CANANDAIGUA NATIONAL CORPORATION 72 South Main Street Canandaigua, New York 14424 Phone: 585-394-4260 or 1-800-724-2621 Fax: 585-394-4001 Internet: www.cnbank.com   2011 Annual Report   Table of Contents  Page  Financial Highlights 1 Management's Discussion and Analysis of Financial Condition and Results of Operations 2 Our Common Stock 23 Management's Report on the Effectiveness of Internal Controls over Financial Reporting 25 Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting 26 Consolidated Financial Statement Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements 27 Consolidated Balance Sheets 28 Consolidated Statements of Income 29 Consolidated Statements of Stockholders' Equity 30 Consolidated Statements of Cash Flows 31 Notes to Consolidated Financial Statements 32   Annual Meeting:  The Annual Meeting of Shareholders of Canandaigua National Corporation (the Company) will be held at the Main Office of The Canandaigua National Bank and Trust Company, 72 South Main Street, Canandaigua, NY, 14424, April 11, 2012, at 1:00 p.m.   Form 10-K:  Copies of the Companys Form 10-K Annual Report and the Companys Code of Conduct are available without charge to shareholders upon written request to: Steven H. Swartout, Secretary, 72 South Main Street, Canandaigua, New York 14424. Copies are also available at the website of the Securities and Exchange Commission (www.sec.gov) and by link from the website of the Companys subsidiary The Canandaigua National Bank and Trust Company (www.cnbank.com/your_bank/cnc_financials).     Forward-Looking Statements  This report, including information incorporated by reference, contains, and future filings by Canandaigua National Corporation on Forms 10-K, 10-Q and 8-K and future oral and written statements, press releases, and letters to shareholders by Canandaigua National Corporation and its management may contain, certain "forward-looking statements" intended to qualify for the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. When used or incorporated by reference in the Company's disclosures and documents, the words "anticipate," "believe," "contemplate," "estimate," "expect," "foresee," "project," "target," "goal," "budget" and similar expressions are intended to identify forward-looking statements within the meaning of Section 27A of the Securities Act. Such forward-looking statements are subject to certain risks discussed within this document and the Companys most recent Annual Report on Form 10-K. These forward-looking statements are based on currently available financial, economic, and competitive data and management's views and assumptions regarding future events. These forward-looking statements are inherently uncertain, so should one or more of these risks or uncertainties materialize, or should underlying assumptions prove incorrect, actual results may vary materially from those anticipated, estimated, expected, projected, targeted, or budgeted. Certain matters which management has identified, which may cause material variations are noted elsewhere herein and in the Companys other publicly filed reports. These forward-looking statements speak only as of the date of the document. We expressly disclaim any obligation or undertaking to publicly release any updates or revisions to any forward-looking statement contained herein.  We caution readers not to place undue reliance on any of these forward-looking statements.  We present below a summary of selected financial highlights to help you see a snapshot of our performance for the past five years.  (All share and per-share information has been adjusted to reflect the 4-for-1 stock split in 2011). This and all information concerning our financial performance should be read in conjunction with the following Management's Discussion and Analysis of Financial Condition and Results of Operations, as well as the Consolidated Financial Statements and Notes thereto.  These sections help to provide context for the information you see here.  Financial Highlights(Dollars in thousands except per share data)2011% Change2010200920082007Income Statement Information:Net interest income$61,4730.5%61,14154,37447,48540,976Provision for loan losses3,775(38.6)%6,1504,3453,8052,375Other income28,8087.8%26,72124,77022,45415,834Operating expenses64,40311.3%57,85154,20447,24337,297Income taxes6,178(0.4)%6,2055,4014,9584,680Net income attributable to CNC16,312(7.6)%17,65615,19413,93312,458Balance Sheet Data:Total investments(1)$284,1394.3%272,336280,797261,149269,990Total loans, net1,276,4267.3%1,189,2211,145,7071,076,620910,870Total assets1,761,4706.0%1,661,5041,566,0001,419,0371,256,349Total deposits1,546,6105.0%1,473,3301,377,6971,228,9071,060,533Total borrowings(2)51,547(0.6)%51,87761,38877,40693,909Total stockholders' equity135,7809.7%123,794111,735100,43892,208Average assets1,695,3274.2%1,627,1131,535,2241,329,0561,229,664Average stockholders' equity128,39310.0%116,696104,19695,00485,962Asset Under Administration:(3)Book value (cost basis)$1,726,1724.1%1,658,1111,591,9431,573,9601,034,737Market value1,858,1301.5%1,830,5491,651,7771,450,0211,193,068Per Share Data:Net income, basic$8.64(7.6)%9.358.067.366.54Net income, diluted$8.48(7.8)%9.207.937.246.41Cash dividends$2.875.5%2.722.472.252.00Book Value$71.959.8%65.5459.3353.2148.61Closing stock price(4)$129.2234.8%95.8581.7878.9881.17Weighted average share - diluted1,923,7770.2%1,919,1921,917,5121,926,0441,942,872Other ratios:Return on average assets0.96%(11.9)%1.09%0.99%1.05%1.01%Return on average equity12.70%(16.1)%15.13%14.58%14.67%14.49%Return on beginning equity13.18%(16.6)%15.80%15.13%15.11%14.91%Dividend payout33.84%14.8%29.48%31.23%31.10%31.19%Average equity to average assets7.57%5.6%7.17%6.90%7.15%6.99%Net interest margin4.05%(4.9)%4.26%4.10%4.10%3.77%Efficiency(5)70.02%8.2%64.71%67.14%66.04%65.34%Employees (year end)Total5014.2%481459430386FTE's4418.4%407379363331    (1)Includes the Company's required investment in Federal Reserve Bank stock and Federal Home Loan Bank stock. (2)Includes junior subordinated debentures. (3)These assets are held in a fiduciary or agency capacity for clients and are not included in our balance sheet. Beginning in 2008, the figures include our subsidiary Genesee Valley Trusts assets under administration. (4)For the respective year, price is based upon last sealed-bid auction administered by the Banks Trust Department. Due to the limited number of transactions, the prices may not be indicative of the actual market value of the Company's stock or prices on OTC.BB. (5)Operating expenses, exclusive of intangible amortization, divided by total revenues.  1   Management's Discussion and Analysis of Financial Condition and Results of Operations The Management Discussion and Analysis (MD&A) is intended to provide, in one section, historical and prospective material disclosure enabling investors and other users to assess the financial condition and results of operations of the Company, with particular emphasis on our prospects for the future.  It is intended to give you an opportunity to look through the eyes of your Company's management (we/us) by providing both a short-term and long-term analysis of our business.  On the following pages, we will discuss the dynamics of our business and analyze our financial information through text and tables. (Dollar and percentage changes are calculated before rounding.) Throughout this and other documents we prepare from time to time, we include our predictions (or "forward-looking information"). Of course, any discussion of the future is subject to many risks and uncertainties, and, while we seek ways to manage these risks and develop programs to control those we can, we ultimately cannot predict the future. Our actual results may differ materially from those indicated by our forward-looking statements. Significant risks and uncertainties affecting our business are enumerated below. · The strength of the United States economy in general and the strength of the local economy in particular; general economic conditions, either nationally or locally could be less favorable than expected, resulting in, for example, a deterioration in credit quality of assets; · The effects of and changes in United States trade, monetary, and fiscal policies and laws, including and most importantly, the interest rate policy of the Federal Open Market Committee (FOMC) of the Federal Reserve Board, which can have an immediate and significant impact on earnings; · The impact of changes in laws and regulations governing financial services and public companies, including laws, regulations, and rules concerning taxes, accounting, auditing and reporting standards; · The impact of the imposition of legislative or regulatory price controls on financial transactions; · The cost of compliance with governmental regulations, particularly as a result of passage of The Dodd-Frank Wall Street Reform and Consumer Protection Act (Financial Reform Act) · The impact of technological changes; · The development of new products, their competitiveness, and their acceptance by customers; · Changes in commercial and consumer spending and saving habits; · Changes in demographics within the Company's market area; · The commission of fraud by customers and non-customers against the Company; and · Our success in managing these risks.  OVERVIEW  Mr. Hamlin's message to shareholders in this Annual Report provides a further overview of the Company's 2011 results.  He includes a discussion of the economy, the banking industry, the regulatory environment, and their impact on the Company.  During the year we celebrated a number of significant corporate activities. Among those are the following, which impacted our financial results for the year:  · Acquisition  On November 30, 2011, we acquired a majority interest in WBI OBS Financial, LLC (WBI), a company formed to concurrently acquire OBS Holdings, Inc. (OBS).  OBS, an Ohio-based company, provides investment sub-advisory services to the Bank and several other financial institutions, primarily community banks and credit unions, and has approximately $900 million in managed assets. The results of WBIs consolidated operations are included in our Consolidated Statements of Income from the date of acquisition.  WBI reported an approximate $1.1 million loss since acquisition, which was a result of merger-related legal and advisory expenses, which is reflected in Operating Expenses.  · Stock sale-On November 22, 2011, a sealed-bid public auction of our stock yielded a new average price of $129.22, up 16.1% in one quarter over the previous price of $111.34 set in August, 2011.  This increase resulted in a pre-tax $2.2 million upward adjustment to our Stock Appreciation Rights Plan liability, which is reflected in operating expenses.  · Financial Holding Company Election-On November 21, 2011, the Companys election to become a Financial Holding Company (FHC) became effective. As a FHC the Company may engage in activities that are financial in nature or incidental to a financial activity.  The FHC election permits the Company to engage in a wider range of business activities.  · New office-On October 24, 2011, on Latta Road in the Town of Greece, New York, the Company opened its newest banking office.  This 3,100 square foot building has three drive-up lanes and a drive up ATM. It is designed to simulate the appearance of an early 20th century grade-school in conjunction with the historical architecture of the area.  · Stock split-On September 14, 2011, shareholders approved a 4-for-1 forward stock split and charter amendment to affect the split by increasing the Companys total number of authorized shares from 8,000,000 to 20,000,000 shares and increasing the authorized number of shares of common stock, thereunder, from 4,000,000 to 16,000,000 shares, while concurrently reducing the par value per share to $5.00 from $20.00. All share and per-share information has been adjusted to reflect the split.    2   Financially, for the year ended December 31, 2011, we reported net income of $16.3 million compared to $17.7 million for the year ended December 31, 2010, and $15.2 million for the year ended December 31, 2009.  Diluted earnings per share for each of these years were $8.48, $9.20, and $7.92, respectively.  The major components of these results, which include net interest income, provision for loan losses, other income, operating expenses, and income taxes, are discussed below.  Net interest income  Net interest income is the difference between the interest and dividend income earned on loans and investments and the interest expense paid on deposits and borrowings.  Net interest income is the Company's principal source of earnings, comprising approximately 70% of total revenues.  Net interest income is affected by a number of factors, including the level, pricing and maturity of interest-earning assets and interest-bearing liabilities, interest rate fluctuations and asset quality, as well as general economic conditions and regulatory policies.  As we entered 2011, we saw our local economy was slowly recovering, and the national economy was showing signs of improved performance.  However, with slow growth, high unemployment, and little prospect for significant inflation, the FOMC signaled its willingness to maintain short-term interest rates at historically low levels.  Furthermore, its second round of quantitative easing was expected to keep long-term interest rates low for some time. Accordingly, we believed general market interest rates would reflect improving conditions, but not begin to rise until the fourth quarter at the earliest. As rates began to rise we expected the yield curve would flatten out (lower spread between short and long term interest rates). The occurrence of both of these would lead to reductions in our net interest margin and interest rate spread.  However, notwithstanding these reductions, we expected to continue to modestly grow the balance sheet.  Thus, even with shrinkage in margin and spread, the volume growth would lead to higher overall revenues in the form of net interest income.  Our predictions of an improving economy were accurate.  However these improvements were comparatively weak. As a result, the FOMC kept the fed funds rate historically low at its target range of 0.00% to 0.25% (one quarter of one percent), and announced in mid 2011 that it expected rates to remain historically low through mid 2013 (amended in January 2012 with a through date of 2014).  With rates thus remaining low for all of 2011, our asset yields declined significantly due to refinancing of existing loans and originations of new loans at lower rates than those maturing.  Funding costs also decreased, but to a lesser extent, since these were already low.  Additionally, in the first half of the year, we experienced low net loan growth and a high level of investment security calls, leading us to invest liquid funds in fed funds sold, yielding a meager 25 basis points.  Following the FOMCs announcement mid-year, we embarked upon a multi-loan portfolio effort to increase originations of short- to medium term- duration, higher yielding loans to replace low yielding fed funds.  These efforts were most notable in the fourth quarter of 2011 and will carry into 2012 in the form of higher net interest revenues.  As a result of slow loan growth in 2011, total net interest income on a taxable equivalent basis was flat relative to 2010.  Net interest margin fell 20 basis points year-over-year to 4.05%. The interest rate spread fell 17 basis points to 3.92% mainly due to growth of non-interest bearing deposits.  For 2011, tax-equivalent net interest income grew less than $0.1 million.  Impacting these results was a $76.3 million (5.0%) increase in average earning assets, mostly in low-yielding fed funds sold, and a $37.6 million (2.9%) increase in average interest-bearing liabilities. During the year, the tax-equivalent yield on earning assets fell 47 basis points to 4.79%, while the cost of interest-bearing liabilities fell only 30 basis points to 0.87%. The combination of these reductions led to a 17 basis point decline in net interest spread (the difference between rates earned and rates paid).  Net interest margin (net interest income divided by average earning assets, or balance sheet profit margin) fell to 4.05% from 4.26%. In 2010, tax-equivalent net interest income grew $6.6 million or 11.3%.  Contributing to this increase was a $101.5 million (7.2%) increase in average earning assets, and a $66.0 million (5.3%) increase in average interest-bearing liabilities. During the year, the tax-equivalent yield on earning assets fell 30 basis points to 5.26%, while the cost of interest-bearing liabilities fell an even greater 50 basis points to 1.17%. The combination of these reductions led to a 20 basis point improvement in net interest spread (the difference between rates earned and rates paid).  Net interest margin (net interest income divided by average earning assets, or balance sheet profit margin) grew to 4.26% from 4.10%.  The two following tables analyze the components of net interest income.  The following table provides additional details of net interest income and shows average balances, tax-equivalent interest earned or paid, and average rates for the years ended December 31, 2011, 2010, and 2009.  Taxable securities include the Company's required investments in Federal Reserve Bank Stock and Federal Home Loan Bank Stock. The mark-to-market adjustments on securities available for sale are included in non-interest-earning assets. Nonaccrual loans are included in the average balances of loans.   Non-interest-bearing demand deposit accounts are included in non-interest-bearing liabilities. Borrowings include junior subordinated debentures. Tax-exempt interest includes a tax equivalency adjustment of $3,342,000 in 2011, $3,646,000 in 2010, and $3,811,000 in 2009.  A marginal federal income tax rate of 35% was applied in each year. Interest on loans includes a deduction for net deferred loan costs of $2,067,000 in 2011, $2,043,000 in 2010, and $1,885,000 in 2009. (dollars in thousands).  3    Average Balances and Interest for the Years Ended December 31,201120102009AverageAverageAverageAverageAverageAverageBalanceInterestRateBalanceInterestRateBalanceInterestRateAssetsInterest-earning assets:Interest-bearing depositswith  others$1,301$241.84%$1,104$363.23%$1,457$583.95%Federal funds sold145,5093540.2487,2032070.2449,2541180.24Securities:Taxable58,5411,5052.5748,3731,5473.2030,1901,2864.26Tax-exempt214,9859,7734.55224,27210,7504.79235,30011,4184.85Loans, net1,178,13264,9075.511,161,17267,5715.821,104,42266,1075.99Total interest-earningassets1,598,46876,5634.791,522,12480,1115.261,420,62378,9875.56Non-interest-earningassets96,859104,989114,601Total assets$1,695,327$1,627,113$1,535,224Liabilities andStockholders' EquityInterest-bearing liabilities:Interest-bearing demand$155,6881460.09%$139,1582550.18%$121,3572700.22%Savings and moneymarket690,4401,8310.27636,5902,3190.36564,9233,2910.58Time deposits449,4046,8661.53476,4869,5392.00490,63213,6822.79Borrowings51,5752,9055.6357,2563,2125.6166,5653,5595.35Total interest-bearingliabilities1,347,10711,7480.871,309,49015,3251.171,243,47720,8021.67Non-interest-bearingdeposits207,551187,957173,042Other non-interest-bearingliabilities12,27612,97014,509Stockholders' equity128,393116,696104,196Total liabilities andstockholders' equity$1,695,327$1,627,113$1,535,224Interest rate spread3.92%4.09%3.89%Net interest margin$64,8154.05%$64,7864.26%$58,1854.10%  The rate/volume analysis below is meant to show separately the relative contribution that changes in rates and in volume (balances) have on total tax-equivalent net interest income year over year.  By looking at these components separately, we can identify the sources from which revenue growth arises - changes in balances or changes in rates.  Because each component requires different management techniques, for example: customer demand in the case of balances, and market interest rate changes in the case of rates, separating them gives us a clearer view for analyzing our results.  In deriving the information, volume changes are computed by multiplying the balance difference by the prior year's rate.  Rate changes are computed by multiplying the rate difference by the prior year's balance.  The change in interest due to both rate and volume has been allocated to rate and volume changes in proportion to the dollar amounts of the change in each.  2011 compared to 20102010 compared to 2009Increase/(decrease)Increase/(decrease)Due to change inDue to change inVolumeRateTotalVolumeRateTotalInterest-earning assets:Interest-bearing deposits with others$6(18)(12)$(13)(9)(22)Federal funds sold142514790(1)89Securities, taxable292(334)(42)638(377)261Securities, tax-exempt(435)(542)(977)(530)(138)(668)Loans, net976(3,640)(2,664)3,337(1,873)1,464Total981(4,529)(3,548)3,522(2,398)1,124Interest-bearing liabilities:Interest-bearing demand27(136)(109)36(51)(15)Savings and money market184(672)(488)378(1,350)(972)Time deposits(517)(2,156)(2,673)(384)(3,759)(4,143)Borrowings(320)13(307)(516)169(347)Total(626)(2,951)(3,577)(486)(4,991)(5,477)Net Change$1,607(1,578)29$4,0082,5936,601  Our local economy is showing ever-improving results. Nationally the economy showed growth in the fourth quarter, but many believe this is likely to slow in 2012. With slow growth, high unemployment, and little prospect for significant inflation, as previously noted, the FOMC has signaled its willingness to maintain short-term interest rates at historically low levels into 2014.  The impact to our balance sheet will be continued downward pressure on asset yields combined with some reduction in liability costs.  This will erode both margin and spread.  Thus, net interest revenue growth will have to come from higher volumes of loans, a strategy we will continue to pursue in 2012.  4    Provision for Loan Losses  The provision for loan losses (a charge to earnings) in each period is a result of our judgment about the credit quality of the Company's assets.  We present a detailed discussion and analysis in a following section entitled "Loan Loss Experience and Allowance for Loan Losses" and Note 4 of the Consolidated Financial Statements.  Other Income Other income accounts for approximately 30% of total revenue.  It is composed mainly of revenues from: (a) service charges on deposit accounts, (b) fees for trust and investment services, and (c) net revenues from mortgage banking.  For the year ended December 31, 2011, other income increased $2.1 million or 7.8% from 2010, and for the year ended December 31, 2010, it increased $2.0 million or 7.9% from 2009. Service charges on deposit accounts increased 2.3% in 2011 from 2010 with growth only seen in electronic banking services. Service charges on deposit accounts increased 18.9% in 2010 from 2009, attributable to both increased revenues for electronic transaction services, and the full year impact of our Courtesy Limit service, which was initiated in the fourth quarter of 2009.  