)

(1,449
)Net cash
provided by operating activities


1,933


1,722Lending
  and Investing Activities:Proceeds from
maturities, redemptions, calls and principal repayments
  of investment securities, available-for-sale


16,373


11,723Purchase of
investment securities available-for-sale


(23,712
)

(4,996
)Purchase of
FHLB and FRB stock


(6,501
)

(1,205
)Redemption of
FHLB stock


5,175


2,218Net increase
in loans and leases


(3,022
)

(12,982
)Purchases of
premises and equipment


(243
)

(263
)Proceeds from
the sale of premises and equipment


107


79Net cash used
in lending and investing activities


(11,823
)

(5,426
)Deposit
  and Financing Activities:Net increase
in demand deposits, NOW and savings accounts


20,131


18,407Net (decrease)
increase in time deposits


(21,192
)

25,976Net increase
(decrease) in short-term borrowings


16,167


(19,235
)Payments on
long-term borrowings


(5,000
)

(5,000
)Proceeds from
the exercise of stock options


178


9Treasury stock
purchased


(982
)

(496
)Tax benefit of
stock-based compensation


17


Cash
dividends


(1,057
)

(753
)Net cash
provided by deposit and financing activities


8,262


18,908Net (decrease)
increase in cash and cash equivalents


(1,628
)

15,204Cash and cash
equivalents at beginning of period


27,398


22,878Cash and cash
equivalents at end of period

$
25,770

$
38,082Supplemental
  Disclosures of Cash Flow Information:Interest
received during the period

$
16,734

$
12,090Interest paid
during the period


8,941


6,091Income
taxes


47


100Non-cash
investing activities:Change in
unrealized loss on available-for-sale securities


269


(665
)Transfers of
loans to other real estate and repossessed assets


66


Non-cash
financing activities:Dividend
declared and unpaid


1,052


781The accompanying notes are an
integral part of the consolidated financial statements.

6

Alliance Financial Corporation and SubsidiariesNotes to Consolidated Financial StatementsA.
Basis of
  PresentationThe
accompanying unaudited consolidated financial statements include the accounts
of Alliance Financial Corporation (the Company or Alliance), its
wholly-owned subsidiaries Ladds Agency, Inc. and Alliance Bank N.A. (the
Bank), and the Banks wholly-owned subsidiaries. All significant intercompany
accounts and transactions have been eliminated in consolidation. The accompanying
unaudited consolidated financial statements were prepared in accordance with
the instructions for Form 10-Q and Regulation S-X and, therefore, do not
include information for footnotes necessary for a complete presentation of
financial condition, results of operations, and cash flows in conformity with
generally accepted accounting principles. The following material under the
heading Managements Discussion and Analysis of Financial Condition and
Results of Operations is written with the presumption that the users of the
interim financial statements have read, or have access to, the latest audited
financial statements and notes thereto of the Company, together with
Managements Discussion and Analysis of Financial Condition and Results of
Operations as of December 31, 2006 and for the three-year period then ended,
included in the Companys Annual Report on Form 10-K for the year ended
December 31, 2006. Accordingly, only material changes in the results of
operations and financial condition are discussed in the remainder of Part I.
Certain amounts from prior year periods are reclassified, when necessary, to
conform to the current period presentation.

All
adjustments that in the opinion of management are necessary for a fair
presentation of the financial statements have been included in the results of
operations for the three months ended March 31, 2007 and 2006.

B.
Net Income
  Per Common ShareBasic and
diluted net income per common share calculations are as follows:

For three months ended March 312007

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

$
2,354

$
1,440Weighted average common shares
outstanding


4,724,638


3,566,228Net income per common share
 basic

$
0.50

$
0.40Diluted:Net income

$
2,354

$
1,440Weighted average common shares
outstanding


4,724,638


3,566,228Incremental shares from assumed
conversion
  of stock options and restricted stock


75,000


73,409Weighted average common shares
outstanding
   diluted


4,799,638


3,639,637Net income per common share
 diluted

$
0.49

$
0.40Basic earnings
per share are computed by dividing net income by the weighted average number of
common shares outstanding throughout each period. Diluted earnings per share
gives the effect to weighted average shares which would be outstanding assuming
the exercise of options and issuances of unearned restricted stock using the
treasury stock method.

C.
Allowance
  for Loan and Lease LossesThe allowance
for loan and lease losses represents managements best estimate of probable
loan and lease losses in the Companys loan and lease portfolio. Managements
quarterly evaluation of the allowance for loan and lease losses is a
comprehensive analysis that builds a total reserve by evaluating the risks
within each loan and lease type, or pool, of similar loans and leases. The
Company uses a general allocation methodology for all residential and consumer
loan pools. This methodology estimates a reserve for each pool based on the
average loss rate for the time period that includes the current year and two
full prior years. The average loss rate is adjusted to reflect the expected
impact that current trends regarding loan growth, delinquency, actual 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

7

Alliance Financial Corporation and SubsidiariesNotes to Consolidated Financial Statementsleases
classified as being impaired in excess of $150,000, which have been risk rated
under the Companys risk rating system as substandard, doubtful, or loss. For
all other commercial loans and leases, the Company uses the general allocation
methodology that establishes a reserve for each risk-rating category. The
general allocation methodology for commercial loans and leases considers the
same factors that are considered when evaluating residential mortgage and
consumer loan pools. The combination of using both the general and specific
allocation methodologies reflects managements best estimate of the probable
loan and lease losses in the Companys loan and lease portfolio.

A loan or
lease is considered impaired, based on current information and events, if it is
probable that the Company will be unable to collect the scheduled payments of principal
or interest when due accord­ing to the contractual terms of the loan or lease
agreement. The measurement of impaired loans and leases is generally discounted­
at the historical effective interest rate, except­­ that all
collateral-dependent loans and leases are measured­ for impairment based on
fair value of the collateral.

Loans are
charged off when they are considered a loss regardless of the delinquency
status. From a delinquency standpoint, the policy of the Company is to charge
off loans when they are 120 days past due unless extenuating circumstances are
documented that attest to the ability to collect the loan. Special
circumstances to include fraudulent loans and loans in bankruptcy will be
charged off no later than 90 days of discovery or within 120 days delinquent,
whichever is shorter. In lieu of charging off the entire loan balance, loans
with collateral may be written down to the value of the collateral, less cost
to sell, if foreclosure or repossession of collateral is assured and in process.