In 2011, we saw lower revenues from our Courtesy Limit product compared to 2010.  Changes in banking regulations for overdraft payment services, requiring affirmative customer opt-in and other limits on charges were effective in the middle of 2010, reducing year-over-year revenue.  Account maintenance service charges (included in service charges) were down slightly year-on-year due to higher customer balances offsetting their periodic fees. Electronic banking services (debit and ATM card revenues) continued to increase with consumers shifting from cash and checks (paper-based) to electronic transactions. We expect a similar trend in 2012.  Trust and investment services income is earned based upon the fair value of assets under our administration.  Income is further dependent upon the services we provide (managed or custodial) and the mix of assets underlying the accounts - stock, bonds, and money markets.  This income increased in 2011 by $1.6 million or 15.0% from 2010, and increased in 2010 by $0.9 million or 9.2% from 2009. For both 2011 and 2010, the increases in revenue were a result of an increase in the underlying fair value of assets under administration (see table below), because of sales to new customers, and due to improved conditions in the stock market in general.  The table below presents information about period-end actual and average balances of assets under administration and the related income for the respective years (dollars in thousands).  201120102009Book value of assets under administration (period end)$1,726,1721,658,1111,591,943Fair value of assets under administration (period end)$1,858,1301,830,5491,651,777Fair value of assets under administration (average)$1,869,9001,685,6941,500,041Trust and investment income$12,63210,98410,056  Our acquisition of OBS in late 2011 is expected to add approximately $3.3 million of trust and investment revenue in 2012. Excluding these revenues, we expect total revenue to increase about 5% over 2011, assuming the markets continue their upward trends and we gain new customer accounts. However, should the markets remain volatile as they did in 2011 or fall as they did during the first quarter of 2009, total revenues in 2012 would likely be closer to that of 2011.  Mortgage banking income is our third most important source of other income and is comprised of the net gain on sale of mortgage loans and loan servicing income.  Our residential mortgage originations are handled through our wholly owned subsidiary, CNB Mortgage Company (CNB Mortgage), where its results are primarily reflected in the net gain on sale of mortgage loans.  Due mostly to changes in the volume of loans closed each year the line item fell 10.1% in 2011 and 21.5% in 2010.  We typically sell long-term, non-callable, fixed-rate residential mortgages with loan-to-value ratios less than 85% to the Federal Home Loan Mortgage Corporation (Freddie Mac) to: (1) provide mortgage financing to homeowners we could not otherwise accommodate, primarily due to our inability to fund the high demand for these loans with local deposits, and (2) to reduce our long-term interest rate risk.  However, we continue to service these loans locally with our staff.  Generally, residential mortgage loans with an original loan-to-value ratio greater than 85%, and loans requiring escrow services are sold with servicing released to third parties.  The revenue generated by CNB Mortgage is dependent upon the volume of loans originated.  This volume is composed of purchase money loans (loans to purchase a property) and refinance loans (loans that change the terms of an already existing loan).  CNB Mortgage generally must originate approximately $160 million annually to break even based on its current operating expense structure. This breakeven volume has increased significantly from less than $100 million in prior years due to the impact of increasing costs required as a result of regulatory changes, particularly enhanced disclosure requirements, appraisal requirements, and underwriting costs.  During years without a refinance boom, the Company is more dependent upon purchase money mortgages.  Refinance activity in 2011 and 2010, while very strong, was much lower than in 2009 when mortgage interest rates fell by a relatively large percentage.  Total mortgage originations peaked for us in the fourth quarter of 2011 compared to the second quarter of 2010 and in 2009. For the coming year we anticipate mortgage originations of about $200 million. Of our originations, some are retained in the Banks portfolio.  5   The amount of loans retained is dependent upon the rates and terms of the mortgages.  Generally, the Bank retains loans with interest rates of 4.00% or above and with maturities or call dates of ten years or less.  Because of the low interest rate environment, a smaller percentage of total originations (20%-25%) have been retained in portfolio than in years earlier than presented. For the years ended December 31, 2011, 2010 and 2009, CNB Mortgage originated and sold the following types of loans (dollars in thousands):  201120102009Purchase money mortgages$115,529140,764129,982Refinance mortgages105,554114,012193,516Total mortgage originations$221,083254,776323,498Of which:Sold to third parties$166,240203,582268,203Sold to (retained by) the Bank$54,84351,19455,295Percentage of total sold to Bank24.8%20.1%17.1%  Net loan servicing income grew by 5.8% in 2011 and 50.1% in 2010. This income source is composed primarily of service fees earned on loans sold to Freddie Mac but serviced by us, service fees we earn on commercial loan participations, and reduced by amortization of loan servicing rights.  (We discuss loan servicing rights in greater detail in Note 6 to the Consolidated Financial Statements. Residential loans sold to Freddie Mac and commercial loan participations are not included in the consolidated balance sheet.) Net loan servicing income grew in 2011 and 2010 comparatively due to higher underlying serviced loan balances and relatively lower amortization expense for loan servicing assets.  Amortization expense was higher in 2009 as heavy refinance activity reduced serviced loans and the related underlying servicing asset.  With continuing low interest rates, we expect loans serviced for Freddie Mac to increase further in 2012 as long as 30-year fixed-rate mortgages stay at or below 4%.  Given our positive outlook for commercial loan demand we also expect participation loans to increase in the coming year, reversing a multi-year decline.  As a result of both of these factors net loan servicing income will increase.   At each of the three years ended December 31, 2011, 2010, and 2009, we were servicing the following types of loans (dollars in thousands):  201120102009Residential mortgages (sold to Freddie Mac)$461,950435,220385,742Commercial loans and mortgages (participations sold)114,969116,111128,107Total loans serviced for others$576,919551,331513,849  The Companys contract to sell loans to FHLMC and to the Federal Housing Administration (FHA) via third-parties contain certain representations and warranties that if not met by the Company would require the repurchase of such loans.  The Company has not historically nor currently been subject to a material volume of repurchases.  Included in Other income are losses on security transactions.  In each of the years 2011, 2010, and 2009, we recorded modest write-downs on a collateralized debt obligation (CDO), which accounted for a portion of the net losses on securities in these years, while the remainder was mostly due to losses on called securities resulting from recognition of unamortized premiums. In the fourth quarter of 2011 we sold approximately 60% of our holdings in this CDO for a modest loss and expect to sell the remainder in the coming years as tax-loss planning opportunities arise. Net of these write-downs and sale, we hold approximately $0.1 million in carrying value of these types of securities with an original remaining cost basis of $0.5 million, representing an immaterial portion of our total securities portfolio.  While future writedowns or a loss on the sale of the CDO could occur, the maximum amount would not exceed its carrying value of less than $0.1 million.  All remaining sources of other income rose $0.5 million in 2011 and fell $0.3 million in 2010.  Income grew in 2011 due to higher income from our investment in Cephas Capital Partners, a Small Business Investment Company, while the opposite occurred in 2010. We expect other income in 2012 to be closer to 2010 due mostly to lower income from our investment in Cephas Capital Partners, which is in liquidation phase, and lower rental income from foreclosed residential properties due to their sale.  Operating Expenses  In 2011, operating expenses increased $6.6 million, with half ($3.3 million) due to the events discussed in the Overview section.  Absent these, operating expenses increased $3.3 million or 5.7% over 2010.  This compares to a $3.6 million or 6.7% increase in 2010 over 2009.  With the exception of these unusually large expenses, most year-over-year increases were reflective of continued growth in our operations and expansion in Monroe County, New York and Sarasota, Florida.  As a high-service financial company we continue to see the largest dollar increase in any category was in salaries and employee benefits and was attributable to increased staffing and raises for incumbent employees.  For 2012, we expect further increases in total operating expenses due to our franchise growth, including the impact of the opening of our new full-service banking office in Greece, New York and the acquisition of OBS.  OBS should add approximately $3.3 million in operating expenses.  Substantially all of the increase in salaries in the past two years has been due to wage increases and new staff, and we expect a similar increase in 2012.  Benefit cost increases in both 2011 and 2010 were principally driven by significant incentive stock plan  6   accruals ($3.1 million in 2011 and $0.6 million in 2010 [See Note 14 to the Consolidated Financial Statements], which were a result of a combination of a higher stock price and lower long-term interest rates.  Benefit costs in 2009 included a $0.8 million expense for retirement benefits accrued for the President of GVT who retired that year.  For 2012, salaries and benefit costs should increase about 4% from 2011 excluding the impact of OBS, which is expected to add another $2.1 million.  Occupancy expenses increased $0.7 million (10.7%) in 2011 over 2010 and increased $0.6 million (10.3%) in 2010 over 2009. For these years rent expense associated with our new offices  Jackson Ridge, Alex-Park, and Henrietta, New York and Sarasota, Florida-- along with rent increases and additional rent expense resulting from our branch sale-leaseback transaction in June 2008, were the largest contributor to the increases.  (Please also see Notes 5 and 15 to the Consolidated Financial Statements.) Occupancy expenses can also fluctuate depending upon growth in the Company and the timing and nature of capital expenditures and cosmetic renovations.  General growth in the Companys operations will result in higher occupancy expenses due to greater purchases, year-over-year cost increases due to inflation and more rentable square footage.  However, the timing of purchases and the age of equipment will impact depreciation expense, which will diminish after the depreciation period expires, even if the equipment is still being used.  In 2012, we expect to see higher occupancy expenses due to the full-year impact of the new offices along with depreciation and renovation costs associated with physical improvement investments in our facilities and related equipment. OBS will add about $0.3 million in occupancy expenses in 2012.  Technology and data processing expenses increased $0.6 million or 15.4% in 2011 over 2010 and increased $0.3 million or 9.2% in 2010 over 2009.  The 2011 and 2010 increases were mostly due to higher software maintenance costs and software amortization, which have increased due to the impact of recent systems upgrades associated with franchise growth and technology improvements. In 2012 and forward we do expect expenses to increase in these categories reflecting the Companys growth.  The largest components of professional services are contract costs, with the largest recurring contract costs being subadvisor investment fees.  Because these fees are tied to the underlying market value of applicable assets under administration, they will fluctuate from year to year.  In 2011 these fees increased about $0.1 million to $0.9 million while in 2010 these fees increased about $0.1 million to $0.8 million.  Included in 2011 fees are $1.1 million in acquisition related expenses associated with OBS.  Included in 2010 is approximately $0.4 million related to the final payment to consultants for work on profitability enhancement for specific products.  For 2012 we expect this category to continue to rise with increases associated with improvements in the market value of managed assets, fees to consultants and professionals, and operating expenses of OBS.  However, we do not expect the acquisition costs to recur in 2012.  Marketing (advertising and promotion) and public relations (contributions and entertainment) expenses increased $0.3 million year-over-year in both 2011 and 2010 with most due to advertising and promoting our new offices and media spending for brand management.  In general, though, as with occupancy expenses, some underlying expenses continue to grow with overall Company growth and inflation, while others fall due to the timing of expenditures. Also included in public relations expenses is our monetary commitment to our communities as measured by our contributions to community organizations which amounted to $ $339,000, $303,000, and $270,000, for 2011, 2010, and 2009, respectively. We expect marketing and public relations expenses will show an increase in 2012 similar to 2011 due to overall franchise growth, continued advertising, and expenses of OBS.  Office-related expenses were relatively flat during these recent years and approximate $1.5 million annually.  Despite growth in customers, staff and physical locations we have been able to manage these costs through continuing investment in cost-saving technology, including electronic communications. Notwithstanding these process improvements, for 2012 it is expected that these expenses will increase due to higher postage costs and expenses of OBS.  Intangible amortization expense was $1.2 million in 2011 and approximated $1.0 million in 2010 and 2009, all related to recent years investment management businesses acquisitions. The acquisition of OBS will add additional amortization expense, the impact of which is not yet determined.  In the fourth quarter of 2011, as a result of the Companys annual fair value estimation, an additional $0.3 million amortization expense over scheduled amortization was recorded to reflect customer account attrition in excess of original estimates.  We believe this higher attrition rate was associated with customers transferring their accounts to a firm started by employees who left the Company.  We do not expect a recurrence in 2012.  Expenses associated with operating other real estate were $1.0 million in 2011, $1.3 million in 2010 and $1.2 million in 2009.  This relatively high level of expense is almost entirely associated with our acquisition of nearly 60 rental properties from a commercial borrower through foreclosure in the first quarter of 2009.  We have been successful during the years in selling some of these properties, and expect to sell more in 2012.  Operating expenses for managing these and the handful of other properties approximated $0.8 million in both 2011 and 2010 and $1.2 million in 2009 with the balance of the expense associated with valuation writedowns.  We regularly review the carrying value of the properties to determine if their fair value has fallen based upon then current market conditions.  We continue to market these properties with a goal to liquidate a substantial number of them in 2012 whether on a property-by-property basis or bulk sale.  Associated operating expenses will be directly impacted by the timing and number of properties sold.  FDIC insurance expenses fell $0.7 million in 2011 and fell $0.4 million in 2010 after having tripled in 2009 when it included a special $0.7 million assessment paid in the second quarter of that year.  At the end of 2009, we, and all banks, prepaid an estimated thirteen quarters of insurance premiums with approximately $3.9 million remaining at December 31, 2011.  Over the past several years the FDIC had raised insurance premiums to cover substantial losses incurred by its insurance fund due to actual and anticipated bank failures.  In October 2010, the FDIC announced that it will extend the period to reach its maximum reserve levels, and combined with lower loss projections, eliminated the three (3) basis point premium increase scheduled for 2011.  In the first quarter of 2011, the FDIC finalized its new assessment system in accordance with the Financial Reform Act.  The changes became effective beginning mid 2011 and were assessed against our prepayments to the FDIC. The FDIC Board approved a final rule that changed the assessment base for  7   deposit insurance, adopted a new large-bank pricing assessment scheme, and set a target size for the Deposit Insurance Fund.  The rule -- as mandated by the Dodd-Frank Act -- finalized a target size for the Deposit Insurance Fund at 2 percent of insured deposits. It also implemented a lower assessment rate schedule when the fund reaches 1.15 percent and, in lieu of dividends, provided for a lower rate schedule when the reserve ratio reaches 2 percent and 2.5 percent. As mandated by the Financial Reform Act, the rule changed the assessment base from adjusted domestic deposits to a banks average consolidated total assets minus average tangible equity. The rule defined tangible equity as Tier 1 capital. The rule lowered overall assessment rates in order to generate the same approximate amount of insurance premiums under the new larger base as was raised under the old base. The largest banks (over $10 billion in assets) pay higher insurance premiums than under the previous formula, while smaller banks, ours included, pay lower relative premiums. When fully implemented, assuming no change in deposit base, we estimate our annualized premiums will fall as much as $1.0 million. However, with our continued growth and FDIC coverage expanded to accounts up to $250,000, premium expenses of the Bank will likely not fall this full amount.  All other operating expenses fell about $0.3 million in 2011 and grew about $0.4 million in 2010 with no particular material item.  For 2012, we expect to see some modest expense growth in this category.  Income Taxes  Our effective income tax rate was approximately 28.0%, 26.0% and, 26.2% in each of the past three years, respectively.  These effective rates differ substantially from our marginal rate of about 40%, mainly due to our significant non-taxable interest income from state and municipal obligations. A detail of their impact can be found in Note 10 to the Consolidated Financial Statements. The rise in rate in 2011 is directly attributable to lower tax-exempt income, which was caused by lower market interest rates. We anticipate our 2012 effective tax rate will be in the 27% to 29% range and is mostly dependent upon the amount of non-taxable interest income we earn in proportion to taxable income, as well as the fiscal policy of New York State and the U.S. Government.  FINANCIAL CONDITION  As of December 31, 2011, total assets of the Company were $1,761.5 million, up $100.0 million or 6.0% from $1,661.5 million at year-end 2010. Substantially all of the asset increase occurred in the loan portfolio. Asset increases were funded by deposit inflows, continuing a multi-year trend as customers sought the safety and convenience of community banks.  Cash and due from banks, including interest-bearing accounts, increased $26.1 million to $59.2 million, principally due to higher balances in the course of collection through the Federal Reserve Bank of New York.  While this balance can fluctuate from day to day, depending upon customer transactions, we expect it to range between $30 million and $50 million on average.  While endeavoring to maintain a sufficient supply of cash for our customers' needs, we also strive to minimize the amount of physical cash on hand, since this is a non-interest earning asset.  Federal funds sold were $67.5 million at year end 2011, down from $105.1 million at year end 2010. These balances generally reflect liquidity (cash) not invested in securities or loans.  These balances are managed on a daily basis by representatives of our Asset/Liability Management Committee (ALCO).  This liquidity is used to manage daily cash inflows and outflows from deposits and loans.  Our floor target for federal funds sold balances is $20 million to $40 million, but day-to-day balances will fluctuate.  During 2011, we averaged about $145.5 million, compared to $87.2 million in 2010.  In both years the balances far exceeded our target as local demand for loans was lower than the amount at which deposits were growing, and a reasonable supply of liquid securities providing sufficient yields were not available for purchase.  Foreseeing market rate stability for several years, and improvements in the local economy, during the second half of 2011 we aggressively grew our loan portfolio with high quality automobile loans, which reduced the fed funds balance by years end. For 2012, we expect federal funds sold balances to near their current level, which exceeds our target, due to a continuation of the general trend of deposit growth exceeding net loan originations.  Net premises and equipment increased $1.7 million in 2011 primarily due to costs of our new banking branch, renovations to existing offices, and purchases of new equipment.  During each of the past few years, we have annually invested approximately $3.0 million to $4.0 million in premises and equipment, mostly for office improvements and technology upgrades. We have no firm commitments for new buildings in 2012, but we do anticipate investing about $4.0 million to be used for existing facility renovations and equipment replacements and the remainder for computer hardware purchases. These investments have been, and will be, funded from current operating cash flow.  Goodwill and intangible assets grew $8.1 million in 2011, net of amortization expense.  The increase was entirely due to the acquisition of OBS. (See Note 2 to the Consolidated Financial Statements).  As of the date of this report, we have not completed our fair value estimates of identifiable intangible assets of OBS.  The process is complicated and time consuming. Together with assistance from our consultants we expect the analysis will be completed within 2012.  As a result, the amount of intangible assets and goodwill may change.  Prepaid FDIC assessment declined $1.3 million due to credits posted for the past four quarters assessments. At December 31, 2011, this balance was $3.9 million compared to $5.1 million at December 31, 2010. In the fall of 2009, the FDIC proposed and approved a requirement that insured institutions prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011, and 2012 (thirteen quarterly periods). The prepaid assessment for these periods was collected on December 30, 2009. The prepaid assessment rate was based on the Banks total base assessment rate for the third quarter of 2009. The prepaid assessment rate for 2011 and 2012 was equal to the Banks modified third quarter 2009 total base assessment rate plus three (3) basis points. Each institutions prepaid assessment base, including ours, was calculated using our third quarter 2009 assessment base,  8   adjusted quarterly for an estimated five (5) percent annual growth rate in the assessment base through the end of 2012. We recorded the entire amount of this prepaid assessment as a prepaid expense (asset) as of December 31, 2009. As of year-end 2009, and each quarter thereafter, we record an expense (charge to earnings) for our regular quarterly assessment for the quarter and an offsetting credit to the prepaid assessment until the asset is exhausted. If the prepaid assessment is not exhausted by December 30, 2014, any remaining amount will be refunded to the Bank. Given the change in assessment methodology discussed in the Operating Expenses section above, we believe it is possible there will be a refund to our Bank.  Other assets increased $4.8 million by year-end 2011 to $26.0 million. The increase was associated with an increase in other real estate owned, as more fully discussed in the Loans section below, mortgage servicing rights, which are more fully described in Note 6 of the 2011 Consolidated Financial Statements, Deferred Taxes, which are more fully described in Note 10, and the impact of acquiring OBS, which is more fully described in Note 2.  Amore detailed discussion of the Company's principal interest-earning assets (securities and loans), and interest-bearing liabilities (deposits and borrowings), follows.  Securities Portfolio  We maintain our portfolio of (investment) securities mostly in U.S. Treasury, U.S. government sponsored enterprise obligations, and municipal obligations. We invest in securities with short to intermediate average maturities in order to better match the interest rate sensitivities of our other earning assets and liabilities. You can find more information about the carrying value of our securities in Note 3 to the Consolidated Financial Statements.  Investment decisions are made within policy guidelines established by our Board of Directors.  The investment policy is based on and supplements the Companys Interest Rate Risk and Funds Management Policy (ALCO Policy), also established by our Board.  Together these policies set financial and investment goals, which direct investment in all assets, including securities.  The investment policy states that "... the Company shall invest funds not needed for local loans and mortgages in United States Government Bonds, United States Agency Bonds, Municipal Bonds, Corporate Obligations, and Money Market Instruments.  The goal of the investment portfolio shall be to provide sufficient safety and liquidity in order to help meet the Company's needs and to produce income for the Company consistent with the safety features of quality, maturity, marketability, and risk diversification." The investment policy further limits total investments to no more than 40% of total Company assets.  There are additional limits on asset classes (U.S. Treasury, U.S. Agency, etc.), issuers, ratings and maturities. Allowed within our policy are securities hedging activities, interest rate risk swaps, and other programs involving the use of off-balance-sheet derivatives.  We classify securities as either "available for sale" or "held to maturity." These classifications result in differing management and accounting treatments.  Securities "available for sale" are used to absorb our available liquidity not used for lending purposes or not sold in the federal funds market.  These securities may or may not be held to their stated maturity, as demand for loan and deposit in- and out-flows change.  Securities which we have both the ability and intent to hold to maturity are classified as "held-to-maturity." Substantially all of these securities are pledged to collateralize municipal deposits.  Municipalities in New York State are generally required to ensure deposits in excess of FDIC insurance limits so these deposits are collateralized by eligible securities.  During 2011, total investment securities increased $11.6 million by year end. Throughout most of the year we experienced a high volume of security calls (i.e., issuers repaid debt obligations before their stated maturities).   The continued low interest rate environment made it beneficial for issuers to call outstanding higher cost debt and replace with lower cost debt.  As noted previously, with low loan demand for most of 2011 and with high deposit inflows, we looked to the investment portfolios as an alternative to very low yielding fed funds.  Accordingly, we purchased more investments during the year than had matured and called.   For 2012 we expect security calls to slow, allowing us to continue to modestly increase the portfolio balance.  Substantially all of the held-to-maturity portfolio is used to support the collateralization of the communities funds in the form of municipal deposits.   At December 31, 2011, about 75% of our total investment portfolio (available-for-sale and held-to-maturity)  was used to collateralize these deposits.  These deposits, in turn, are used to purchase tax-exempt securities of local municipalities, thereby recycling local deposits within our communities.  Other securities consist mainly of triple-A rated taxable US government sponsored enterprise obligations (GSEs)  Federal Home Loan Bank, Fannie Mae, Freddie Mac, and Federal Farm Credit Bank.  We will vary the mix of taxable and tax-exempt securities from time to time depending upon the amount of our taxable income, the securities' tax-equivalent yield, and the supply of high-grade, tax-exempt securities.  Because changes in the interest rate environment impact the market value (price or fair value) of securities and because market interest rates often differ from the rates at which securities were purchased, the underlying price of securities will vary from time to time.  The price of a security will move inversely to interest rates.  So, generally, if market rates are higher than that of the security, the fair value of the security will be lower than our cost.  On the other hand, if market rates are lower than those of the security, the fair value of the security will be higher than our cost.  Since 2008, market rates have declined regularly resulting in relatively higher market values for our securities than their cost, particularly for state and municipal obligations.  At December 31, 2011 the fair value of our securities exceeded their amortized cost basis by $7.4 million or 2.6%. We expect market rates to remain low in 2012, generally not impacting current fair values.  However, with the maturities and calls of securities, new purchases will carry then-current market rates, so the fair value of our securities is likely to fall closer to their amortized cost over time. Additionally, yields available on securities remain at market cycle lows, so as we purchase lower-rate securities, and if market rates subsequently rise, the fair value of these securities may fall below their cost.  Notwithstanding the lower rate environment, even at December 31, 2011, the fair value of some individual securities remained below cost, as more fully discussed in Note 3 to the Consolidated Financial Statements.  However, with the  9   exception of a single CDO, none of these securities was considered to be other than temporarily impaired, therefore no write-down of carrying value in the income statement is required.  Securities available for sale are carried at estimated fair value. In addition, all securities are evaluated for other-than-temporary-impairment, which can result, as in the past several years, in the write-down of securities to fair value with a resulting charge to earnings and to capital.  The valuation of securities can involve a significant amount of judgment, particularly when liquid markets do not exist for the security being valued.  We use quoted market prices to estimate fair value when an active market for the securities exist.  However, when an observable liquid market does not exist, we utilize significant estimates and assumptions to estimate fair value. These assumptions, include among others, discount rates, expected cash flows, and default rates. The use of different assumptions from ours could produce significantly different results, which could have a material effect on our income statement.  Because of the level of judgment involved, we consider the valuation of securities a critical accounting estimate. Note 3 to the Consolidated Financial Statements provides additional information about the fair value of securities.  The following table summarizes the maturities and weighted average yields of debt securities available for sale and held to maturity at their carrying value at December 31, 2011. In this table, we do not reflect yields on a tax-equivalent basis.  Our small balance in mortgage backed securities is reported at its final stated maturity, notwithstanding that principal is prepaid regularly, reducing its effective maturity.  Agencies are obligations of U.S. government sponsored enterprises.  Some securities in the table below can be called by the issuer prior to their stated maturity (dollars in thousands).  Maturities and Yields of Debt Securities at December 31, 2011AfterAfterOneFiveOnethroughthroughAfterYear orFiveTenTenLessYearsYearsYearsAmountYieldAmountYieldAmountYieldAmountYieldAvailable for SaleU.S. Treasury$4010.25%1010.11%--%--%U.S. GSE's3,0032.083,0611.8248,0171.992,0444.29State and municipal15,7763.2735,3183.144,3312.31--Corporate obligations------7991.58Total$19,1803.02%38,4803.03%52,3482.02%2,8433.53%Held to MaturityU.S. GSE's$--%1,0072.98%--%--%State and municipal31,1073.04118,1682.6816,0552.00184.00Corporate obligations------8705.51Total$31,1073.04%119,1752.68%16,0552.00%8885.48%  Loans  Presented in Note 4 to the Consolidated Financial Statements is a description of the types of loans we make. What follows is a historical table of their balances.  The Bank's loan policies establish the general parameters of the types of loans that are desirable, emphasizing cash flow and collateral coverage. Credit decisions are made at the Bank by officers who have extensive experience with commercial and consumer lending, helping to ensure thorough underwriting and sound credit decisions. Our Board of Directors has approved policies for commercial, consumer, and residential mortgage loans. These policies establish the lending authority of individual loan officers as well as the loan authority of the Bank's Officers Loan Committee (OLC). Certain of the Bank's executives each have loan authority up to $1,000,000 while other officers' lending authorities are $250,000 or less. A combination of officers and credit analysts can jointly approve certain loans up to $500,000 and OLC up to $4,000,000.  Loans over that amount generally must be approved by the Board or a designated committee of the Board.  Loans are generally originated in our primary market area (Rochester Metropolitan Statistical Area [MSA]), but as a national bank, we can make loans to customers anywhere in the country.  We use the same credit principles and guidelines for small, medium, and large credits.  A borrower's cash flow, overall financial condition/capacity, character, and the collateral securing a loan are considered during the credit decision process.  Specific emphasis is placed on the borrower's ability to generate cash sufficient to cover operations and financing costs when assessing the overall quality of a borrower's financial condition.  The commercial loan policy imposes limits on loans to one borrower and any borrowing relationship, as well as concentrations of credit to particular industries.  Federal banking regulations limit loans to one borrower (as defined) to 15% of the lending institution's regulatory capital.  At December 31, 2011, this limit for the Bank was approximately $24.6 million, and the Bank's largest committed borrowing relationship under these regulations was $14.9 million.  For all years, the loan portfolio was composed solely of domestic loans with their concentrations set forth in the schedule of loan classifications below. We are not aware of any material concentrations of credit risk to any industry or individual borrower.  The following summary shows the classifications of loans by category as of the year end for the past five years.   10    Composition of Loan PortfolioAs of December 31,(Dollars in thousands)20112010200920082007Commercial and industrial$198,744$212,707$214,841$205,818$194,395Commercial mortgage467,413434,787429,955389,907349,430Residential mortgage - first lien256,173232,953218,731213,411158,655Residential mortgage - junior lien101,87796,41683,23675,97169,407ConsumerAutomobile - indirect227,541181,481171,902168,830119,775Other25,58326,43728,91925,99921,767Other, including loans held for sale7,55614,1136,6572,9003,0731,284,8871,198,8941,154,2411,082,836916,502Plus: Net deferred loan costs7,6345,9625,6985,7764,047Less: Allowance for loan losses(16,095)(15,635)(14,232)(11,992)(9,679)Loans, net$1,276,426$1,189,221$1,145,707$1,076,620$910,870  Gross loans increased $86.0 million (7.2%) in 2011, occurring in most loan categories.  As noted previously, net loan growth was slow the first half of the year, but increased dramatically in the second half of the year. The largest dollar increase occurred in automobile loans, which was a focus of our origination efforts in the latter half of 2011.  Commercial loan growth was concentrated in mortgages, a generally lower risk portfolio than commercial and industrial loans.  We also experienced strong end of year growth in residential loans following both the introduction of our new five-year callable mortgage and a lowering of interest rates on other products.  Excluded from the balances in the table are loans serviced for others, the balances of which are discussed in the Other Income section. We sell some residential and commercial loans to manage liquidity and interest rate risk, but retain the servicing to continue to accommodate the needs of our customers and retain their relationship.  Overall, we are projecting the net balance of loans across all categories to increase approximately 4.0% in 2012, a slower pace than in 2011, but we will adjust this rate depending upon corresponding growth in deposits. We expect to continue to manage the overall mix of loans -- commercial and individual (mortgage and consumer) -- to continue migrating towards a 50% / 50% mix. Since our expansion beginning in the late 1990s, the loan portfolio mix had moved from 50% commercial, 50% individual to a high of 64% / 36%, and stood at 52% / 48% at year-end 2011.  We believe a balanced mix of these assets provides an optimal level of credit, interest rate, and liquidity risk.  To accomplish these goals over time, we will increase consumer loans as well as first- and second-lien residential real estate loans, except when low interest rates lead us to sell residential mortgages rather than retain in portfolio.  Additionally, we will continue to utilize commercial loan participations.  Loan Quality  Poor credit quality can be devastating to a bank, as the world experienced during the past few years. Therefore, we are diligent in initial underwriting and subsequent asset management to measure, monitor and manage credit risk.  The quality of the loan portfolio, as measured by the ratio of non-performing loans to total loans, has mirrored the economy, with the measure worsening in the early years of the decade and improving since then, and declining once again during the most recent recession.  Total non-performing loans fell by $4.6 million in 2011 having increased $3.2 million in 2010 and $10.0 million in 2009.  The highest balances of non-performing loans are concentrated within a relatively few commercial relationships primarily in the real estate investment, home improvement and recreation sectors  all industries impacted by the recession.  We are actively working with the borrowers with credit difficulties.  Our focus is to direct them towards resolving their cash flow issues by addressing the root-causes of their business troubles, rather than forcing business bankruptcy, liquidation, or sale.  We believe this strategy provides longer term value to the Company, the community, and to our customers and their employees, but at times it can result in a higher ratio of non-performing assets relative to our peers, because of our conservative non-accrual policy.  Even with this community-focused strategy for some of these relationships, we could suffer significant losses.  As of December 31, 2011 we believe we have adequately reserved for this risk within the allowance for loan losses.  More information about the reserves established for these impaired loans is included in Note 4 to the Consolidated Financial Statements.  To ensure that we only report income we have or expect to receive, the accrual of interest on commercial and real estate loans is generally discontinued, and previously accrued interest is reversed, when the loans become 90 days delinquent or when, in our judgment, the collection of principal and interest is uncertain. Loans are returned to accrual status when the doubt no longer exists about the loan's collectability and the borrower has demonstrated a sustained period of timely payment history. Specifically, the borrower will have resumed paying the full amount of scheduled interest and principal payments; all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within a reasonable period (six months); and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms involving payments of cash or cash equivalents.  Interest on consumer loans is accrued until the loan becomes 120 days past due at which time principal and interest are generally charged off.  11    Non-performing commercial real estate loans declined in 2011 after having increased in 2010 from 2009. Other than a loan considered a troubled debt restructuring (discussed below), there are no material individual loans.  Most are owner occupied properties.  The long-running economic decline resulted in cash flow difficulties for these commercial borrowers.  Non-performing residential real estate loans also declined year over year. A number of borrowers had, due to their personal economic conditions, been unable to make loan payments timely.  For some we had given short-term (6 months or less) payment deferrals of interest or principal or both.  However, some of these borrowers became unable to begin repayment despite these deferrals. As a result we placed the loans on nonaccrual status. As with commercial real estate, none are individually significant.  As a percentage of the portfolio, we believe 2010 will have represented the high point for non-performing loans. We anticipate the improving economy will positively impact borrowers prospects bringing some of these loans to current payment status as occurred in 2011.  Interest can be earned on a cash basis for these loans in non-accrual status, and it was $127,000 in 2011, was $35,000 in both 2010 and 2009.  Had non-accrual loans been current in accordance with their original terms, we would have recognized additional interest income approximating $662,000, $429,000, and $475,000 during 2011, 2010, and 2009, respectively. Instead these cash payments were applied to reduce our carrying amount of the loans.  Occasionally we must foreclose on mortgaged properties.  These foreclosed properties are initially recorded at the lower of their fair value, including estimated costs to sell, or carrying value and are included in other real estate owned in the Other Assets section of the balance sheet.  At December 31, 2011, we had seven commercial properties and 33 residential properties in other real estate owned. In the first half of 2009 we took possession of 60 one-to-four-family residential rental properties associated with the foreclosure of a commercial loan relationship that was in non-accrual status at December 31, 2008.  At the time, the estimated fair value of the properties was significantly higher than their carrying value, their combined cash flow was positive, exclusive of non-recurring expenses, such as major repairs, and nearly all properties were occupied by tenants. At year end 2011, 28 of these properties remained in other real estate.  Since our foreclosure we have experienced higher than anticipated repair costs, lower revenues, higher vacancies, and lower proceeds from sales.  As a result, and in consideration of current market conditions we wrote down the value of these properties by $0.3 million in the fourth quarter of 2010.  As indicated by our current inventory, we have successfully liquidated over half of these properties, as well as other properties formerly foreclosed. As with non-performing loans, we can anticipate additions and dispositions of other real estate in the future.  In the process of resolving nonperforming loans, we may choose to restructure the contractual terms of certain loans and attempt to work out alternative payment schedules with the borrower in order to avoid foreclosure of collateral. Any loans that are modified are evaluated to determine if they are "troubled debt restructurings (TDR)" and if so, are evaluated for impairment.  A TDR is defined as a loan restructure where for legal or economic reasons related to a borrowers financial difficulties, the creditor grants one or more concessions to the borrower that it would not otherwise consider. Terms of loan agreements may be modified to fit the ability of the borrower to repay in respect of its current financial status and restructuring of loans may include the transfer of assets from the borrower to satisfy debt, a modification of loan terms, or a combination of the two. If a satisfactory restructure and payment arrangement cannot be reached, the loan may be referred to legal counsel for foreclosure.  As of December 31, 2011 there were two lending relationships, one totaling $4.9 million and one totaling $0.3 million that were considered TDRs due to the nature of the concessions granted due to the borrower. These balances are set forth in the Non-Performing Assets table as restructured real-estate debt.  Additional information is set forth in Note 4 to the Consolidated Financial Statements.  