D.
Retirement
  Plan and Post-Retirement BenefitsThe Company
has a noncontributory defined benefit pension plan which it assumed from Bridge
Street Financial Inc. (Bridge Street). The plan covers substantially all
former Bridge Street full-time employees who met eligibility requirements on
October 6, 2006, at which time all benefits were frozen. Under the plan,
retirement benefits are primarily a function of both the years of service and
the level of compensation. The amount contributed to the plan is determined
annually on the basis of (a) the maximum amount that can be deducted for
federal income tax purposes, or (b) the amount certified by an actuary as
necessary to avoid an accumulated funding deficiency as defined by the Employee
Retirement Income Security Act of 1974. The Company does not expect to make
contributions to its pension plan in 2007.

The Company
provides post-retirement medical and life insurance benefits through an
unfunded plan to qualifying employees. Benefits are available to full-time
employees who have worked 15 years and attained age 55. Retirees and certain
active employees with more than 20 years of service to the Company continue to
receive benefits in accordance with plans that existed at First National Bank
of Cortland and Oneida Valley National Bank, prior to the merger of those banks
in 1999.

8

Alliance Financial Corporation and SubsidiariesNotes to Consolidated Financial StatementsThe components
of the pension and post-retirement plans net periodic (benefit) cost for the
periods indicated are as follows (in thousands):

Pension
  Three months ended March 31,2007

2006Service cost

$


$
Interest cost


60


Expected return on
assets


(100
)

Amortization of unrecognized
prior service
  cost





Net periodic pension
benefit

$
(40
)
$
Post-retirement
  Three months ended March 31,2007

2006Service cost

$
44

$
30Interest cost


86


69Amortization of unrecognized
prior service
  cost


15


19Net periodic post-retirement
cost

$
145

$
118E.
Income TaxesThe Company
has adopted the provisions of FASB Interpretation No. 48, Accounting for
Uncertainty in Income Taxes (FIN 48) effective January 1, 2007. There was no
cumulative effect of adoption of FIN 48.

As of January
1, 2007, the Companys gross unrecognized tax benefits totaled $134,000.
Included in this amount is $43,000 which would impact the Companys effective
tax rate, if recognized or reversed, and $69,000 which would affect goodwill.
The Company does not anticipate that total unrecognized tax benefits will
significantly change due to the settlement of audits or the expiration of
statute of limitations prior to March 30, 2008.

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

As of January
1, 2007, the Company has accrued $11,000 of interest related to uncertain tax
positions. As of March 31, 2007, the total amount of accrued interest was
$13,000. The Company accounts for interest and penalties related to uncertain
tax positions as part of its provision for federal and state income taxes.

9

Item 2.
Managements Discussion and Analysis of Financial Condition and
  Results of OperationsGeneral

Throughout
this analysis, the term the Company refers to the consolidated entity of
Alliance Financial Corporation, its wholly-owned insurance subsidiary, Ladds
Agency, Inc., its wholly-owned banking subsidiary, 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 an analysis of material changes in the Companys results of
operations and financial condition during the three months ended March 31,
2007, which are not otherwise apparent from the consolidated financial
statements included in this report.

This
discussion and analysis contains certain forward-looking statements (within the
meaning of the Private Securities Litigation Reform Act of 1995) with respect
to the financial condition, results of operations and business of the Company.
These forward-looking statements involve certain risks and uncertainties.
Factors that may cause actual results to differ materially from those
contemplated by such forward-looking statements include, among others, the
following possibilities:


an increase
  in competitive pressures in the banking industry;
changes in
  the interest rate environment that reduce margins;
changes in
  the regulatory environment;
general
  economic conditions, either nationally or regionally, that are less favorable
  than expected, resulting in, among other things, a deterioration in credit
  quality;
changes in
  business conditions and inflation;
changes in
  the securities markets;
changes in
  technology used in the banking business;
our ability
  to maintain and increase market share and control expenses;
the
  possibility that the Companys investment management business will fail to
  perform as currently anticipated;
changes in
  key management personnel may adversely impact our operations; and
other
  factors detailed from time to time in the Companys Securities and Exchange
  Commission filings.Operating
results for the three months ended March 31, 2007 are not necessarily
indicative of the results that may be expected for the year ending December 31,
2007.

10

Results of Operations For The Three Months
Ended March 31, 2007

Earnings Summary and Executive Overview

Net income for
the first quarter of 2007 was $2.4 million, an increase of $914,000 or 63.5%
compared with $1.4 million in the year-ago quarter. Diluted earnings per share
increased 22.5% to $0.49 in the first quarter, compared with $0.40 in the first
quarter of 2006. The return on average assets and return on average
shareholders equity were 0.75% and 8.58%, respectively, for the three months
ended March 31, 2007, compared with 0.59% and 8.18%, respectively, for the
first quarter of 2006.

Increases in
net interest income of $1.5 million and non-interest income of $1.1 million
offset a $1.5 million increase in non-interest expenses.

The ability to
compare the first quarter of 2007 with the first quarter of 2006 has been
significantly impacted by the acquisition
of Bridge Street Financial, Inc. (Bridge Street), a $219.3 million bank
holding company, in October 2006.

Analysis of Net Interest Income and the Net
Interest Margin


Net interest income was $8.1 million in the first quarter of 2007, an increase of $1.5 million,
or 23.7%, from the first quarter of
2006 which
resulted primarily from an increase in average earning assets of $216.5 million
compared with the year-ago quarter. The acquisition of Bridge Street and growth
in the Companys lease portfolio in the second half of 2006 were the primary
contributors to the earning asset growth. Total interest income increased $4.7
million, to $17.4 million in the first quarter of 2007, compared with $12.7
million in the first quarter of 2006. This increase was partially offset by an
increase in interest expense of $3.1 million, to $9.3 million in the first
quarter of 2007 compared with $6.2 million in the first quarter of 2006. The increase in interest income resulted
primarily from the increase in earning assets and a change in our asset mix,
and a higher yield on those assets. The increase in interest expense resulted
primarily from a $202.1 million increase in average interest-bearing
liabilities in the first quarter of 2007 compared with the same period in 2006,
and a higher cost of funds.