12    The following table summarizes non-performing assets as of December 31 for each of the last five years (dollars in thousands).  Summary of Non-performing AssetsAs of December 31,20112010200920082007Loans past due 90 days or more and accruing:Commercial, financial, and agricultural$7522542210636Real estate-commercial-413-121-Real estate-residential660658290326133Consumer and other23429337524386Total past due 90 days or more and accruing9691,5891,087796255Loans in non-accrual status:Commercial, financial, and agricultural3,9174,07010,2823,134971Real estate-commercial9,07811,0325,6562,6173,703Real estate-residential4,2126,1412,6093,018541Consumer and other100---15Total non-accrual loans17,30721,24318,5478,7695,230Total non-performing loans18,27622,83219,6349,5655,485Other real estate owned:Commercial2,5801,4002,607639459Residential1,6552,34016290232Total other real estate owned4,2353,7402,769729691Total non-performing assets$22,51126,57222,40310,2946,176Restructured real-estatedebt (included in non-accrual loans)$5,2035,087---Non-performing loans to total period-end loans1.42%1.90%1.70%0.88%0.60%Non-performing assets to totalperiod-end loans and other real estate1.75%2.21%1.94%0.95%0.67%Allowance to non-performing loans88.07%68.48%72.49%125.37%176.46%  Loan Loss Experience and Allowance for Loan Losses  Our policy for, and the determination of the appropriate balance of, the allowance for loan losses is our most difficult, subjective, and complex accounting estimate.  It is also highly uncertain, since it is merely an estimate of the inherent risk of loss in the current loan portfolio.  Therefore, we consider this a critical accounting estimate.  Our policy and methodology for its calculation are set forth in Note 1 to the Consolidated Financial Statements.  Changes in the allowance for loan losses may arise as a result of factors both within and outside of our direct control.  For example, we may change the concentration of the loan portfolio to a particular industry, a particular loan type -- commercial, residential, consumer -- or a particular geography in our market area. These changes may increase or decrease the level of allowance necessary to reflect probable and inherent losses within the portfolio. The effect of the economy, including resulting changes in the value of collateral securing loans, are outside of our control, but can have significant impact on the allowance for loan losses.  Generally, a declining economy will negatively impact the ability of borrowers to repay loans in a timely manner and can also negatively impact collateral values. These factors cause probable losses within the portfolio to increase, resulting in the need for a higher allowance for loan losses.  13    The following table summarizes the changes in the allowance for loan losses for each of the last five years (dollars in thousands).  Summary of Changes in the Allowance for Loan LossesAs of and for the years ended December 31,20112010200920082007Balance at beginning of year$15,63514,23211,9929,6799,041Provision charged to operations3,7756,1504,3453,8052,375Charge-offs:Commercial, financial and  agricultural(2,082)(2,957)(1,063)(1,008)(1,386)Real estate-commercial(263)(678)(327)-(20)Real estate-residential(355)(286)(10)(28)-Consumer and other(1,863)(2,077)(1,564)(1,094)(1,060)(4,563)(5,998)(2,964)(2,130)(2,466)Recoveries:Commercial, financial and agricultural15324321654220Real estate-commercial-475908Real estate-residential1515021289Consumer and other9449116174664921,2481,251859638729Net charge-offs:(3,315)(4,747)(2,105)(1,492)(1,737)Balance at end of year$16,09515,63514,23211,9929,679Net charge-offs to average loans0.28%0.41%0.19%0.15%0.20%Allowance to total loans1.25%1.30%1.23%1.11%1.06%  The allowance for loan losses was $16.1 million at December 31, 2011, up from $15.6 million at December 31, 2010. We consider the allowance for loan losses at December 31, 2011 to be at a level adequate to cover probable and inherent losses in the loan portfolio. Growth in the allowance for loans losses has been driven by a combination of general growth in the overall loan portfolio and the provision for loan losses associated with impaired loans, which were not already included in the pool-based allowance calculation. Net charge-offs to average loans decreased in 2011 after having increased during the past two years reflective of the slow economy.  The largest dollar amounts of net charge-offs continue to be in commercial loans, which are generally higher in amount and higher in risk than the residential and consumer portfolios. Looking to 2012, we expect net charge-offs to stabilize around the 2011 level.  At December 31, 2011 we identified a total of 80 loans totaling $17.3 million that were considered impaired.  Of these, 6, with a balance of $2.5 million outstanding, had specific reserves associated with them amounting to $1.1 million. These reserves are included in the total allowance for loan losses.  One loan relationship accounted for about half of the balance of impaired loans and the related allowance associated with impaired loans.  The specific reserve associated with these and other loans was partially funded by the existing pool-based reserves. As more fully described in the Notes to the 2011 Consolidated Financial Statements, the allowance is a combination of both specific and general reserve pool-based components.  Internally classified loans not considered impaired are included in a pool calculation.  If the loans become impaired, the related allowance becomes a specific reserve, and is adjusted upward or downward as necessary through the provision for loan losses. This pool-based reserve is then recalculated to determine whether additional provision is necessary on the remaining portfolio as part of the regular allowance process.  We are seeing improvements in the economy.  Our local employment picture is faring better than the rest of the state and the nation, but is still relatively weak, just returning to a pre-recession state.  According to a February 2012 report from the Office of the New York State Comptroller, the Rochester area has recouped 98 percent of the jobs lost since the 2008 economic turmoil, a percentage more than twice as high as the statewide average and far better than any other metropolitan area of New York. According to the January 2012 Empire State Manufacturing Survey from the Federal Reserve Bank of New York, business conditions improved in January, with the general business conditions index rising five points to 13.5. This index has been on a clear upward trend since October 2011...  Also, the new orders index rose, and the shipments index rose modestly. Employment indices are also positive.  Furthermore, supplemental surveys indicate that slightly more than half of respondents expected their workforce to increase in the year ahead, while just 9 percent predicted declines in the total number of workers.  Noting the above improved economic conditions, and the changing mix in our portfolios, we have increased the dollar amount of allowance provided for the consumer portfolio.  The dollar amount in the mortgage portfolio has increased due mostly to the portfolios balance increases. The dollar amount in the commercial portfolio has slightly fallen recognizing its declining percentage of the entire loan portfolio, overall improvement in credit quality, and an improved business climate.   14   The following table presents an allocation of the allowance for loan losses and the percentage of loans in each category to total gross loans at December 31 for each of the last five years.  In addition to an allocation for specific problem loans, each category includes a portion of the general allowance for loan losses based upon loans outstanding, credit risk and historical charge-offs.  The unallocated portion of the allowance is not specifically associated with a loan category, but represents the portion of the allowance for which we have less precise loan data; it represents our estimate, based on our judgment, decades of lending experience, and total portfolio considerations.  Notwithstanding the following allocation, the entire allowance for loan losses is available to absorb charge-offs in any category of loans (dollars in thousands).  Allocation of Allowance for Loan Loss and Categorical Percentage of Loan TypesAs of December 31,20112010200920082007$(1)%(2)$(1)%(2)$(1)%(2)$(1)%(2)$(1)%(2)Commercial(3)$7,38751.8%$7,73554.0%$7,53655.9%$5,68955.0%$4,71759.3%Residential2,30727.91,86727.51,40226.21,38326.71,30024.9Consumer5,75520.35,35118.54,49917.93,74918.33,04315.8Unallocated646-682-795-1,171-619-$16,095100.0%$15,635100.0%$14,232100.0%$11,992100.0%$9,679100.0%  (1)Amount of allowance for loan losses (2)Percent of loans in each category to total loans (3)Includes commercial, financial, agricultural, and commercial real estate   Funding sources - Deposits and Borrowings  Our principal sources for funding assets are deposits and borrowings.  Set forth below, and in Notes 7, 8 and 9 of the Consolidated Financial Statements is more detailed information about deposits and borrowings at period ends and during the year.  The following tables summarize the average deposits and average rates paid during each of the three years presented (dollars in thousands).  Average Deposits and Rates PaidFor the Years Ended December 31,201120102009AmountRateAmountRateAmountRateNon-interest-bearing demand$207,551-%$187,957-%$173,042-%Interest-bearing demand155,6880.09139,1580.18121,3570.22Savings and money market690,4400.27636,5900.36564,9230.58Time449,4041.53476,4862.00490,6322.79$1,503,0830.59%$1,440,1910.84%$1,349,9541.28%  The following table sets forth time deposits of $100,000 or greater classified by the time remaining until maturity which were on deposit as of December 31, 2011 (dollars in thousands).  3 months or less$41,2924 through 6 months26,0307 through 12 months51,839Over 12 months46,150$165,311  Total deposits at December 31, 2011, were $1,546.6 million and were up $73.3 million from December 31, 2010.   Retail and commercial account deposits grew $60.0 million or 4.7%, due mainly to the continued success of our products, services, and brand, as well as a continued flight-to-safety of depositors toward strong community banks. Municipal deposits grew about $13.3 million or 7.2%.  Time deposits were the only category that showed a year-over-year decline.  In this low rate environment, depositors are reluctant to invest in CDs for long periods.  As a result they reduce both the amount they place in time deposits and the maturity terms.  Included in the reduction of time deposits in 2011 was the maturity of $15 million of three-year brokered deposits, which we raised in the fall of 2008 to fund the growth in our indirect automobile loan portfolio and manage the related interest rate risk (matched fixed-rate funding to fixed-rate loans for the estimated term of the loans).  We do not project raising new brokered deposits in the coming year.  About 65% of the retail and commercial deposit growth occurred in Monroe County, with about 35% coming from Ontario County.  Substantially all municipal deposit growth came in Ontario County, where we have a relatively larger long-term municipal deposit base of customers.  For 2012, we anticipate retail and commercial deposits to grow about 3% and municipal deposits to climb 3.5% from 2011. As in 2012 we expect more of the deposit growth to come from Monroe County where we have opened new banking offices and our current market penetration is lower.  With our high level of federal funds sold in 2011 and 2010, we found no need to borrow short-term funds during these years.  At December 31, 2011 we had no overnight borrowings.  Depending upon our liquidity needs, we might use short-term borrowings in 2012  15   from time to time, as we have in the past. Short-term borrowings from the Federal Home Loan Bank of New York and the Federal Reserve Bank of New York, collateralized by loans, are used to fund near-term liquidity needs. More information about our borrowings and borrowing capacity can be found in Notes 8 and 9 to the Consolidated Financial Statements.  We have no short-term or medium-term borrowings as of December 31, 2011 and do not anticipate any in 2012.  Our only recent short-term obligation was a $0.3 million final payment made in January 2011 for our purchase of GVT.  Our long-term borrowings are in the form of junior subordinated debentures.  In 2007, we issued $20.6 million of fixed-rate junior subordinated debentures and paid off a similar amount of floating rate debentures.  In 2006, we issued $30.9 million of floating rate junior subordinated debentures.  The terms of these borrowings are more fully described in Note 9 to the Consolidated Financial Statements.  Also in Note 9, you will find a discussion and details of interest rate swap agreements used to modify the interest rate of these debentures from floating rate to fixed rate.  Liquidity  Liquidity can be considered the lifeblood of banking.  Our Board of Directors has set general liquidity guidelines for management to meet, which can be summarized as: the ability to generate adequate amounts of cash to meet the demand from depositors who wish to withdraw funds, borrowers who require funds, and capital expansion.  Liquidity is produced by cash flows from our operating, investing, and financing activities.  Liquidity needs generally arise from asset originations and deposit outflows. Liquidity needs can increase when asset origination (of loans and investments) exceeds net deposit inflows.  Conversely, liquidity needs are reduced when the opposite occurs.  In these instances, the needs are funded through short-term borrowings, while excess liquidity is sold into the Federal Funds market.  Our principal source of day-to-day liquidity is through wholesale, secured borrowing lines from the Federal Home Loan Bank of New York (FHLB) and the Federal Reserve Bank of New York (FRB), details of which are set out in Note 8 to the Consolidated Financial Statements.  During 2011, credit available to us under these lines increased by $66.6 million to $561.7 million at December 31, 2011, due principally to growth in the loan portfolios we pledge as collateral. Since February 2009, we have not accessed either of these lines as deposit inflows were sufficient to provide funds for asset growth.  Secondarily, we occasionally use the liquidity source of time deposit sales in the national brokered market.  We will use this source from time to time to manage both liquidity and interest rate risk as conditions may require.  At December 31, 2011 we had no outstanding.  It is possible we will increase the balance of brokered deposits from time to time if our internal models dictate the need for additional long-term funds at relatively attractive rates.  We measure our liquidity on a daily basis with reference to our Fed Funds and Federal Reserve Bank of New York clearing account balances.  This is supplemented by a monthly Liquidity Report, which projects expected liquidity sources and uses over a twelve-month period.  The results of this model provide ALCO with a near-term view of liquidity and allow us to make appropriate plans and adjustments in a comprehensive manner, consistent with short- and long-term financial goals.  Our use of the model reduces the risk of short-term, unplanned liquidity crises, which can be costly to net interest income, or ultimately, a banks survival.  As measured using the Consolidated Statement of Cash Flows, for the year ended December 31, 2011, we used $11.5 million in net cash equivalents versus generating $60.0 million in net cash and equivalents in 2010.  Net cash provided by operating activities was $39.4 million in 2011 and $22.3 million in 2010.  Both the largest source and use of operating cash in each year were mortgage banking-related activities.  These activities were about 20% lower in 2011 than in 2010.  We expect 2012 operating activities to approximate levels experienced in 2011.  Cash used by investing activities in 2011 increased from 2010 to $121.2 million from 43.3 million. Net portfolio loan originations caused the largest fluctuation.   Net purchases of securities used $12.3 million in cash in 2011, while in 2010 securities transactions generated $5.6 million. In 2011 we increased our portfolio to reinvest the high level of fed funds sold.  The 2010 results were due to a higher volume of called securities in the continued low interest rate environment, and our inability to find suitable investments at reasonable interest rates.  Net portfolio loan originations were $99.4 million in 2011 and $45.1 million in 2010. The increase in 2011 was due to our efforts to reinvest liquid assets into higher yielding loans from fed funds sold.  The decline in 2010 from 2009 was caused by our decision to sell most of our residential mortgage originations to third parties, and secondarily to slow the rate of growth of the balance sheet.  In 2012, we expect net loan originations to be similar to 2011s due to strong demand for our lending products.  Cash provided by financing activities was $70.3 million in 2011 compared to $81.1 million in 2010.  The largest source of financing funds in 2011 and 2010 was customer deposits.  Repayments of term borrowings used cash in both years.  For 2012, we expect financing to be provided by deposits, though we may use long-term borrowings if rates are attractive. We expect deposit growth to come from consumer and business deposits, which, are expected to come mainly from Monroe County sources.  Less material, but a part of our ongoing operations, and expected to be funded by normal operations, are liquidity uses such as lease obligations and long-term debt repayments. A summary of these required commitments is included in the table below and details can be found in Notes 8, 9, 15 and 16 to the Consolidated Financial Statements.  Contingent funding commitments associated with extensions of credit to customers are set out in Note 16 to the Consolidated Financial Statements and are not included in the table below, because we are unable to determine the amount that would be drawn or its timing.   16    Payment due by periodAs of December 31, 2011(dollars in  thousands)AfterOneThreeYearYearsMoreLessThroughThroughThanThan oneThreeFiveFiveTotalYearYearsYearsYearsBorrowings$51,547---51,547Operating leases23,1872,4404,6324,26711,848OBS acquisition payments5,6752,7502,925--Cephas Capital Partners II2,250---2,250Trillium Lakefront Partners5050---Total$82,7095,2407,5574,26765,645  Total obligations are $82.7 million at year-end 2011 compared to $78.5 million at year-end 2010.  The only significant change is the $5.7 million commitment associated with the acquisition of OBS.  Except for the payments set forth in the table above, we are not aware of any material commitments in 2012.  Interest Rate Risk Management  Because our biggest source of revenue is net interest income, interest rate risk management is an important function at our Company.  We consider interest rate risk to be our most significant market-based risk.  We realize net interest income principally from the differential or spread between the interest earned on loans, investments and other interest-earning assets and the interest paid on deposits and borrowings. Loan volumes and yields, as well as the volume of and rates on investments, deposits and borrowings, are affected by market interest rates. Additionally, because of the terms and conditions of many of our loans and deposit accounts, a change in interest rates could also affect the projected maturities of the loan portfolio and/or the deposit base, which could alter our sensitivity to future changes in interest rates.  Interest rate risk management focuses on maintaining consistent growth in net interest income within Board-approved policy limits. Considered in the evaluation, among other factors are: overall credit risk, operating income, operating costs, and available capital. Our Asset/Liability Committee (ALCO) includes the Bank's CEO, President and senior officers in various disciplines including Treasury, Finance, Commercial Lending, Retail Lending, and Sales.  The Committee reports to the Board on its activities to monitor and manage interest rate risk.  Management of interest rate risk leads us to select certain techniques and instruments to utilize after considering the benefits, costs and risks associated with available alternatives.  Since we do not utilize derivative financial instruments, other than interest rate swap agreements, we usually consider one or more of the following: (1) interest rates offered on products, (2) maturity terms offered on products, (3) types of products offered, and (4) products available to us in the wholesale market such as advances from the FHLB and brokered time deposits.  ALCO's principal focus is net interest income at risk. We use a net interest margin shock simulation model as one method to identify and manage our interest rate risk profile.  The model measures projected net interest income "at-risk" and anticipated resulting changes in net income and economic value of equity.  The model is based on expected cash flows and repricing characteristics for all financial instruments at a point in time and incorporates our market-based assumptions regarding the impact of changing interest rates on these financial instruments over a twelve-month period. We also incorporate assumptions based on the historical behavior of deposit rates and balances in relation to changes in interest rates. These assumptions are inherently uncertain and, as a result, the model cannot precisely measure net interest income or precisely predict the impact of fluctuations in interest rates on net interest income. While actual results will differ from simulated results due to timing, magnitude, and frequency of interest rate changes, as well as changes in market conditions and management strategies, this model has proven to be an important guidance tool for ALCO.  The following table sets forth the results of this model for the Bank, the principal entity exposed to market risk, at December 31, 2011.   Changes in InterestEstimatedRatesPercentage Change in(basis points)Future Net Interest Income200(4)%100(6)%No change-%-100-%-200-%  17    We measure net interest income at risk by estimating the changes in future net interest income resulting from instantaneous and sustained parallel shifts in interest rates of plus or minus 200 basis points over a twelve-month period.  This provides a basis or benchmark for ALCO to manage the Company's interest rate risk profile.  At December 31, 2011, a relatively small upward shock (100 basis points) would cause an estimated 6% reduction in net interest income, due to our gap position (discussed below), and a larger shock would have a lower impact as asset yields would rise considerably more than liability costs.  Downward shocks would have little impact on net interest income, because rates paid are near zero, although they could be lowered somewhat, and asset yields are near our floor rates.   