The Companys tax-equivalent earning assets yield was 6.30% in the first
quarter of 2007, an increase of 59 basis points compared with the same quarter
in 2006, due primarily to a higher proportion of earning assets in loans and
leases and also to higher yields resulting from rate adjustments on certain
variable rate assets and reinvestment of certain asset cash flows at generally
higher rates. Loans and leases comprised 77.1% of average earning assets in the
first quarter of 2007, compared with 70.8% in the year-ago quarter. The growth
in percentage terms in loans and leases occurred in the higher yielding
commercial loans and leases categories, which comprised 25.2% and 14.9%,
respectively, of total average loans and leases in the first quarter of 2007,
compared with 24.4% and 10.2%, respectively, in the first quarter of 2006.
First quarter growth in our lease portfolio was slowed by normal seasonal
factors and by the departure of the president of our leasing subsidiary
in March 2007. The rate of
growth in the Companys commercial lease portfolio in 2007 will be less than
the $66.2 million in growth experienced in 2006. Average indirect auto loans increased $8.2 million in the first quarter
of 2007 compared with the year-ago quarter, but as a percentage of total
average loans and leases decreased to 20.6% from 26.4% in the year-ago quarter.
The decrease in percentage terms is due primarily to the fact that there were
no indirect auto loans in the portfolio acquired from Bridge Street.

Our cost of funds was 3.67% in the first quarter of 2007, an increase of
62 basis points compared with the first quarter of 2006. The increase in the
cost of funds compared with the year-ago quarter resulted primarily from higher
short-term interest rates and highly competitive pricing for time deposits, and
a slightly larger portion of the Companys funding in time deposits and
borrowings. Time deposits and borrowings comprised 54.5% of the Companys total
average deposits and borrowings in the first quarter of 2007, compared with
53.9% in the year-ago period. The average rate paid on the Companys time
accounts in the first quarter was 4.60%, up 89 basis points from the first
quarter of 2006.

11

Our earning assets yield and cost of funds each decreased 3 basis points
in the first quarter of 2007 compared with the fourth quarter of 2006,
reflecting slower growth in higher-yielding commercial loans and leases and a
significant slowing of the rate of increase in our cost of funds as a large
portion of our current time deposits and borrowings have adjusted over the past
year to rates that are at or near current rates

The Companys net interest margin on a tax-equivalent basis was 3.04% in
the first quarter of 2007, which was unchanged from the first quarter of 2006.
The net interest margin was 3.08% in the fourth quarter of 2006.

Maintaining and growing our loans
and deposits is highly dependent on our ability to effectively compete in a
market whose economy is marked by slow growth and intense competition among
financial institutions. In some cases we have elected to forego retaining or
pursuing a relationship because of competitive rates or terms which we believed
to be inappropriate under the circumstances. We expect that the slow economic
growth and intense competition among financial institutions in our market will
continue for the foreseeable future, which, along with the continuing flat and
sometimes inverted treasury yield curve, will continue to restrain balance
sheet growth and pressure net interest margin. In addition, consumer preference
for higher rate short-term time deposits could result in a continuing migration
of retail money market accounts to time accounts, which would increase our cost
of funds and pressure the net interest margin.

12

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 and
assumes a 34% tax rate. Non-accrual loans have been included in the average
balances. Securities are shown at average amortized cost.

Three months ended March 31,2007

2006AverageBalance

InterestEarned/Paid

Yield/Rate
AverageBalance

InterestEarned/Paid

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

$
283

$
6


7.77
%
$
5,147

$
61


4.74
%Taxable
investment securities


167,158


1,828


4.37
%

185,613


1,838


3.96
%Nontaxable
investment securities


85,732


1,315


6.14
%

73,026


1,132


6.20
%FHLB and FRB
stock


8,193


114


5.57
%

6,089


74


4.86
%Real estate
loans


255,426


3,861


6.05
%

186,721


2,799


6.00
%Commercial
loans


213,298


4,209


7.89
%

153,892


2,832


7.36
%Nontaxable
commercial loans


8,596


152


7.05
%

6,357


107


6.76
%Taxable
leases, net of unearned discount


110,591


1,979


7.16
%

49,860


766


6.15
%Nontaxable
leases, net of unearned discount


20,550


300


5.84
%

16,780


244


5.82
%Indirect
loans


181,646


2,407


5.30
%

173,404


2,106


4.86
%Consumer
loans


90,692


1,807


7.97
%

68,804


1,254


7.29
%Total
interest-earning assets


1,142,165


17,978


6.30
%

925,693


13,213


5.71
%Non-interest
earning assets:Other
assets


130,865








62,760Allowance for
loan and lease losses


(7,155
)







(4,999
)Net unrealized
loss on securities available-for-sale


(2,011
)







(2,400
)Total
assets

$
1,263,864







$
981,054Liabilities
and shareholders equity:Interest
bearing liabilities:Demand
deposits


96,479


183


0.76
%

85,881


83


0.39
%Savings
deposits


84,635


110


0.52
%

55,424


73


0.53
%Money market
deposits


200,490


1,552


3.10
%

178,745


1,177


2.63
%Time
deposits


424,971


4,884


4.60
%

342,042


3,170


3.71
%Borrowings


180,149


2,078


4.61
%

138,018


1,480


4.29
%Junior
subordinated obligations


25,774


489


7.59
%

10,310


191


7.41
%Total
interest-bearing liabilities


1,012,498


9,296


3.67
%

810,420


6,174


3.05
%Non-interest
bearing liabilities:Demand
deposits


124,238








90,473Other
liabilities


17,387








9,781Shareholders equity


109,741








70,380Total
liabilities and shareholders equity

$
1,263,864







$
981,054Net interest
income (tax equivalent)




$
8,682







$
7,039Net interest
rate spread








2.63
%







2.66
%Net interest
margin








3.04
%







3.04
%Federal tax
exemption on non-taxable investment securities
  included in interest income




$
601







$
50413

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

Three
  months ended March 31, 2007
  compared to 2006Increase
  (decrease) due toVolume

Rate

Net
  Change(In
thousands)Federal funds sold

$
(76
)
$
21

$
(55
)Taxable investment
  securities


(191
)

181


(10
)Non-taxable investment
  securities


196


(13
)

183FHLB and FRB stock


27


13


40Real estate loans


1,034


28


1,062Commercial loans


1,133


244


1,377Non-taxable commercial
  loans


39


6


45Taxable leases, net of
  unearned discount


1,010


203


1,213Non-taxable leases, net of
  unearned discount


55


1


56Indirect loans


105


196


301Consumer loans


417


136


553Total
interest-earning assets

$
3,749

$
1,016

$
4,765Interest-bearing demand
  deposits


15


85


100Savings deposits


38


(1
)

37Money market deposits


156


219


375Time deposits


861


853


1,714Borrowings


469


129


598Junior subordinated obligations
issued to unconsolidated subsidiary
  trusts


290


8


298Total
interest-bearing liabilities

$
1,829

$
1,293

$
3,122Net interest
income (tax equivalent)

$
1,920

$
(277
)
$
1,64314

Analysis of Asset Quality and the Provision
and Allowance for Loan and Lease Losses

We establish
provisions for loan and lease losses, which are charged or credited to
operations, in order to maintain the allowance for loan and lease losses at a
level management considers adequate to absorb probable credit losses in the
current loan and lease portfolio. The amount of the allowance is based on
estimates and the ultimate losses may vary from such estimates as more
information becomes available or later events occur. Management assesses the
allowance for loan and lease losses on a quarterly basis and makes provisions
for loan and lease losses in order to adjust the allowance, when necessary.

Nonperforming assets increased $3.0 million in the first quarter, and
were $5.6 million or 0.44% of total assets, compared with $2.6 million or 0.21%
of total assets at December 31, 2006. The Companys earnings release for the first quarter of 2007 dated April
19, 2007 incorrectly reported the amount of nonperforming assets as $4.4
million at March 31, 2007.

Four relationships comprised most of the increase in nonperforming
assets in the quarter, the largest of which is a $1.2 million short-term
commercial loan that was 30 days past due on March 31, 2007. The other three
were secured commercial relationships totaling $1.3 million (the largest of
which is a $548,000 relationship) which were acquired as part of the
acquisition of Bridge Street. These loans are considered to be adequately
collateralized and no specific loss allocations were necessary in connection
with placing these loans on nonaccrual status.

Despite the
increase in nonperforming assets, total loan delinquencies were lower at March
31, 2007 compared with December 31, 2006. The ratio of loans and leases
delinquent 30 days or more to total loans and leases declined to 1.23% at March
31, 2007 from 1.84% at December 31, 2006. The overall improvement in the total
delinquencies is due in large part to improvements in residential, commercial
and consumer delinquencies as we implemented operational adjustments in
connection with the Bridge Street acquisition and applied our collection
procedures to delinquent loans acquired from Bridge Street.

In addition to
the nonperforming loans discussed above, the Company has also identified
approximately $6.0 million in potential problem loans at March 31, 2007 as
compared to $6.7 million at December 31, 2006. Potential problem loans are
loans that are currently performing, but where known information about possible
credit problems of the related borrowers causes management to have concerns as
to the ability of such borrowers to comply with the present loan repayment
terms and which may result in disclosure of such loans as nonperforming at some
time in the future. At the Company, potential problem loans are typically loans
that are performing but are classified by our loan rating system as
substandard. At March 31, 2007, potential problem loans primarily consisted
of commercial real estate and commercial loans. There can be no assurance that
additional loans will not become nonperforming, require restructuring, or
require increased provision for loan losses.

The provision for loan and lease losses was $750,000 in the first
quarter of 2007, compared with $1.0 million in the year-ago quarter. Net
charge-offs were $446,000 in the three months ended March 31, 2007, compared
with $914,000 in the year-ago quarter. The lower provision was due primarily to
the decrease in net charge-offs in the first quarter of 2007
compared with the year-ago quarter.

The allowance
for loan and lease losses was $7.3 million at March 31, 2007, compared with
$7.0 million at December 31, 2006. The
ratio of the allowance for loan and lease losses to nonperforming loans and
leases decreased in the first quarter due to the increase in nonperforming
loans and leases, and was 132.7% at March 31, 2007, compared with 266.4% at
December 31, 2006. The ratio of the allowance for loan and lease losses to
total loans and leases was 0.83% at March 31, 2007, compared with 0.80% at
December 31, 2006.

15

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

March 31, 2007

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

$
297

$
298Commercial
loans


2,874


1,248Leases


228


99Indirect
loans


84


63Other consumer
loans


280


141Total
non-accruing loans and leases


3,763


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


1,763


790Total
non-performing loans and leases


5,526


2,639Other real estate and
  repossessed assets


66


Total
non-performing assets

$
5,592

$
2,639Three
  months ended March 31,2007

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

$
7,029

$
4,960Loans and leases
  charged-off


(635
)

(1,070
)Recoveries of loans and
  leases previously charged-off


189


156Net loans and leases
  charged-off


(446
)

(914
)Provision for loan and
  lease losses


750


1,000Allowance for loan and
  lease losses, end of period

$
7,333

$
5,046The following
table presents certain asset quality ratios for the periods indicated:

Three
  months ended March 31,2007

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


0.20
%

0.56
%Provision for loan and
  lease losses to average loans and leases, annualized


0.34
%

0.61
%Allowance for loan and
  lease losses to period-end loans and leases


0.83
%

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


132.7
%

222.5
%Non-performing loans and
  leases to period-end loans and leases


0.62
%

0.34
%Non-performing assets to
  period-end assets


0.44
%

0.23
%16

Non-interest Income

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

Three
  months ended March 31,2007

2006

ChangeTrust & brokerage
  income

$
2,218

$
2,248

$
(30
)