We recognize the model only provides a benchmark, because it makes the simplifying assumptions that: (1) interest rates will move in a parallel direction with no change in the yield curve; (2) the interest rate moves will be instantaneous and sustained; and (3) there will be no change in the product mix as determined by customer demand or pricing policies by management.  A second tool used by ALCO is its proprietary cost of funds model.  This model is used weekly and measures actual interest rates paid on deposits and borrowings and earned on loans and investments.  This model takes into consideration current interest rates, interest rate trends, product and portfolio spreads, and projected and historical net interest income data.  Using this model, we can adjust and determine the financial impact on net interest income on a more rapid basis than the net interest margin shock simulation model, which is prepared monthly.  A third method used to identify and manage our interest rate risk profile is the static gap analysis. Interest sensitivity gap ("gap") analysis measures the resulting difference between interest-earning assets and interest-bearing liabilities repricing or maturing within specific time periods. An asset-sensitive position indicates that there are more rate-sensitive assets than rate-sensitive liabilities repricing or maturing within specific time horizons.  This generally implies a favorable impact on net interest income in periods of rising interest rates and a negative impact in periods of falling rates. A liability-sensitive position generally implies a negative impact on net interest income in periods of rising rates and a positive impact in periods of falling rates.  The following table presents an analysis of our interest rate sensitivity gap position at December 31, 2011. Interest-earning assets are shown based on the earlier of their contractual maturity or repricing date.  Securities include the market value of available-for-sale securities, amortized cost of held-to-maturity securities, FRB and FHLB stock.  Callable securities are shown at their stated maturity.  Loans, without deferred costs, include principal amortization adjusted for estimated prepayments (principal payments in excess of contractual amounts) and non-accrual loans. All interest-bearing liabilities are shown based on the earlier of their contractual maturity or repricing date with no adjustment for decay (withdrawal) rates. Borrowings include the junior subordinated debentures.  Because the interest rate sensitivity levels shown in the table could be changed by external factors such as loan prepayments and liability decay rates, or by factors controllable by us such as asset sales, it is not an absolute reflection of our potential interest rate risk profile.  The maturities set forth are based upon contractual maturities.  Demand loans, overdrafts and certain time loans, the principal of which may be renewed in whole or in part, are included in the " One Year or Less" classification.  Our loan policy encourages a repayment schedule to be established whenever possible for loans that do not have stated contractual maturities. The policy provides that a demand loan should mature within one year of its origination, with any renewals at the then-prevailing interest rate and with the assurance that the borrower demonstrates the ability to repay on maturity of the loan.  Interest Rate Sensitivity GapDecember 31, 2011(Dollars in thousands)Maturity/Repricing PeriodWithin 34 to 1213 to 3637 to 48Over 48MonthsMonthsMonthsMonthsMonthsInterest-earning assets:Interest-bearing deposits$126,740----Securities12,92037,52486,39433,320113,981Loans377,089119,229341,878138,564308,127Total interest-earnings assets516,749156,753428,272171,884422,108Interest-bearing liabilities:NOW accounts175,409----Savings and money market745,713----Time deposits89,51764,109120,846123,732-Borrowings30,92820,619---Total interest-bearing liabilities1,041,56784,728120,846123,732-Interest rate swap affecting liabilities(30,928)(20,619)--51,547Interest rate sensitivity gap$(493,890)92,644307,42648,152370,561Cumulative gap$(493,890)(401,246)(93,820)(45,668)324,893Cumulative gap ratio(1)51.1%62.7%92.2%96.5%123.7%Cumulative gap as percent of total assets(28.0)%(22.8)%(5.3)%(2.6)%18.4%  (1)Cumulative total interest-earning assets divided by cumulative total interest-bearing liabilities.    18   The table indicates that $493.9 million more interest-bearing liabilities (than interest-earning assets) will reprice in the 0-3 month range. For the 4-12 month period, we are asset sensitive, as $92.6 million more of interest-earning assets are repricing than interest-bearing liabilities.  For the entire one-year range, we are repricing $401.2 million more interest-bearing liabilities than assets and at 62.7% are within our gap ratio targets of 30% to 125%. We are asset sensitive at $307.2 million for the 13-36 month range, $48.2 million for the 37 to 48 month year range, and $370.6 million over 48 months. For the entire portfolio range, we are asset sensitive at $324.9 million versus asset sensitive of $248.9 million last year, mostly reflecting the growth in non-interest-bearing liabilities.  Our product mix is such that nearly all assets and liabilities reprice or mature within five years.  With such a balance sheet profile, we face interest rate risk over the short to medium term. We consider this interest rate gap manageable, as substantially all of the NOW accounts and savings balances are considered insensitive to rate changes.  The following table provides additional detail of the interest sensitivity specifically of certain commercial and industrial loans as of December 31, 2011 (dollars in thousands).  AfterOneOneThroughAfterYear orFiveFiveLessYearsYearsTotalCommercial, financial and agricultural loans$156,508$40,092$2,144$198,744Maturing or repricing after one year:with a fixed interest rate$1,69340,0922,14343,928with a floating or adjustable rate$154,816--154,816  Capital and Dividends  The Company and Bank are each subject to certain regulatory capital requirements.  As of December 31, 2011, the Company and Bank each far exceeded all capital requirements to which they were subject.  A full description of these requirements and applicable calculations are set out in Note 17 to the Consolidated Financial Statements.  Our goal is to maintain the Company's and Bank's categorization as "well-capitalized," and our current operating plans project the Company and Bank to remain at well-capitalized status.  This will be accomplished mainly through balancing asset growth and net capital formation (net income less dividends and treasury stock purchases).  We can take other steps to improve capital ratios as considered necessary, such as dividend reductions, asset sales, issuing equity securities, or issuing additional debt qualifying as regulatory capital and other means.  None of these are contemplated in 2012.  On September 12, 2010, the Basel Committee on Banking Supervision released its proposal for revising capital requirements for internationally active financial institutions. These new standards are called Basel III.  As a signatory to this proposal, the United States banking regulators will be revising capital standards for all financial institutions in the U.S.  Accordingly, our capital standards will change.  However, regulators have not released any new standards and are not expected to do so for some time.  Furthermore, the international standards do not become fully effective until 2018, which is likely when the U.S. standards would become fully effective.  It is too early to determine whether there will be any material impact to the Company.  We expect capital to increase in 2012.  Considering our strong results in 2011, we raised our semi-annual, per-share dividend in January 2012, to $1.50 compared to $1.43 in the first half of 2010.  We also paid a semi-annual cash dividend of $1.44 per share in August 2011.  Together the 2011 dividends totaled $5.4 million or $2.87 per outstanding common share versus $5.1 million or $2.72 per outstanding common share in 2010 and $2.47 per outstanding common share in 2009. Payment of dividends by the Bank to the Company is limited in certain circumstances, which are discussed in Note 11 to the Consolidated Financial Statements.  You can find historical dividend information in the Common Stock Data section below and in the Financial Highlights.  While we cannot provide assurance that the amount and timing of dividends paid in recent years will continue, we have no knowledge of current activities that would require us to reduce dividends or change the timing of their payment.  We expect common shares to be available in the open market resulting from stock option exercises and shareholders' sales.  From time to time, we may buy shares into treasury, from which we fund our ESOP and other employee awards, including the annual Arthur S. Hamlin Award.  Off Balance Sheet Arrangements  We offer certain financial products which are not recorded on our balance sheet because actual funds have not been extended.  These are in the form of standby letters of credit and loan commitments.  We have enumerated these in Note 16 to the Consolidated Financial Statements.  At December 31, 2011, there were no material commitments to extend credit which represent unusual risks outside of our normal course of business.  19    Legislative and Fiscal Matters  On July 21, 2010, the President signed into law The Dodd-Frank Wall Street Reform and Consumer Protection Act (Financial Reform Act). The Financial Reform Act significantly alters financial regulation in the United States by creating new regulators, regulating new markets, bringing new firms into the regulatory arena, and providing new rulemaking and enforcement powers to regulators. The Financial Reform Act is intended to address specific issues that contributed to the financial crisis and is heavily remedial in nature. Many of the provisions in the Act are applicable to larger institutions (greater than $10 billion in assets). A summary of the Financial Reform Acts provisions that may potentially impact the Company follows.  The Financial Reform Act created the Financial Stability Oversight Council with the primary obligation to identify, monitor, and assist in the management of systemic risk that may pose a threat to the countrys financial system.  Included in its responsibilities is a requirement to review and at its option submit comments, as appropriate to any standard-setting body (such as the Financial Accounting Standards Board [FASB]) with respect to existing or proposed accounting principles, standards or procedures.  Though this responsibility may not directly impact the Company, the Councils review and commentary on accounting matters may result in more consideration by standard-setters of the volatility created by some of its current and proposed standards.  We hope the Councils activities will bring restraint to standard setters and temper proposals such as mark-to-market accounting for all financial instruments.  The Act permanently implemented FDIC insurance coverage for all deposit accounts up to $250,000. Furthermore, the insurance premium assessment base was revised from all domestic deposits to the average of total assets less tangible equity.  The minimum reserve ratio of the deposit insurance fund was increased from 1.15% to 1.35%, with the increase to be covered by assessments on insured institutions with assets over $10 billion until the new reserve ratio is reached. We discussed the impact of this provision in section above, but in summary, this provision has significantly reduced the Companys deposit insurance premiums.  The Act creates the Consumer Financial Protection Bureau (CFPB). It has an independent budget and is housed in the Federal Reserve Board, but not subject to its jurisdiction.  The CFPB has rulemaking authority to promulgate regulations regarding consumer financial products and services offered by all banks and thrifts, their affiliates and many non-bank financial services firms.  We cannot determine what the impact the CFPBs rules and regulations might have on the Company, its product offerings, its customers ability to purchase products to meet their specific needs, or the Companys general business practices, but they are likely to be significant given the CFPBs broad powers.  The so-called Durbin Amendment requires the Federal Reserve Board to adopt regulations limiting interchange fees that can be charged in an electronic debit card transaction to the reasonable and proportionate costs related to the incremental cost of the transaction. Banks under $10 billion in assets are exempt, which would include the Company.  Final rules were implemented in 2011.  While the rules are not designed to negatively impact smaller banks, and to date we have not experienced any detrimental effects, since the Company contracts with large debit card processors with which we have relatively weak bargaining power, it is possible these processors, as a result of the Act, will earn lower revenues, leaving less revenue per transaction for the Company.  The Act has changed oversight authority for the prudential regulation of our Company so both the Bank and its holding company will be regulated by the Office of the Comptroller of the Currency (OCC), because the Company has less than $50 billion in assets.  Formerly the Bank was regulated by the OCC and the holding company was regulated by the Federal Reserve Board.  The Act significantly changes the regulatory structure of the mortgage lending business, but, in effect, has codified the prudent and customer-focused activities the Company has always pursued.  For example, the Act provides that a creditor must make a reasonable and good faith determination of a consumers ability to repay before making a residential mortgage loan. The determination must be based on verified and documented information and must take into account all applicable taxes, insurance and assessments.  On the other hand, the Act does add substantial burdens to the Company by, subject to certain exemptions, requiring the establishment of an escrow account in connection with a closed-end consumer credit transaction secured by a first lien on a consumers principal dwelling for the payment of taxes and hazard insurance and, if applicable, flood insurance, mortgage insurance, ground rents and any other required periodic payments or premiums with respect to the property or the loan terms. The Company has not historically escrowed such payments. We provide financial advice and a savings product for customers to self-escrow, believing that customers are the best stewards and managers of their personal cash flow sources and uses, and government is ill-suited to dictate how much and when individual consumers should save to meet their financial obligations.  The Act also modified the calculation for a loan to be subject to high-cost-loan status under the Home Ownership and Equity Protection Act (HOEPA) by requiring the Annual Percentage Rate (APR) to be compared to the average prime offer rate for a comparable transaction and not the rate on U.S. Treasury securities having a comparable maturity. The points and fees trigger is lowered, and a prepayment fee trigger is added.  We believe any comparison is a flawed policy, because low balance loans, those most beneficial to first-time homeowners, would carry an interest rate unprofitable to the Company. Principally the methodology ignores that originating a loan, no matter what its balance, has certain fixed costs, and these costs when spread over a smaller balance result in a higher effective interest rate. Recent Accounting Standards to be implemented in Future Periods  The following presents a summary of Accounting Standards Updates (ASUs), exclusive of technical correction ASUs that will be subject to implementation in future periods.   20   ASU 2011-03.Reconsideration of Effective Control for Repurchase Agreements, issued April 2011. The main objective in developing this Update is to improve the accounting for repurchase agreements (repos) and other agreements that both entitle and obligate a transferor to repurchase or redeem financial assets before their maturity. The amendments in this Update remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee, and (2) the collateral maintenance implementation guidance related to that criterion. Other criteria applicable to the assessment of effective control are not changed by the amendments in this Update. The guidance in this Update is effective for us on January 1, 2012. Since the Company does not currently engage in these types of transactions, the Update had no impact on the Companys financial condition or results of operations upon implementation.  ASU 2011-04 Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, issued May 2011. The amendments are intended to converge fair value measurement and disclosure guidance in U.S. GAAP with the guidance in the International Accounting Standards Boards concurrently issued IFRS 13, Fair Value Measurement. The amendments in ASU 2011-04 do not modify the requirements for when fair value measurements apply; rather, they generally represent clarifications on how to measure and disclose fair value under ASC 820, Fair Value Measurement, including the following revisions: · The concepts of highest and best use and valuation premise are relevant only for measuring the fair value of nonfinancial assets and do not apply to financial assets and liabilities. · An entity should measure the fair value of an equity-classified financial instrument from the perspective of the market participant that holds the instrument as an asset. · An entity that holds a group of financial assets and financial liabilities whose market risk (that is, interest rate risk, currency risk or other price risk) and credit risk are managed on the basis of the entitys net risk exposure may apply an exception to the fair value requirements in ASC 820 if certain criteria are met. The exception allows such financial instruments to be measured on the basis of the reporting entitys net, rather than gross, exposure to those risks. · Premiums or discounts related to the unit of account are appropriate when measuring fair value of an asset or liability if market participants would incorporate them into the measurement (for example, a control premium). However, premiums or discounts related to size as a characteristic of the reporting entitys holding (that is, a blockage factor) should not be considered in a fair value measurement. The following new disclosures related to an entitys fair value measurements are required:  For Level 3 fair value measurements: · Quantitative information about unobservable inputs · Description of the valuation processes · Qualitative discussion about the sensitivity of the measurements · Information about the use of a nonfinancial asset when it differs from the assets highest and best use · The level of fair value hierarchy for assets and liabilities that are not measured at fair value but whose fair value is required to be disclosed. The guidance in this Update is effective for us on January 1, 2012.  We expect to expand certain footnote disclosures, but, in general, implementation of this standard had no impact on our financial statements.  ASU 2011-05 Presentation of Comprehensive Income, issued June 2011. The objective of this Update is to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. To increase the prominence of items reported in other comprehensive income and to facilitate convergence of U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS), the FASB decided to eliminate the option to present components of other comprehensive income as part of the statement of changes in stockholders equity, among other amendments in this Update.  The amendments require that all non-owner changes in stockholders equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present total other comprehensive income, the components of other comprehensive income, and the total of comprehensive income.  The amendments do not change the items that must be reported in other comprehensive income or when an item of other comprehensive income must be reclassified to net income. Currently we present components of other comprehensive income as part of the statement of changes in stockholders equity, which will no longer be allowable under this amendment.  The amendment will be applied retrospectively (prior periods will be restated), and will be effective for us beginning the first quarter of 2012.  In ASU 2011-12 Deferral of the Effective Date for Amendments to the Presentation of Reclassification of Items Out of Accumulated Other Comprehensive Income in Accounting Standards Update No. 2011-05, the FASB  deferred the certain reporting requirements for reclassifications out of accumulated other comprehensive income on a components basis. During the first quarter of 2012 we will be revising our reporting systems to provide the necessary information to implement this standard in 2012.  ASU 2011-08 Testing Goodwill for Impairment, issued September 2011. The objective of this Update is to simplify how entities, both public and nonpublic, test goodwill for impairment. The amendments in the Update permit an entity to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Previous guidance required an entity to test goodwill for impairment, on at least an annual basis, by comparing the fair value of a reporting unit with its carrying amount, including goodwill (step one). If the fair value of a reporting unit is less than its carrying amount, then the second step of the test must be performed to measure the amount of the impairment loss, if any. Under the amendments in this Update, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount. The amendments are effective for us beginning in 2012. Its impact will be unknown until we complete our next annual goodwill evaluation.   21   ASU 2011-11 Disclosures about Offsetting Assets and Liabilities, issued December 2011. The amendments in this Update require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position.  The amendments are intended to bring closer convergence of US GAAP with International Financial Reporting Standards (IFRS). The amendments are effective for us beginning in 2013. We do not anticipate any material impact to our financial statements.  Summary Quarterly Financial Data  In the tables below, we present summary quarterly financial results for each of the quarters in the years ended December 31, 2011, and 2010.  The sum of each quarter's earnings-per-share data may differ from the full year's results due to rounding (in thousands except share data).   2011 Quarters:1st2nd3rd4thNet interest income$14,823$15,145$15,310$16,195Provision for loan losses(750)(140)(1,500)(1,385)Non-interest income7,1926,9197,3387,359Operating expenses(15,321)(14,835)(13,961)(20,286)Income taxes(1,605)(2,045)(2,162)(366)Noncontrolling interests---387Net income$4,339$5,044$5,025$1,904Basic earnings per share$2.30$2.67$2.66$1.01Diluted earnings per share$2.26$2.63$2.61$0.992010 Quarters:Net interest income$14,487$15,378$15,654$15,622Provision for loan losses(2,425)(525)(1,700)(1,500)Non-interest income6,4146,4876,7887,032Operating expenses(13,710)(14,087)(14,396)(15,658)Income taxes(1,249)(1,899)(1,627)(1,430)Net income$3,517$5,354$4,719$4,066Basic earnings per share$1.87$2.84$2.50$2.35Diluted earnings per share$1.84$2.80$2.46$2.31  The fourth quarter of 2011s results were positively impacted by higher net interest income due to loan portfolio growth, offset by significantly higher operating expenses driven by higher incentive stock plan accruals associated with the increase in the price of the Companys stock and higher intangible amortization. The fourth quarter of 2010s results were positively impacted by growth in non-interest income, offset by higher operating expenses associated with higher bonus accrual based upon full-year earnings and writedowns of other real estate.  22   Our Common Stock  At December 31, 2011, we had approximately 1,370 shareholders of record. Information about beneficial ownership of the Company's stock by directors and certain officers is set forth in the Companys Proxy Statement for the 2012 Annual Meeting of Shareholders. Market value and dividend information is set forth in a table below.  The Company currently pays a semi-annual dividend in February and August.  We expect to continue to pay cash dividends to our stockholders for the foreseeable future.  The following table sets forth, for the monthly period indicated in 2011, the total number of shares purchased and the price paid per share by The Canandaigua National Bank and Trust Company (Bank) for the Arthur S. Hamlin Award, the Canandaigua National Corporation Employee Stock Ownership Plan (ESOP) and the Canandaigua National Corporation for treasury.  Each of these entities is considered an affiliated purchaser of the Company under Item 703 of Regulation S-K.  Shares repurchased by Company are not part of a publicly announced plan or program.  The Bank, ESOP, and Company purchase prices per share were determined based on the most recent price established at the sealed-bid auction immediately preceding the purchase. Purchases occur on an ad-hoc basis when shares become available in the marketplace and the Company is interested in purchasing these shares for the corporate purposes discussed above. Sales occur when corporate needs require the use of shares and there are none available in the market at the time.  Purchases and Sales of Equity Securities for the Year Ended December 31, 2011TotalAverageSharesPrice PerDatePurchased (Sold) (#)Share ($)PurposeJanuary200$95.85TreasuryApril(140)$99.89CompensationJune848$103.87TreasuryJune(16)$103.87CompensationJune(36)$103.87Arthur S. Hamlin AwardSeptember(107)$111.34CompensationDecember(119)$129.22CompensationDecember864$129.22TreasuryTotal  purchases1,912Total sales(418)  23    While the Company's stock is not actively traded, from time to time, shareholders sell shares to interested persons in sealed-bid public auctions administered by the Banks Trust Department at the request of selling shareholders. Our stock is not listed with a national securities exchange. Due to the limited number of transactions, the quarterly high, low and weighted average sale prices may not be indicative of the actual market value of the Company's stock. The following table sets forth a summary of transactions by selling shareholders and bidders in the Company's common stock during each period for transactions that were administered by the Banks Trust Department.  Also included are the book value at quarter end, and semi-annual dividends paid per share since the first quarter of 2009.  #QuarterlyQuarterlyQuarterlySharesAverageHighLowBookDividendSoldSales PriceSales PriceSales PriceValuePaid20114th Quarter1,492$129.22$150.00$123.75$71.953rd Quarter3,216$111.34$118.13$107.50$69.55$1.442nd Quarter3,036$103.87$110.00$102.50$69.341st Quarter2,948$99.89$107.21$98.69$66.71$1.4320104th Quarter2,528$95.85$102.90$93.91$65.543rd Quarter3,172$91.89$100.00$90.03$63.55$1.432nd Quarter3,200$88.44$92.50$87.53$62.991st Quarter3,040$85.37$91.75$83.75$59.93$1.2920094th Quarter2,700$81.78$87.97$81.25$59.303rd QuarterNone$N/A$N/A$N/A$57.18$1.262nd Quarter3,064$80.93$87.50$78.81$55.701st Quarter3,244$78.69$88.75$75.50$53.94$1.21  Although the Companys common stock is not listed with a national securities exchange, it trades sporadically on the Over-the-Counter Bulletin Board System under the symbol CNND or CNND.OB. The following table sets forth a summary of information about these trades. Due to the limited number of transactions, the quarterly high, low and weighted average bid/ask prices may not be indicative of the actual market value of the Company's stock.  The OTC Bulletin Board® (OTCBB) is a regulated quotation service that displays real-time quotes, last-sale prices, and volume information in over-the-counter (OTC) equity securities. An OTC equity security generally is any equity that is not listed or traded on NASDAQ® or a national securities exchange. The OTCBB is a quotation medium for subscribing members, not an issuer listing service, and should not be confused with The NASDAQ Stock MarketSM.  Investors must contact a broker/dealer to trade OTCBB securities. Investors do not have direct access to the OTCBB service. The Securities and Exchange Commission's (SEC's) Order-Handling Rules which apply to NASDAQ-listed securities do not apply to OTCBB securities.  The OTCBB market quotations set forth below reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions.  QuarterlyQuarterlyQuarterly#AverageHighLowSharesBid/Ask PriceBid/Ask PriceBid/Ask Price20114th Quarter7,375$97.00$160.00$79.643rd Quarter2,456$97.70$105.00$87.502nd Quarter636$90.12$93.75$86.501st Quarter2,536$85.26$88.50$83.7520104th Quarter2,544$81.82$90.00$78.253rd Quarter3,256$75.55$78.75$70.252nd Quarter748$78.01$80.00$75.251st Quarter1,808$77.42$82.50$70.0020094th Quarter2,048$76.88$83.75$69.753rd Quarter32$69.16$69.75$68.752nd Quarter4,136$65.72$75.00$55.001st Quarter1,128$52.82$55.00$50.75  24   Management Report on the Effectiveness of Internal Controls over Financial Reporting  Management of Canandaigua National Corporation (the Company) is responsible for the preparation, integrity, and fair presentation of its published financial statements and all other information presented in its annual report. The consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles and, as such, include amounts based on informed judgments, assumptions and estimates made by management.  Management is also responsible for establishing and maintaining adequate and effective internal control over financial reporting presented in conformity with both U.S. generally accepted accounting principles and the Federal Financial Institutions Examination Council instructions for Consolidated Reports of Condition and Income (call report instructions) and as defined in Exchange Act Rules 13a-15(f).  This internal control contains monitoring mechanisms, and actions are taken to correct deficiencies identified.  There are inherent limitations in any internal control, including the possibility of human error and the circumvention of overriding controls.  Accordingly, even effective internal control can provide only reasonable assurance with respect to financial statement preparation.  Further, because of changes in conditions, the effectiveness of internal control may vary over time.  Management assessed the Company's internal control over financial reporting presented in conformity with both U.S. generally accepted accounting principles and call report instructions as of December 31, 2011.  This assessment was based on criteria for effective internal control over financial reporting described in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  Based on this assessment, management believes that, as of December 31, 2011, the Company maintained effective internal control over financial reporting presented in conformity with both U.S. generally accepted accounting principles and call report instructions.  KPMG LLP, an independent registered public accounting firm, has audited the consolidated financial statements included in the annual report and the effectiveness of the Company's internal control over financial reporting as of December 31, 2011.  Management is also responsible for complying with federal laws and regulations concerning dividend restrictions and loans to insiders, designated by the FDIC as safety and soundness laws and regulations.  Management assessed compliance with the aforementioned designated safety and soundness laws and regulations.  Based on this assessment, management believes that the Company complied, in all material respects, with such designated laws and regulations relating to safety and soundness during the year ended December 31, 2011.   February 22, 2012   /s/ George W. Hamlin, IV /s/  Lawrence A. Heilbronner  George W. Hamlin, IV Lawrence A. Heilbronner Chairman and Chief Executive Officer Executive Vice President and Chief Financial Officer      25   Report of Independent Registered Public Accounting Firm  The Board of Directors and Stockholders Canandaigua National Corporation:  We have audited Canandaigua National Corporations (the Company) internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control-Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission. The Companys management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on the Effectiveness of Internal Controls over Financial Reporting. Our responsibility is to express an opinion on the Companys internal control over financial reporting based on our audit.  We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.  A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Because managements assessment and our audit were conducted to also meet the reporting requirements of Section 112 of the Federal Deposit Insurance Corporation Improvement Act (FDICIA), managements assessment and our audit of the Companys internal control over financial reporting included controls over the preparation of the schedules equivalent to the basic financial statements in accordance with the instructions to the Consolidated Financial Statements for Bank Holding Companies (FR Y-9C). A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the companys assets that could have a material effect on the financial statements.  Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.  In our opinion, Canandaigua National Corporation maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal ControlIntegrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.  We do not express an opinion or any other form of assurance on managements statement referring to compliance with laws and regulations.  We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Canandaigua National Corporation and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders equity, and cash flows for each of the years in the three-year period ended December 31, 2011, and our report dated February 22, 2012 expressed an unqualified opinion on those consolidated financial statements.  /s/ KPMG LLP  Rochester, New York February 22, 2012  26   Report of Independent Registered Public Accounting Firm  The Board of Directors and Stockholders Canandaigua National Corporation:  We have audited the accompanying consolidated balance sheets of Canandaigua National Corporation and subsidiaries as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders equity, and cash flows for each of the years in the three-year period ended December 31, 2011. These consolidated financial statements are the responsibility of the Companys management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.  We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.  In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Canandaigua National Corporation and subsidiaries as of December 31, 2011 and 2010, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2011, in conformity with U.S. generally accepted accounting principles.  We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Canandaigua National Corporations internal control over financial reporting as of December 31, 2011, based on criteria established in Internal ControlIntegrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 22, 2012 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting.  /s/ KPMG LLP  Rochester, New York February 22, 2012  27    CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETSDecember 31, 2011 and 2010 (Unaudited)
(dollars in thousands, except per share data)   Assets20112010Cash and due from banks$52,71528,951Interest-bearing deposits with other financial institutions6,4904,200Federal funds sold67,535105,078Securities:- Available for sale, at fair value114,258113,995- Held-to-maturity (fair value of $172,517 in 2011 and $160,401 in 2010)167,225155,881Loans - net1,276,4261,189,221Premises and equipment  net16,10114,370Accrued interest receivable6,6276,337Federal Home Loan Bank stock and Federal Reserve Bank stock2,6562,460Goodwill15,8108,818Intangible assets6,7875,724Prepaid FDIC assessment3,9055,175Other assets24,93521,294Total Assets$1,761,4701,661,504Liabilities and Stockholders' EquityDeposits:DemandNon-interest bearing$227,284186,289Interest bearing175,409150,360Savings and money market745,713648,291Time398,204488,390Total deposits1,546,6101,473,330Borrowings-330Junior subordinated debentures51,54751,547Accrued interest payable and other liabilities27,53312,503Total Liabilities1,625,6901,537,710Canandaigua National Corporation stockholders' equity:Preferred stock, $.01 par value; 4,000,000 sharesauthorized, no shares issued or outstanding--Common stock, $5.00 par value; 16,000,000 sharesauthorized, 1,946,496 shares issued in 2011 and 20109,7329,732Additional paid-in-capital8,8348,823Retained earnings120,675109,768Treasury stock, at cost (59,242 shares at December 31, 2011and 57,748 at December 31, 2010)(4,912)(4,728)Accumulated other comprehensive income, net(1,455)199Total Canandaigua National Corporation Stockholders' Equity:132,874123,794Non-controlling interests2,906-Total Equity135,780123,794Total Liabilities and Equity$1,761,4701,661,504   See accompanying notes to consolidated financial statements.  28   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOMEYears Ended December 31, 2011, 2010 and 2009 
 (dollars in thousands, except per share data)   201120102009Interest income:Loans, including fees$64,90767,57166,107Securities7,9368,6528,893Federal funds sold354207118Other243658Total interest income73,22176,46675,176Interest expense:Deposits8,84312,11317,243Borrowings-207550Junior subordinated debentures2,9053,0053,009Total interest expense11,74815,32520,802Net interest income61,47361,14154,374Provision for loan losses3,7756,1504,345Net interest income after provision for loan losses57,69854,99150,029Other income:Service charges on deposit accounts10,97210,7259,019Trust and investment services income12,63210,98410,056Net gain on sale of mortgage loans2,1262,3663,015Loan servicing income, net928877582Loan-related fees267351332(Loss) on securities transactions, net(191)(170)(159)Other operating income2,0741,5881,925Total other income28,80826,72124,770Operating expenses:Salaries and employee benefits35,01930,52628,447Occupancy, net7,5306,8056,172Technology and data processing4,4803,8813,555Professional and other services4,7513,2972,949Marketing and public relations2,8292,5152,206Office supplies, printing and postage1,5561,4701,519Intangible amortization1,1879951,063Other real estate operations1,0491,2971,200FDIC insurance1,4052,1522,586Other operating expenses4,5974,9134,507Total operating expenses64,40357,85154,204Income before income taxes22,10323,86120,595Income taxes6,1786,2055,401Net income attributable to noncontrolling interests andCanandaigua National Corporation15,92517,65615,194Less: Net (loss) attributable to noncontrolling interests(387)--Net income attributable to Canandaigua National Corporation$16,31217,65615,194Basic earnings per share$8.649.358.06Diluted earnings per share$8.489.207.92   See accompanying notes to consolidated financial statements.  29   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITYYears Ended December 31, 2011, 2010 and 2009 (Unaudited)
(dollars in thousands, except share data)    AccumulatedNumber ofAdditionalOtherNon-SharesCommonPaid-inRetainedTreasuryComprehensivecontrollingOutstandingStockCapitalEarningsStockIncome (Loss)InterestTotalBalance at December 31, 20081,887,436$9,7328,59187,273(4,819)(339)-100,438Comprehensive income:Change in fair value ofinterest rate swaps,net of taxes of $170----266-266Change in unrealized gain onon securities available for sale,net of taxes of $502----808-808Plus reclassification adjustmentfor realized losses included innet income on called securities,net of taxes of $15----25-25Net income--15,194---15,194Total comprehensive income16,293Purchase of treasury stock(4,516)---(360)--(360)Shares issued as compensation424--(3)36--33Cash dividend - $ 2.47 per share--(4,669)---(4,669)Balance at December 31, 20091,883,344$9,7328,59197,795(5,143)760-111,735Comprehensive income:Change in fair value ofinterest rate swaps,net of taxes of $180----324-324Change in unrealized gain onon securities available for sale,net of taxes of ($483)----(971)-(971)Plus reclassification adjustmentfor realized losses included innet income on called securities,net of taxes of $44----86-86Net income--17,656---17,656Total comprehensive income17,095Purchase of treasury stock(5,564)---(511)--(511)Shares issued as compensation624---54--54Exercise of stock options,including tax benefit of $23210,344-232(562)872--542Cash dividend - $ 2.72 per share--(5,121)---(5,121)Balance at December 31, 20101,888,748$9,7328,823109,768(4,728)199-123,794Comprehensive income:Change in fair value ofinterest rate swaps,net of taxes of ($1,341)----(2,141)-(2,141)Change in unrealized gain onon securities available for sale,net of taxes of $180----346-346Plus reclassification adjustmentfor realized losses included innet income on called securities,net of taxes of $69----141-141Net income attributable to non-controlling interest andCanandaigua National Corporation--16,312--(387)15,925Total comprehensive income14,271Purchase of treasury stock(1,912)---(219)--(219)Shares issued as compensation418-11-35--46Cash dividend - $ 2.87 per share--(5,405)---(5,405)Change in non-controlling interest-----3,2993,299Dividend to non-controlling interests-----(6)(6)Balance at December 31, 20111,887,254$9,7328,834120,675(4,912)(1,455)2,906135,780   See accompanying notes to consolidated financial statements.  30   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2011, 2010 and 2009 (Unaudited)
 (dollars in thousands)   201120102009Cash flow from operating activities:Net income attributable to Canandaigua National Corporation$16,31217,65615,194Adjustments to reconcile net income toNet cash provided by operating activities:Depreciation, amortization and accretion6,0975,2855,071Provision for loan losses3,7756,1504,345Gain on sale of premises and equipment and other real estate, net(105)(32)(61)Writedown of other real estate20849381Deferred income tax benefit(574)(763)(589)Income from equity-method investments, net(363)59(83)Loss on calls of securities and write-down, net191170159Gain on sale of mortgage loans, net(2,126)(2,366)(3,015)Originations of loans held for sale(166,240)(203,582)(268,203)Proceeds from sale of loans held for sale174,923198,492266,614Prepaid FDIC assessment--(7,659)Decrease (increase) in other assets1143,564(4,046)Increase (decrease) in all other liabilities3,103(2,857)3,330Net cash provided by operating activities35,31522,26911,138Cash flow from investing activities:Securities available-for-sale:Proceeds from maturities and calls80,15665,84429,488Purchases(79,888)(62,409)(50,823)Securities held to maturity:Proceeds from maturities and calls42,61333,25637,868Purchases(55,228)(31,076)(36,369)Loan originations in excess of principal collections, net(99,398)(45,135)(71,692)Purchase of premises and equipment, net(4,044)(4,428)(2,726)Calls of FHLB stock, net of purchases of FHLB and FRB stock(196)229322Investment in equity-method investments(5)(752)(37)Proceeds from sale of other real estate1,1581,144711Acquisition of WBI net of cash acquired(2,250)--Net cash used by investing activities(117,082)(43,327)(93,258)Cash flow from financing activities:Net increase in demand, savings and money market deposits163,46696,846112,881Net decrease in time deposits(90,186)(1,213)35,909Overnight borrowings, net--(4,400)Principal repayments of term borrowings(330)(9,534)(11,720)Proceeds from sale of treasury stock465433Payments to acquire treasury stock(219)(511)(360)Proceeds from issuance of treasury stock under stock option plan-310-Tax benefit from stock option exercise-232-Change in noncontrolling interest, net2,906--Dividends paid(5,405)(5,121)(4,669)Net cash provided by financing activities70,27881,063127,674Net (decrease) increase in cash and cash equivalents(11,489)60,00545,554Cash and cash equivalents - beginning of period138,22978,22432,670Cash and cash equivalents - end of period$126,740138,22978,224Supplemental disclosure of cash flow information:Interest paid$12,25115,44421,447Income taxes paid$7,3958,0294,926Supplemental schedule of noncash investing activitiesReal estate acquired in settlement of loans$1,8612,9272,864Acquisitions:Fair value of assets acquired (noncash)$10,178--Fair value of liabilities assumed$8,445--   See accompanying notes to consolidated financial statements.  31


CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009     (1) Summary of Significant Accounting Policies  Business  Canandaigua National Corporation (the Company) provides a full range of financial services, including banking, trust, investment, and insurance services to individuals, corporations, and municipalities. The Company is subject to competition from other financial services and commercial companies in various regulated and unregulated industries. The Company and its subsidiaries are subject to the regulations of certain federal and state agencies and undergo regular examinations by those regulatory authorities.  Basis of Presentation  The Consolidated Financial Statements include the accounts of the Company and its wholly- and majority-owned subsidiaries. Its principal operations comprise the activities of The Canandaigua National Bank and Trust Company (the Bank), CNB Mortgage Company (CNBM), Genesee Valley Trust Company (GVT), and WBI OBS Financial, LLC (OBS). OBS is included effective November 30, 2011, the date of its acquisition. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company accounts for investments in minority-owned entities under the equity method. The Consolidated Financial Statements have been prepared in conformity with U.S. Generally Accepted Accounting Principles and conform to predominant practices within the financial services industry.  In preparing the Consolidated Financial Statements, management made estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements; as well as the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates, particularly with respect to the allowance for loan losses and securities with other than temporary impairment.  Amounts in prior years Consolidated Financial Statements are reclassified whenever necessary to conform to the current years presentation.  Management has evaluated the impact of subsequent events on these financial statements to the date of filing of this Annual Report with the Securities and Exchange Commission.  Effective August 31, 2010, CNB Mortgage Company became a wholly-owned subsidiary of The Canandaigua National Bank and Trust Company. It was formerly a wholly-owned subsidiary of Canandaigua National Corporation. The reason for the change was to bring CNB Mortgage Company under the federal banking regulatory structure from New York States banking regulatory structure, which had become increasingly rigid and costly. There was no change in the consolidated financial results, in segment reporting, or in management of the companies.  Cash Equivalents  For the purpose of reporting cash flows, cash and cash equivalents include cash, interest-bearing and other balances due from banks, and federal funds sold.  Securities  The Company classifies its debt securities as either available for sale or held to maturity as the Company does not hold any securities considered to be trading. Held to maturity securities are those that the Company has the ability and intent to hold until maturity. Held to maturity securities are recorded at amortized cost. All other securities not included as held to maturity are classified as available for sale.  Available for sale securities are recorded at fair value. Except for unrealized losses charged to earnings for other-than-temporary-impairment deemed to be credit-related or based on intent to sell, unrealized holding gains and losses, net of the related tax effect, are excluded from earnings and are included in accumulated other comprehensive income (loss) in stockholders equity until realized.  Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation.  Consideration is given to: (1) the length of time and the extent to which the fair value has been less than cost; (2) the financial condition and near-term prospects of the issuer; and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.  A decline in fair value of any security below cost that is deemed other than temporary and related to the credit-worthiness of the issuer is charged to earnings, resulting in the establishment of a new cost basis for the security.  Management generally evaluates the credit-worthiness of the issuer based on their ability to produce sufficient cash flows to service the contractual debt obligation.   32   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   Interest income and dividends are recognized when earned. Premiums and discounts are amortized or accreted over the life of the related security as an adjustment to yield using the interest method. Realized gains and losses are included in earnings and are determined using the specific identification method.  Loans  Loans, other than loans designated as held for sale, are stated at the principal amount outstanding net of deferred origination costs. Interest and deferred fees and costs on loans are credited to income based on the effective interest method. Loans held for sale are carried at the lower of cost or fair value.  The accrual of interest on commercial and real estate loans is generally discontinued, and previously accrued interest is reversed, when the loans become 90 days delinquent or when, in managements judgment, the collection of principal and interest is uncertain. Loans are returned to accrual status when the doubt no longer exists about the loan's collectability and the borrower has demonstrated a sustained period of timely payment history. Specifically, the borrower will have resumed paying the full amount of scheduled interest and principal payments; all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within a reasonable period (6 months); and there is a sustained period of repayment performance (generally a minimum of six months) by the borrower, in accordance with the contractual terms involving payments of cash or cash equivalents.  Interest on consumer loans is accrued until the loan becomes 120 days past due at which time principal and interest are generally charged off.  Management, considering current information and events regarding the borrowers ability to repay their obligations, considers a loan to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. When a loan is considered to be impaired, and sufficient information exists to make a reasonable estimate of the inherent loss, the amount of the impairment is measured based on the present value of expected future cash flows discounted at the loans effective interest rate, or as a practical expedient, at the loans observable fair value or the fair value of underlying collateral if the loan is collateral-dependent.  In the absence of sufficient, current data to make a detailed assessment of collateral values or cash flows, management measures impairment on a pool basis using historical loss factors equivalent to similarly impaired loans. Impairment reserves are included in the allowance for loan losses through a charge to the provision for loan losses. Cash receipts on impaired loans are generally applied to reduce the principal balance outstanding. In considering loans for evaluation of specific impairment, management generally excludes smaller balance, homogeneous loans: residential mortgage loans, home equity loans, and all consumer loans, unless such loans were restructured in a troubled debt restructuring. These loans are collectively evaluated for risk of loss on a pool basis.  Allowance for Loan Losses  The allowance for loan losses is a valuation reserve for probable and inherent losses in the loan portfolio. Credit losses arise primarily from the loan portfolio, but may also be derived from other credit-related sources, when drawn upon, such as commitments, guarantees, and standby letters of credit. Additions are made to the allowance through periodic provisions, which are charged to expense. All losses of principal are charged to the allowance when incurred or when a determination is made that a loss is expected. Subsequent recoveries, if any, are credited to the allowance.  The Company has established a process to assess the adequacy of the allowance for loan losses and to identify the risks in the loan portfolio. This process consists of the identification of specific reserves for impaired commercial loans and residential mortgages, and the calculation of general reserves, which is a formula-driven allocation.  The calculation of the general reserve involves several steps. A historical loss factor is applied to each loan by loan type and loan classification. The historical loss factors are calculated using a loan-by-loan, trailing eight-quarter net loss migration analysis for commercial loans. For all other loans, a portfolio-wide, trailing eight-quarter net loss migration analysis is used. Adjustments are then made to the historical loss factors based on current-period quantitative objective elements (delinquency, non-performing assets, classified/criticized loan trends, charge-offs, concentrations of credit, recoveries, etc.) and subjective elements (economic conditions, portfolio growth rate, portfolio management, credit policy, and others). This methodology is applied to the commercial, residential mortgage, and consumer portfolios, and their related off-balance sheet exposures. Any allowance for off-balance sheet exposures is recorded in Other Liabilities.  While management uses available information to recognize losses on loans, future additions to the allowance may be necessary. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Companys allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.  Troubled Debt Restructurings  In the process of resolving nonperforming loans, we may choose to restructure the contractual terms of certain loans and attempt to work out alternative payment schedules with the borrower in order to avoid foreclosure of collateral. Any loans that are modified are evaluated to determine if they are "troubled debt restructurings (TDR) and if so, are evaluated for impairment.  A TDR is defined as a loan restructure where for legal or economic reasons related to a borrowers financial  33   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   difficulties, the creditor grants one or more concessions to the borrower that it would not otherwise consider. Terms of loan agreements may be modified to fit the ability of the borrower to repay in respect of its current financial status and restructuring of loans may include the transfer of assets from the borrower to satisfy debt, a modification of loan terms, or a combination of the two. If a satisfactory restructure and payment arrangement cannot be reached, the loan may be referred to legal counsel for foreclosure.  Premises and Equipment  Land is carried at cost. Land improvements, buildings, leasehold improvements and equipment are carried at cost, less accumulated depreciation and amortization. Depreciation is computed using straight-line and accelerated methods over the estimated useful lives of the assets, three to twenty-five years. Amortization of leasehold improvements is provided over the lesser of the term of the lease, including renewal options, when applicable, or the estimated useful lives of the assets.  Other Real Estate  Real estate acquired through foreclosure or deed in lieu of foreclosure (other real estate) is included in other assets and is recorded at the lower of the unpaid loan balance on the property at the date of transfer, or fair value, less estimated costs to sell. Adjustments made to the value at transfer are charged to the allowance for loan losses. After transfer, the property is carried at the lower of cost or fair value less estimated costs to sell. Adjustments to the carrying values of such properties that result from subsequent declines in value are charged to operations in the period in which the declines occur. Operating earnings and costs associated with the properties are charged to other operating income and expense as incurred. Gains on the sale of other real estate are included in results of operations when the sale occurs.  Loan Servicing Assets  The Company services first-lien, residential loans for the Federal Home Loan Mortgage Company (FHLMC), also known as Freddie Mac, and certain commercial loans as lead participant.  The associated servicing rights (assets) entitle the Company to a future stream of cash flows based on the outstanding principal balance of the loans and contractual servicing fees.  Failure to service the loans in accordance with contractual requirements may lead to a termination of the servicing rights and the loss of future servicing fees.  The Company services all loans for FHLMC on a non-recourse basis; therefore, its credit risk is limited to temporary advances of funds to FHLMC, while FHLMC retains all credit risk associated with the loans.  Commercial loans are serviced on a non- recourse basis, whereby the Company is subject to credit losses only to the extent of the proportionate share of the loans principal balance owned. The Companys contract to sell loans to FHLMC and to the Federal Housing Administration (FHA) via third-parties contain certain representations and warranties that if not met by the Company would require the repurchase of such loans. The Company has not historically been subject to a material volume of repurchases nor is it as of the current year end.  Loan servicing assets are amortized to loan servicing income in the statement of income.  In computing amortization expense, the Company uses historical prepayment rates for similar loan pools and applies this amortization rate to each pool. If prepayments occur at a rate different than the applied rate, the Company adjusts the specific pools amortization in the period in which the change occurs.  For purposes of evaluating and measuring impairment of loan servicing rights, the Company stratifies these assets based on predominant risk characteristics of the underlying loans that are expected to have the most impact on projected prepayments, cost of servicing, and other factors affecting future cash flows associated with the servicing rights, such as loan type, rate, and term. The amount of impairment recognized is the amount by which the carrying value of the loan servicing rights for a stratum exceeds fair value. Impairment is recognized through the income statement.  Goodwill and Intangible Assets  Goodwill has an indefinite useful life and is not amortized, but is tested for impairment. Goodwill impairment tests are performed on an annual basis or when events or circumstances dictate. In these tests, the fair value of the reporting unit with goodwill is compared to the carrying amount of that reporting unit in order to determine if impairment is indicated. If so, the implied fair value of the reporting units goodwill is compared to its carrying amount and an impairment loss is measured by the excess of the carrying value over fair value.  Fair value of goodwill is estimated using a weighted average of market-based analysis and discounted cash-flow income analysis of the underlying reporting unit.  Intangible assets that have finite useful lives, such as customer relationship and trade name intangibles, are amortized over their useful lives. Customer relationship intangibles are generally amortized over 15 years using an accelerated method. Trade name intangible has been amortized on a straight-line basis over three years.  Amortization of these assets is reported in other operating expenses.  The amortization period is monitored to determine if circumstances require the period to be revised. The Company also periodically reviews its intangible assets for changes in circumstances that may indicate that the carrying amount of the assets are impaired. The Company tests its intangible assets for impairment if conditions indicate that an  34   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   impairment loss has more likely than not been incurred by evaluating the recoverability of the assets carrying value using estimates of undiscounted future cash flows over the remaining assets lives. Any impairment loss is measured by the excess of carrying value over fair value and is recorded in the measured period as additional amortization expense.  Stock-Based Compensation  Stock-based compensation expense is recognized in the statement of income over the awards vesting period based on the fair value of the award at the grant date.  The Company accounts for the liability associated with its stock appreciation rights plan at fair value which is re-measured each quarterly reporting period.  Fair value is measured using the Black-Scholes-Merton option pricing model.  The associated compensation expense or credit reported in the statement of income represents the change in the re-measured liability.  Income Taxes  The Company and its subsidiaries file income tax returns in the U.S. Federal jurisdiction and the states of New York and Florida. Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in the period that includes the enactment date.  The Company recognizes interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense.  Derivative Financial Instruments  Derivatives are recognized as either assets or liabilities in the balance sheet and are measured at fair value. If certain conditions are met, a derivative may be specifically designated as: (a) a hedge of the exposure to changes in the fair value of a recognized asset or liability or an unrecognized firm commitment; (b) a hedge of the exposure to variable cash flows of a forecasted transaction; or (c) a hedge of the foreign currency exposure of a net investment in a foreign operation, an unrecognized firm commitment, an available for sale security, or a foreign currency denominated forecasted transaction. The accounting for changes in the fair value of a derivative depends on the intended use of the derivative and the resulting designation. At inception of the hedge, management establishes the application of hedge accounting and the method it will use for assessing the effectiveness of the hedging derivative and the measurement approach for determining the ineffective aspect of the hedge. These are consistent with managements approach to managing risk.  The Companys derivative financial instruments include: (1) commitments to originate fixed-rate residential real estate loans to be held for sale; (2) commitments to sell fixed-rate residential loans; and (3) interest rate swap agreements.  Commitments to originate and commitments to sell fixed-rate residential real estate loans are recorded in the consolidated balance sheet at estimated fair value. Neither of these derivatives instruments is considered a hedge; therefore, periodic changes in the fair value of these instruments are recognized in mortgage banking income in the period in which the change occurs. However, due to the minimal volume and short-term nature of these instruments, the net impact of a change in fair value from the instruments initially recognized fair value is generally immaterial.  The Company utilizes interest rate swap agreements as part of its management of interest rate risk to modify the repricing characteristics of its floating-rate junior subordinated debentures. For swap agreements, amounts receivable or payable are recognized as accrued under the terms of the agreement, and the net differential is recorded as an adjustment to interest   expense of the related debentures. Interest rate swap agreements are designated as cash flow hedges. Therefore, the effective portion of the swaps unrealized gain or loss was initially recorded as a component of other comprehensive income, and subsequent effective portions are recognized in interest expense. The ineffective portion of the unrealized gain or loss, if any, is reported in other operating income.   Common and Preferred Stock and Stock Split  At a special meeting of the Companys shareholders held on September 14, 2011, the Companys shareholders approved (a) a 4-for-1 forward stock split of the Companys common stock (the Stock Split) and (b) a corresponding amendment to the Companys Certificate of Incorporation that would affect the stock split by increasing the Companys total number of authorized shares from 8,000,000 to 20,000,000 shares, increasing the authorized number of shares of common stock from 4,000,000 to 16,000,000 shares, including changing the par value per share from $20.00 to $5.00, and implementing the Stock Split. The amendment to the Companys Certificate of Incorporation effecting the Stock Split was filed with New York State on September 20, 2011.  All share data has been adjusted retroactively to reflect this stock split.   35   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   At the Companys April 2011 Annual Meeting, shareholders authorized a class of 4,000,000 shares of preferred stock, $.01 par value.  No shares of preferred stock have been issued.  Accumulated Other Comprehensive Income  The Companys comprehensive income consists of net income, changes in the net unrealized holding gains and losses of securities available for sale, and the unrealized gain or loss on the effective portion of cash flow hedges. Accumulated other comprehensive income (loss) on the consolidated statements of stockholders equity is presented net of taxes.  Treasury Stock  Treasury stock is carried on the consolidated balance sheet at cost as a reduction of stockholders equity. Shares are released from treasury at original cost on a first-in, first-out basis, with any gain on the sale reflected as an adjustment to additional paid-in capital. Losses are reflected as an adjustment to additional paid-in capital to the extent of gains previously recognized, otherwise as an adjustment to retained earnings.  Trust and Investment Services Income  Assets held in fiduciary or agency capacity for clients are not included in the accompanying consolidated balance sheets, since such assets are not assets of the Company. Fees are calculated based upon the market value of the underlying assets. Fee income is recognized when earned, and is not subject to return-performance contingencies.  Earnings Per Share  Basic earnings per share is calculated by dividing net income available to common shareholders by the weighted average number of shares outstanding during the year. Diluted earnings per share includes the maximum dilutive effect of stock issuable upon exercise of stock options.  New Accounting Standards  The following Accounting Standards Updates (ASU) were implemented in 2011 with no material impact to our financial condition or results of operations. In some instances, expanded disclosures were required:  ASU 2010-28,IntangiblesGoodwill and Other (Topic 350): When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts (a consensus of the FASB Emerging Issues Task Force). ASU 2010-28 modifies Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. In determining whether it is more likely than not that a goodwill impairment exists, an entity should consider whether there are any adverse qualitative factors. The qualitative factors are consistent with the existing guidance and examples in paragraph 350-20-35-30, which requires that goodwill of a reporting unit be tested for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.  ASU 2010-29, Business Combinations (Topic 805): Disclosure of Supplementary Pro Forma Information for Business Combinations (a consensus of the FASB Emerging Issues Task Force). ASU201-29 specifies that if a public entity presents comparative financial statements, the entity (acquirer) should disclose revenue and earnings of the combined entity as though the business combination(s) that occurred during the current year had occurred as of the beginning of the comparable prior annual reporting period only. It also expands the supplemental pro forma disclosures under Topic 805 to include a description of the nature and amount of material, nonrecurring pro forma adjustments directly attributable to the business combination included in the reported pro forma revenue and earnings.  ASU 2011-02.A Creditors Determination of Whether a Restructuring Is a Troubled Debt Restructuring, issued April, 2011.  The amendments in this Update clarify the guidance on a creditors evaluation of whether it has granted a concession. In evaluating whether a restructuring constitutes a troubled debt restructuring, a creditor must separately conclude that both of the following exist: (1) the restructuring constitutes a concession; and (2) the debtor is experiencing financial difficulties. The amendments in this Update were effective beginning with the third quarter of 2011, and were to be applied retrospectively to the beginning of 2011. In general, the Company does not renegotiate nor does it materially modify loans to non-troubled borrowers.  