(1.3
%)Service charges on deposit
  accounts


1,252


957


295


30.8
%Card-related fees


446


271


175


64.6
%Insurance agency income


397





397


100
%Income from bank-owned life
  insurance


156


98


58


59.2
%Gain on the sale of loans


44


13


31


238.5
%Rental income from operating
  leases


76


213


(137
)

(64.3
%)Other non-interest income


500


231


269


116.5
%Total non-interest income

$
5,089

$
4,031

$
1,058


26.2
%Non-interest income was $5.1 million in the first quarter of 2007,
which was an increase of $1.1 million or 26.2% compared with $4.0 million in
the first quarter of 2006. The increase occurred primarily in service charges,
debit card related fees, and insurance agency income as a result of the Bridge
Street acquisition. Rental income from leases decreased $137,000 or 64.3% due
to the declining balance in our operating lease portfolio. We ceased
originating operating leases in early 2004, and as a result, rental income (and
related depreciation expense) will continue to decline in 2007. Other
non-interest income increased $269,000 or 116.5% due primarily to the
recognition of income of $147,000 on an equity investment and to a $61,000
increase in mortgage servicing income relating primarily to the Bridge Street
portfolio.

Non-interest expenses

The following
table sets forth certain information on operating expenses for the periods
indicated (dollars in thousands):

For the
  three months ended March 31,2007

2006

ChangeSalaries and employee
  benefits

$
4,434

$
3,917

$
517


13.2
%Occupancy and equipment


1,822


1,488


334


22.4
%Communication expense


192


135


57


42.2
%Stationery and supplies
  expense


129


107


22


20.6
%Marketing expense


289


397


(108
)

(27.2
%)Amortization of intangible
  assets


449


126


323


256.3
%Professional fees


700


746


(46
)

(6.2
%)Other non-interest expenses


1,306


907


399


44.0
%Total non-interest expense

$
9,321

$
7,823

$
1,498


19.1
%Non-interest expenses were $9.3 million in the first quarter of 2007,
an increase of $1.5 million or 19.1% compared to the first quarter of 2006. The
increase resulted primarily from the incremental costs associated with the
operation of the Bridge Street branches and insurance agency, the costs
associated with processing the increased volume of customer transactions due to
the Bridge Street acquisition and amortization of intangible assets recorded in
connection with the acquisition. Acquisition related expenses totaled
approximately $113,000 in the first quarter of 2007 and included primarily
professional fees. No further expenses are anticipated in connection with the
Bridge Street acquisition.

Marketing expense decreased $108,000 due primarily to a higher
proportion of 2006 marketing related activities recognized in that years first
quarter, with the 2007 first quarter amount representing a more normal level.

17

In excess of
$4 million of Bridge Streets pre-merger annualized expenses have been
eliminated as a result of its merger and integration into the Company, which,
combined with the revenue attributable to Bridge Street, resulted in an
improvement in the Companys efficiency ratio to 70.8% in the first quarter of
2007, down from 74.0% in the prior year period.

Income taxes

The Companys
effective tax rate was 24.0% for the three months ended March 31, 2007,
compared with 17.4% in the year-ago period. The higher tax rate is primarily
the result of tax-exempt income representing a lower proportion of our total
income as a result of the Bridge Street acquisition.

ANALYSIS OF FINANCIAL CONDITION

Total assets were $1.3 billion at March 31, 2007, an increase of $10.3
million from December 31, 2006. Securities available-for-sale increased $7.7
million in the first quarter, and totaled $261.7 million at March 31, 2007.
Loans and leases, net of unearned income, increased $2.5 million in the first
quarter, to $885.1 million at March 31, 2007.

The following
table sets forth the amortized cost and fair value for the Companys securities
available-for-sale portfolio (dollars in thousands):

March 31,
  2007

December
  31, 2006AmortizedCost

FairValue

AmortizedCost

FairValueU.S. Treasury obligations

$
14,879

$
14,463

$
6,839

$
6,420U.S. Government sponsored
  corporations


61,176


60,564


62,178


61,452Mortgage-backed securities


98,304


96,895


97,908


96,163Obligations of states and
  political subdivisions


86,254


87,178


86,299


87,388Other equity securities


2,443


2,561


2,442


2,579Total

$
263,056

$
261,661

$
255,666

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


(1,395
)




(1,664
)Total carrying value

$
261,661




$
254,002Commercial
loans totaled $224.2 million or 25.3% of total loans and leases at March 31,
2007, compared with $223.5 million or 25.3% of total loans and leases at
December 31, 2006. Commercial loan growth in the first quarter was below our
expectations due in large part to intense competitive pressures and slow
economic growth in our markets. These challenges are likely to continue to
influence the rate of commercial loan growth for the foreseeable future.

Commercial leases, net of unearned income, totaled $132.4 million or
15.0% of total loans and leases, compared with $131.3 million (14.9% of total
loans and leases) at December 31, 2006. First quarter growth was slowed by
normal seasonal factors and by the departure of the president of the Companys
leasing subsidiary in March 2007. The rate of growth in the Companys
commercial lease portfolio in 2007 will be less than the $66.2 million in
growth experienced in 2006.

18

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

March 31,
  2007

Percent

December
  31, 2006

PercentCommercial
  loans

$
224,209


25.3
%
$
223,527


25.3
%Leases, net
  of unearned income


132,400


15.0
%

131,338


14.9
%Residential
  real estate loans


257,682


29.1
%

253,825


28.8
%Indirect
  loans


181,746


20.5
%

182,528


20.7
%Other
  consumer loans


89,039


10.1
%

91,348


10.3
%Total loans
& leases

$
885,076


100.0
%
$
882,566


100.0
%Allowance for
loan & lease losses


(7,333
)




(7,029
)Net loans and
leases

$
877,743




$
875,537Total deposits were $934.5 million at March 31, 2007, a decrease of
$1.1 million from December 31, 2006. Money market accounts
increased $20.5 million due primarily to a seasonal increase in municipal
deposits. Time deposits decreased $21.2 million, with most of the decrease
resulting from the decision to not renew a portion of brokered time deposits
that matured during the quarter.

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

March 31, 2007

December 31, 2006Retail

Commercial

Municipal

Total

Percent

Retail

Commercial

Municipal

Total

PercentNon-interest checking

$
34,278

$
80,712

$
10,829

$
125,819


13.5
%
$
34,236

$
90,667

$
4,672

$
129,575


13.9
%Interest checking


72,471


8,989


15,710


97,170


10.4
%

69,642


9,083


15,094


93,819


10.0
%Total checking


106,749


89,701


26,539


222,989


23.9
%

103,878


99,750


19,766


223,394


23.9
%Savings


76,815


6,470


2,608


85,893


9.2
%

77,751


6,436


1,701


85,888


9.2
%Money market


73,333


39,875


96,464


209,672


22.4
%

76,771


39,709


72,662


189,142


20.2
%Time deposits


352,562


24,668


38,751


415,981


44.5
%

367,751


27,876


41,545


437,172


46.7
%Total deposits

$
609,459

$
160,714

$
164,362

$
934,535


100.0
%
$
626,151

$
173,771

$
135,674

$
935,596


100.0
%Borrowings
increased $11.2 million, or 6.2%, during the first quarter of 2007, and the
proceeds were used primarily to replace brokered time deposits that matured
near the end of the quarter.

Liquidity

The Companys
liquidity primarily reflects the Banks ability to provide funds to meet loan
and lease requests, to accommodate possible outflows in deposits, to take
advantage of market interest rate opportunities, and to pay dividends to the
company. Funding loan and lease requests, providing for liability outflows, and
managing of interest rate fluctuations require continuous analysis in order to
match the maturities of specific categories of short-term loans and leases and
investments with specific types of deposits and borrowings. Liquidity is
normally considered in terms of the nature and mix of the Banks sources and
uses of funds. The Asset Liability Committee (ALCO) of the Bank is
responsible for implementing the policies and guidelines for the maintenance of
prudent levels of liquidity. Management believes, as of March 31, 2007, that
liquidity as measured by the Bank is in compliance with its policy guidelines.

The Banks
principal sources of funds for operations are cash flows generated from
earnings, deposits, loan and lease repayments, borrowings from the Federal Home
Loan Bank of New York (FHLB), and securities sold under repurchase agreements.
During the three months ended March 31, 2007, cash and cash equivalents
decreased by $1.6 million, as net cash used in lending and investing activities
of $11.8 million exceeded the cash provided by operating, deposit and financing
activities of $10.2 million. Net cash provided by deposit and financing
activities primarily reflects net increase in borrowings of $11.2 million,
partially offset by a $1.1 million decrease in deposits and cash dividends of
$1.1 million in the first quarter of 2007. Net cash from operating activities
was primarily

19

provided by
net income in the amount of $2.4 million, partially offset by net cash used in
other assets and liabilities. Net cash used in lending and investing activities
reflects a net increase in loans and leases of $3.0 million and a net increase
in investment securities of $7.3 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 March 31, 2007, the Banks credit limit with
the FHLB was $191.3 million. The total of the Banks outstanding borrowings
from the FHLB on that date was $123.2 million.

Capital Resources

Shareholders
equity increased $806,000 in the first quarter as net income of $2.4 million
was partially offset by dividends declared totaling $1.1 million ($0.22 per
share). In addition, the Company completed its stock repurchase program in the
first quarter of 2007 with the purchase of 31,830 shares of its stock for a
total of $982,000.

In September
2006, the Company formed a wholly-owned subsidiary, Alliance Financial Capital
Trust II (theTrust), which
completed the sale of $15,000,000 of trust preferred securities on September
21, 2006 that qualify as Tier 1 capital of the Company. The Trust issued the
trust preferred securities at an annual rate equal to the three month LIBOR
rate plus 1.65%. The trust preferred securities mature on September 15, 2036,
and can be called without penalty beginning on September 15, 2011. The Trust simultaneously
issued 464 shares of the Trusts common securities to the Company for a
purchase price of $464,000, which constitutes all of the issued and outstanding
common securities of the Trust. The Trust used proceeds from the sale of the
trust preferred securities and common securities to purchase the Companys
junior subordinated deferrable interest notes due 2036. Approximately $13.2
million of the net proceeds of the offering were used by the Company to fund
the cash portion of the Bridge Street acquisition.

On December
19, 2003, the Company formed a wholly-owned subsidiary, Alliance Financial
Capital Trust I (AFCT), a Delaware business trust. AFCT issued $10,000,000 of
30-year floating rate Company-obligated pooled capital securities (trust
preferred securities) that qualify as Tier I capital of the Company.

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).

In accordance
with the Financial Accounting Standards Board (FASB) Interpretation No. 46
(FIN 46) Consolidation of Variable Interest Entities, the Company does not
consolidate the assets and liabilities or income and expenses of Alliance
Financial Capital Trust I and II (Variable Interest Entities) with the
Companys financial statements.

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 tables below) 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, 2005, 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

20

ratios as set
forth in the tables below. Management believes that, as of March 31, 2007, the
Company and its subsidiary Bank met all capital adequacy requirements to which
they were subject.

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 (dollars in thousands):

Actual

To be Well
  Capitalized Under
  Prompt Corrective
  Action ProvisionsAmount

Ratio

Amount

RatioAs of March 31,
2007Total Capital (to Risk-Weighted
Assets)

$
96,596

11.01
%

$
87,714

>10.00
%Tier I Capital (to
Risk-Weighted Assets)


88,996

10.15
%


52,629

>6.00
%Tier I Capital (to Average
Assets)


88,996

7.34
%


60,641

>5.00
%As of December 31,
2006Total Capital (to Risk-Weighted
Assets)

$
95,510

10.97
%

$
87,039

>10.00
%Tier I Capital (to
Risk-Weighted Assets)


88,215

10.14
%


52,223

>6.00
%Tier I Capital (to Average
Assets)


88,215

7.34
%


60,103

>5.00
%Application of Critical Accounting Estimates

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

The most
significant accounting policies followed by the Company are presented in Note 1
to the consolidated financial statements included in the 2006 Annual Report on
Form 10-K (the Consolidated Financial Statements). These policies, along with
the disclosures presented in the other financial statement notes and in this
discussion, provide information on how significant assets and liabilities are
valued in the financial statements and how those values are determined. Based
on the valuation techniques used and the sensitivity of financial statement
amounts to the methods, assumptions, and estimates underlying those amounts,
management has identified the determination of the allowance for loan and lease
losses, accrued income taxes, and the fair value analysis of the intangible
asset to be the accounting areas that require the most subjective and complex
judgments, and as such could be the most subject to revision as new information
becomes available.

The allowance
for loan and lease losses represents managements estimate of probable loan and
lease losses inherent in the loan and lease portfolio. Determining the amount
of the allowance for loan and lease losses is considered a critical accounting
estimate because it requires significant judgment and the use of estimates
related to the amount and timing of expected future cash flows on impaired loans
and leases, if the loan is not collateraldependent and measured based on the
fair value of the collateral. It also requires estimates of losses on pools of
homogeneous loans and leases based on historical loss experience and
consideration of current economic trends and conditions, both 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

21

Form 10-Q
describes the methodology used to determine the allowance for loan and lease
losses, and a discussion of the factors driving changes in the amount of the
allowance for loan and lease losses is included in this report.

The Company
estimates its tax expense based on the amount it expects to owe the respective
tax authorities. Accrued taxes represent the net estimated amount due or to be
received from taxing authorities. In estimating accrued taxes, management
assesses the relative merits and risks of the appropriate tax treatment of
transactions, taking into account statutory, judicial and regulatory guidance
in the context of the Companys tax position. If the 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

In December of
1998, the Oneida Indian Nation (The Nation) and the U.S. Justice Department
filed a motion to amend a long-standing land claim against the State of New
York to include a class of 20,000 unnamed defendants who own real property in
Madison County and Oneida County. An additional motion sought to include the
Company as a representative of a class of landowners. On September 25, 2000,
the United States District Court of Northern New York rendered a decision
denying the motion to include the landowners as a group, and thus, excluding
the Company and many of its borrowers from the litigation. The State of New
York, the County of Madison and the County of Oneida remain as defendants in
the litigation. This ruling may be appealed by The Nation, and does not prevent
The Nation from suing landowners individually, in which case the litigation
could involve assets of the Company. On August 3, 2001, the Justice Department
moved to amend its complaint to drop landowners as defendants. A Wisconsin
Oneida tribe has filed lawsuits against individual landowners, and has publicly
stated its intention to continue to file other suits against landowners.
Management believes that, ultimately, the State of New York will be held
responsible for these claims and that this matter will be settled without
adversely impacting the Company, although to date efforts to settle this
litigation have been unsuccessful.

New Accounting Pronouncements

In February
2007, the FASB issued SFAS No. 159, The Fair
Value Option for Financial Assets and Financial Liabilities -
Including an Amendment of FASB Statement No. 115. This standard permits an
entity to choose to measure many financial instruments and certain other items
at fair value. This option is available to all entities, including
not-for-profit organizations. Most of the provisions in Statement 159 are
elective; however, the amendment to FASB Statement No. 115, Accounting for
Certain Investments in Debt and Equity Securities, applies to all entities with
available-for-sale and trading securities. Some requirements apply differently
to entities that do not report net income. The FASBs stated objective in
issuing this standard is to improve financial reporting by providing entities
with the opportunity to mitigate volatility in reported earnings caused by
measuring related assets and liabilities differently without having to apply
complex hedge accounting provisions.

The fair value
option established by Statement 159 permits all entities to choose to measure
eligible items at fair value at specified election dates. A business entity
will report unrealized gains and losses on items for which the fair value
option has been elected in earnings (or another performance indicator if the
business entity does not report earnings) at each subsequent reporting date. A
not-for-profit organization will report unrealized gains and losses in its
statement of activities or similar statement. The fair value option: (a) may be
applied instrument by instrument, with a few exceptions, such as investments
otherwise accounted for by the equity method; (b) is irrevocable (unless a new
election date occurs); and (c) is applied only to entire instruments and not to
portions of instruments.

This Statement
is effective for the Company as of January 1, 2008. The Company is currently
analyzing the effects of this statement and the impact on the Companys
financial conditions or results of operations has not yet been determined.

22

In September
2006, the FASB issued SFAS No. 157, Fair Value Measurements. This Statement
defines fair value, establishes methods for measuring fair value and expands
disclosures about fair value measurements. While this Statement does not
require any new fair value measurements, it is intended to increase consistency
and comparability in fair value measurements, and expand disclosures about fair
value measurements among companies. This Statement is effective for the Company
beginning January 1, 2008. The Company is currently evaluating the impact this
will have on the Companys current practice of measuring fair value and any
additional disclosures required in our financial statements.

In September
2006, the Financial Accounting Standards Board ratified the consensus reached
in the Emerging Issues Task Force (Task Force) Issue No. 06-4, Accounting
for Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements (Issue). Issue 06-4 requires the
recognition of a liability and related compensation costs for endorsement
split-dollar life insurance arrangements that provide a benefit to an employee
that extends to postretirement periods. The Task Force reached a consensus that
for an endorsement split-dollar life insurance arrangement within the scope of
this Issue, an employer should recognize a liability for future benefits in
accordance with Statement 106 (if, in substance, a postretirement benefit plan
exists) or Opinion 12 (if the arrangement is, in substance, an individual
deferred compensation contract) based on the substantive agreement with the
employee. The consensus reached in this Issue is effective for January 1, 2008.
The Company is currently analyzing the effects of the Issue and the impact on
the Companys financial conditions or results of operations has not yet been
determined.


Item 3.

Quantitative and Qualitative Disclosures
About Market RiskMarket risk is
the risk of loss in a financial instrument arising from adverse changes in
market rates or prices such as interest rates, foreign currency exchange rates,
commodity prices, and equity prices. The Companys market risk arises
principally from interest rate risk in its lending, deposit and borrowing
activities. Other types of market risks do not arise in the normal course of
the Companys business activities.

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

Interest rate
risk is monitored primarily through the use of two complementary measures:
earnings simulation modeling and net present value estimation. Both measures
are highly assumption-dependent and change regularly as the balance sheet and
business mix evolve; however, the Company believes that taken together they
represent a reasonably comprehensive view of the magnitude of interest rate
risk, the distribution of risk along the yield curve, the level of risk through
time, and the amount of exposure to changes in certain interest rate
relationships. The key assumptions employed by these measures are analyzed
regularly and reviewed by ALCO.

Earnings Simulation Modeling

Net interest
income is affected by changes in the absolute level of interest rates and by
changes in the shape of the yield curve. In general, a flattening of the yield
curve would result in a decline in earnings due to the compression of earning
asset yields and funding rates, while a steepening of the yield curve would
result in increased earnings as investment margins widen. The model requires
management to make assumptions about how the Banks balance sheet is likely to
evolve through time in different interest rate environments. Loan and deposit
growth rate assumptions are derived from historical analysis and managements
outlook, as are the assumptions used to project yields and rates for new loans
and deposits. Securities portfolio maturities and prepayments are assumed to be
reinvested in similar instruments. Mortgage loan prepayment assumptions are developed
from industry median estimates of prepayment speeds in conjunction with the
historical prepayment performance of the Banks own loans. Non-contractual
deposit growth rates and pricing are modeled on historical patterns. Interest
rates of the various assets and liabilities on the balance sheet are assumed to
change proportionally, based on their historic relationship to short-term
rates. The Banks guidelines for risk management call for preventative measures
to be taken if the simulation modeling demonstrates that an instantaneous 2%
increase or decrease in short-term rates over the next twelve months would
adversely affect net interest income over the same period by more than 15% when
compared to the stable rate scenario. At March 31, 2007, based on the results
of the Banks simulation model, and assuming that management does not take
action to alter the outcome, the Bank would expect net interest income to
decline 13.1% if short term interest rates increase by 2%, and to increase
12.0% if short term interest rates decrease by 2%.

23

Net Present Value Estimation

The Net
Present Value of Equity (NPV) measure is used for discerning levels of risk
present in the balance sheet that might not be taken into account in the
earnings simulation model due to the shorter time horizon used by that model.
The NPV of the balance sheet, at a point in time, is defined as the discounted
present value of the asset cash flows minus the discounted value of liability
cash flows. Interest rate risk analysis using NPV involves changing the
interest rates used in determining the cash flows and in discounting the cash
flows. The Banks NPV analysis models both an instantaneous 2% increasing and
2% decreasing interest rate scenario comparing the NPV in each scenario to the
NPV in the current rate scenario. The resulting percentage change in NPV is an
indication of the longer-term repricing risk and options risk embedded in the
balance sheet. The NPV measure assumes a static balance sheet versus the growth
assumptions that are incorporated into the earnings simulation measure, and an
unlimited time horizon instead of the one-year horizon applied in the earnings
simulation model. As with earnings simulation modeling, assumptions about the
timing and the variability of balance sheet cash flows are critical in NPV
analysis. Particularly important are assumptions driving mortgage prepayments
in both the loan and investment portfolios, and changes in the noncontractual
deposit portfolios. These assumptions are applied consistently in both models.
Based on the March 31, 2007 NPV estimation, a 2% instantaneous increase in
interest rates was estimated to decrease NPV by 2.7%. NPV was estimated to
decrease by 1.8% if rates immediately declined by 2%. Policy guidelines limit
the amount of the estimated increase/decline to 25% in a 2% rate change
scenario.


Item 4.
Controls and ProceduresThe 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 March 31, 2007, an
evaluation was performed under the supervision of and with the participation of
the Chief Executive Officer and Chief Financial Officer, of the effectiveness
of the design and operation of the Companys disclosure controls and
procedures. Based on that evaluation, the CEO and the CFO concluded that the
Companys disclosure controls and procedures as of March 31, 2007 were
effective.

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

24

PART II.
OTHER INFORMATIONItem
  1.
Legal
  ProceedingsNot applicable.Item
  1A.
Risk
  FactorsThere are no material changes in the risk factors
disclosed in the Companys 2006 Annual Report on Form 10-K for the fiscal year
ended December 31, 2006.

Item
  2.
Unregistered
  Sales of Equity Securities and Use of Proceedsa)
Not applicableb)
Not applicablec)
The table below sets forth the information with
  respect to purchases made by the Company (as defined in Rule 10b-18(a) (3)
  under the Securities Exchange Act of 1934, as amended), of our common stock
  during the quarter ended March 31, 2007:Period

Total
  Number
  of Shares
  Purchased

Average
  PricePaid
  Per Share

Total
  Number of
  Shares Purchased
  as Part of Publicly
  Announced Plan

Maximum
  Number
  of Shares that May
  Yet be Purchased
  Under the Plan (1)1/1/07  1/31/07

1,100


$30.40

1,100


30,7302/1/07  2/28/07

6,500


$30.34

6,500


24,2303/1/07  3/31/07

24,230


$31.00

24,230


Total

31,830


$30.85

31,830(1) On September 28, 2005 the Company announced that
its Board of Directors had authorized the repurchase of up to 5% of the Companys
outstanding common stock, or approximately 180,000 shares, over a 12-month
period commencing on October 1, 2005. On October 5, 2006 the Companys board of
directors approved a six-month extension of this repurchase program, through
March 2007. The plan has now been completed.

Item 3.
Defaults
  Upon Senior SecuritiesNot applicable.Item
  4.
Submission
  of Matters to a Vote of Security HoldersNot applicable.Item
  5.
Other
  InformationNot applicable.25

Item
  6.
ExhibitsExhibits required by Item 601 of Regulation S-K:Exhibit
  Number

Exhibit3.1

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 amended3.2

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)31.1

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

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

Certification of Jack H. Webb, Chairman of the Board,
  President and Chief Executive Officer of the Registrant, pursuant to 18
  U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley
  Act of 200232.2

Certification of J. Daniel Mohr, Treasurer and Chief
  Financial Officer of the Registrant, pursuant to 18 U.S.C. Section 1350, as
  adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 200226

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: May 9, 2007
/s/ Jack H. WebbJack H. Webb, Chairman
  of the Board, President
  and Chief Executive OfficerDATE: May 9, 2007
/s/ J. Daniel MohrJ. Daniel Mohr, Treasurer and Chief Financial
  Officer27