Loans to troubled borrowers are typically placed in non-accrual status in advance of any consideration of renegotiation, and in only rare instances will the Company renegotiate a loan that results in a material concession to the borrower.  36   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (2) Acquisitions of Trust and Investment Companies and Trust and Investment Management Accounts  On November 30, 2011, the Company acquired a majority interest in WBI OBS Financial, LLC (WBI), a company formed to concurrently acquire OBS Holdings, Inc. (OBS).  OBS, an Ohio-based company, provides investment sub-advisory services to the Bank and several other financial institutions, primarily community banks and credit unions, and has approximately $900 million in managed assets. Under the terms of WBIs acquisition, it will pay the seller a total of $7 million, consisting of a $2.5 million payment on May 31, 2012, a $3.5 million payment on May 31, 2014, and $1 million cumulative quarterly non-maturity payments contingent upon net revenue improvements at OBS, all of which is included in Accrued interest Payable and Other Liabilities at December 31, 2011.  Under the terms of the Companys purchase of WBI, in exchange for a 65% ownership interest, the Company paid WBI $2.3 million on November 30, 2011, and will pay an additional $0.3 million in November 2012.  Additionally, the company will fund the $2.5 million payment due May 31, 2012.  The remaining payment obligations of WBI will be shared pro-rata with other WBI investors. WBI investors have agreed to allocate up to 15% of the ownership structure to employees of OBS, subject to certain conditions.  As of December 31, 2011, no interests have been allocated.  The results of WBIs consolidated operations are included in our Consolidated Statements of Income from the date of acquisition.  Since acquisition, WBI reported an approximate $1.1 million loss, which was a result of merger-related legal and advisory expenses. As of December 31, 2011, the Company had not completed its comprehensive analysis of the fair value of assets acquired and liabilities assumed.  The Company expects to complete this analysis in 2012.  As of December 31, 2011, the Companys estimates, as recorded in the financial statements, follow (dollars in thousands):  Consideration paid:Cash paid and to be paid to WBI$2,500Cash to be paid by WBI7,000Fair value of non-contolling interest1,750Total consideration$11,250Estimated recognized amounts of identifiable assets acquired:Cash and equivalents$2,525Premises and equipment61Other assets7,867Customer list intangible2,250Due to seller(7,000)Accrued expenses(545)Deferred tax liability(900)Total identifiable net assets4,258Goodwill:$6,992  We preliminarily estimated the customer list intangible by using a market multiple of revenues. This estimate is subject to revision when the Company finalizes its fair valuation in 2012.  Actual consolidated financial information since the date of acquisition is included in the Segment footnote.  The following table presents consolidated, unaudited pro-forma information as if the acquisition had occurred on January 1, 2010. The proforma information does not necessarily reflect the results of operations that would have occurred had the Company completed the acquisition at the beginning of 2010, since the results do not include possible cost savings, revenue improvements, or other investments that a new owner might have made.  Unaudited Pro-forma year end information20112010Net interest income after provision for loan loss$57,69854,991Other income31,17928,316Intangible amortization expense(2,167)(1,756)Merger-related expenses-(1,122)All other expenses(70,316)(65,633)Non-controlling interest360608Net income attributable to CNC$16,75415,404Pro-forma earnings per shareBasic$8.878.16Diluted$8.718.03  37   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    On September 29, 2006, the Bank acquired investment management accounts from another bank and assumed the successor trustee role for personal trusts. The market value of the underlying assets was approximately $66.6 million and was added to existing assets under administration.  In connection with the acquisition, the Company recorded, at cost, a customer list intangible asset of approximately $1.4 million. The asset is being amortized on an accelerated basis over fifteen years. As a result of the Companys annual fair value estimation in 2011, an additional $50,000 amortization expense over expected amortization was recorded to reflect customer account attrition in excess of original estimates.  On January 2, 2008, the Company completed its acquisition of 100% of the voting shares of Genesee Valley Trust Company (GVT), a Rochester-based New York State chartered trust company.  The acquisition of GVT provided the Company with additional trust and investment services income.  The total cash purchase price approximated $18.8 million. A payment of $13.1 million was made at closing, and subsequent payments of $4.1 million, $1.3 million, and $0.3 million were made each January 2009, 2010, and 2011, respectively. The acquisition resulted in the recording of certain intangible assets (customer list: $6.9 million; trade name: $0.1 million) and goodwill, all of which totaled $8.8 million and substantially all of which will be deductible for income tax purposes.  In addition, a non-interest bearing note payable totaling $5.5 million was recorded along with a discount on the note of $0.5 million.  The customer list intangible is being amortized on an accelerated basis over fifteen years, the trade name was amortized over three years.  The note discount was amortized over three years to interest expense. As a result of the Companys annual fair value estimation in 2011, an additional $250,000 amortization expense over expected amortization was recorded to reflect customer account attrition in excess of original estimates.  On December 31, 2008, the Bank acquired from an investment management company, investment management accounts and assumed the successor trustee role for personal trusts. The market value of the underlying assets was approximately $42.6 million and was added to existing assets under administration.  An initial payment of $0.3 million was made at closing with subsequent payments of $0.2 million in December 2009 and $0.2 million in December 2010. The acquisition resulted in the recording of a customer list intangible asset of $0.7 million, substantially all of which will be deductible for income tax purposes.  The Company also recorded a non-interest bearing note totaling $0.3 million, which was paid as of December 31, 2010. The intangible asset is being amortized on an accelerated basis over fifteen years.  Acquisition-related identifiable intangible assets were comprised of the following at December 31, (in thousands):  20112010Gross carrying amountsCustomer list intangible from 2006$1,4201,420Customer list intangible from GVT6,8706,870Trade name from GVT100100Customer list intangible from investment company665665Estimated customer list intangible from OBS2,250-Total11,3059,055Less accumulated amortization(4,518)(3,331)Intangible asset  net$6,7875,724  Amortization expense amounted to $1,187,000, $995,000, and $1,063,000 for the years ended December 31, 2011, 2010, and 2009, respectively. Amortization expense, exclusive of amortization that may result from the WBI acquisition, is projected over the next five years as follows: 2012: $812,000, 2013: $739,000; 2014: $663,000; 2015: $589,000 and 2016: $513,000.  38   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (3) Securities  Information about the securities portfolios follows (in thousands):  December 31, 2011Gross UnrealizedAmortizedFairCostGainsLossesValueSecurities Available for Sale:U.S. Treasury$502--502U.S. government sponsored enterprise obligations55,766377(18)56,125State and municipal obligations53,5311,917(23)55,425Corporate obligations(1)1,0932(296)799Equity securities1,295112-1,407Total Securities Available for Sale$112,1872,408(337)114,258(1)Amortized cost includes cumulative $360,000 write-down for other-than-temporary impairment.  Securities Held to Maturity:U.S. government sponsored enterprise obligations$1,0071-1,008State and municipal obligations165,3485,113(135)170,326Corporate obligations870313-1,183Total Securities Held to Maturity$167,2255,427(135)172,517  December 31, 2010Gross UnrealizedAmortizedFairCostGainsLossesValueSecurities Available for Sale:U.S. Treasury$503--503U.S. government sponsored enterprise obligations43,669203(663)43,209State and municipal obligations66,0041,988(34)67,958Corporate obligations(1)1,191-(233)958Equity securities1,29374-1,367Total securities Available for Sale$112,6602,265(930)113,995(1)Amortized cost includes cumulative write-downs of $860,000 prior to 2010 for other-than-temporary impairment.  Securities Held to Maturity:U.S. government sponsored agencies obligations$7,00533-7,038State and municipal obligations147,9654,400(324)152,041Corporate obligations911414(3)1,322Total securities Held to Maturity$155,8814,847(327)160,401  39   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    (3) Securities(continued)  The amortized cost and fair value of debt securities by years to maturity as of December 31,  2011, follow (in thousands). Maturities of amortizing securities are classified in accordance with their contractual repayment schedules. Expected maturities will differ from contracted maturities since issuers may have the right to call or prepay obligations without penalties.  Available for SaleHeld to MaturityAmortizedAmortizedCost(1)Fair ValueCostFair ValueYearsUnder 1$18,97719,18031,10731,4671 to 536,87238,480119,175123,2645 to 1052,04552,34816,05516,58310 and over2,9982,8438881,203Total$110,892112,851167,225172,517(1)Amortized cost includes a cumulative $360,000 write-down for other-than-temporary impairment.  At December 31, 2011, and 2010, securities at amortized cost of $209.8 million and $185.3 million, respectively, were pledged to secure municipal deposits and for other purposes required or permitted by law.  During 2011, the Company sold $0.1 million of corporate obligations at a minor loss. There were no securities sales in 2010 or 2009.  Interest on securities segregated between taxable interest and tax-exempt interest for the years ended December 31, 2011, 2010, and 2009, follows (in thousands):  201120102009Taxable$1,5051,5471,286Tax-exempt6,4317,1057,607Total$7,9368,6528,893  The following table presents the fair value of securities with gross unrealized losses at December 31,  2011, aggregated by category and length of time that individual securities have been in a continuous loss position (in thousands).


|                               |                                                  |                                       |       |       |                |    |            |       |     |       |        |     |            |       |       |       |        |     |           
|------------------------------ | ------------------------------------------------ | ------------------------------------- | ----- | ----- | -------------- | -- | ---------- | ----- | --- | ----- | ------ | --- | ---------- | ----- | ----- | ----- | ------ | --- | ----------
|                               |                                                  | Less than 12 months                   |       |       | Over 12 months |    |            | Total
|                               |                                                  |                                       |       | Fair  |                |    | Unrealized |       |     | Fair  |        |     | Unrealized |       |       | Fair  |        |     | Unrealized
|Securities Available for Sale: |                                                  | Value                                 |       |       | Losses         |    |            | Value |     |       | Losses |     |            | Value |       |       | Losses
|                               | U.S. government sponsored enterprise obligations | $                                     | 7,610 |       |                | 18 |            |       | -   |       |        | -   |            |       | 7,610 |       |        | 18 
|                               | State and municipal obligations                  |                                       | 355   |       |                | 3  |            |       | 996 |       |        | 20  |            |       | 1,351 |       |        | 23 
|                               | Corporate obligations                            |                                       | -     |       |                | -  |            |       | 759 |       |        | 296 |            |       | 759   |       |        | 296
|                               |                                                  |                                       |       |       |                |    |            |       |     |       |        |     |            |       |       |       |        |     |           
|                               |                                                  | Total temporarily impaired securities | $     | 7,965 |                |    | 21         |       |     | 1,755 |        |     | 316        |       |       | 9,720 |        |     | 337       
|                               |                                                  |                                       |       |       |                |    |            |       |     |       |        |     |            |       |       |       |        |     |           




|                             |                                 |                                       |       |       |  |    |    |  |       |       |  |    |    |  |        |        |  |     |    
|---------------------------- | ------------------------------- | ------------------------------------- | ----- | ----- |  | -- | -- |  | ----- | ----- |  | -- | -- |  | ------ | ------ |  | --- | ---
|                             |                                 |                                       |       |       |  |    |    |  |       |       |  |    |    |  |        |        |  |     |    
|Securities Held to Maturity: |                                 |                                       |       |       |  |    |    |  |       |       |  |    |    |  |        |        | 
|                             | State and municipal obligations | $                                     | 7,886 |       |  | 80 |    |  | 4,647 |       |  | 55 |    |  | 12,533 |        |  | 135
|                             |                                 |                                       |       |       |  |    |    |  |       |       |  |    |    |  |        |        |  |     |    
|                             |                                 | Total temporarily impaired securities | $     | 7,886 |  |    | 80 |  |       | 4,647 |  |    | 55 |  |        | 12,533 |  |     | 135

Substantially all of the unrealized losses on the Company's securities were caused by market interest rate changes from those in effect when the specific securities were purchased by the Company. The contractual terms of these securities do not permit the issuer to settle the securities at a price less than par value. Except for certain corporate obligations, all securities rated by an independent rating agency carry an investment grade rating. Because the Company does not intend to sell the securities and it believes it is not likely to be required to sell the securities before recovery of their amortized cost basis, which may be,  40   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   and is likely to be, maturity, the Company does not consider these securities to be other-than-temporarily impaired at December 31,  2011, except as discussed below.  In the available-for-sale portfolio, the Company holds approximately $0.8 million of bank trust-preferred securities with an adjusted cost basis of $1.1 million.  These securities are backed by debt obligations of banks, with approximately $0.7 million of the securities backed by two of the largest U.S. banks and $0.1 million backed by a pool of banks debt in the form of a collateralized debt obligation (CDO). As a result of market upheaval, a lack of regular trading market in these securities, and bank failures, the fair value of these securities had fallen sharply in 2008 and continued to fall in the first half of 2009.  The Company recognized cumulative other-than-temporary-impairment (OTTI) amounting to $0.9 million on one CDO over several years. Management sold a portion of this security in 2011 and intends to sell the remainder in whole or in part over time. If the financial condition of the underlying banks deteriorates, further write-downs could occur before a sale, which would be reflected in the statement of operations. The maximum potential write-down would be its current carrying value of less than $0.1 million.  The following table presents the fair value of securities with gross unrealized losses at December 31, 2010, aggregated by category and length of time that individual securities have been in a continuous loss position (in thousands).


|                               |                                                  |                                       |        |                     |        |            |                |       |       |       |        |            |     |       |        |        |        |            |    
|------------------------------ | ------------------------------------------------ | ------------------------------------- | ------ | ------------------- | ------ | ---------- | -------------- | ----- | ----- | ----- | ------ | ---------- | --- | ----- | ------ | ------ | ------ | ---------- | ---
|                               |                                                  |                                       |        |                     |        |            |                |       |       |       |        |            |     |       |        |        |        |            |    
|                               |                                                  |                                       |        | Less than 12 months |        |            | Over 12 months |       |       | Total
|                               |                                                  |                                       | Fair   |                     |        | Unrealized |                |       | Fair  |       |        | Unrealized |     |       | Fair   |        |        | Unrealized
|Securities Available for Sale: |                                                  | Value                                 |        |                     | Losses |            |                | Value |       |       | Losses |            |     | Value |        |        | Losses
|                               | U.S. government sponsored enterprise obligations | $                                     | 27,565 |                     |        | 663        |                |       | -     |       |        | -          |     |       | 27,565 |        |        | 663       
|                               | State and municipal obligations                  |                                       | 1,066  |                     |        | 21         |                |       | 1,352 |       |        | 13         |     |       | 2,418  |        |        | 34        
|                               | Corporate obligations                            |                                       | -      |                     |        | -          |                |       | 778   |       |        | 233        |     |       | 778    |        |        | 233       
|                               |                                                  |                                       |        |                     |        |            |                |       |       |       |        |            |     |       |        |        |        |            |    
|                               |                                                  | Total temporarily impaired securities | $      | 28,631              |        |            | 684            |       |       | 2,130 |        |            | 246 |       |        | 30,761 |        |            | 930
|                               |                                                  |                                       |        |                     |        |            |                |       |       |       |        |            |     |       |        |        |        |            |    
|                               |                                                  |                                       |        |                     |        |            |                |       |       |       |        |            |     |       |        |        |        |            |    
|Securities Held to Maturity:   |                                                  |                                       |        |                     |        |            |                |       |       |       |        |            |     |       |        |        |       
|                               | State and municipal obligations                  | $                                     | 11,950 |                     |        | 276        |                |       | 4,777 |       |        | 48         |     |       | 16,727 |        |        | 324       
|                               | Corporate obligations                            |                                       | 151    |                     |        | 3          |                |       | -     |       |        | -          |     |       | 151    |        |        | 3         
|                               |                                                  |                                       |        |                     |        |            |                |       |       |       |        |            |     |       |        |        |        |            |    
|                               |                                                  | Total temporarily impaired securities | $      | 12,101              |        |            | 279            |       |       | 4,777 |        |            | 48  |       |        | 16,878 |        |            | 327
|                               |                                                  |                                       |        |                     |        |            |                |       |       |       |        |            |     |       |        |        |        |            |    

The aggregate cost of the Company's cost-method investments totaled $4.5 million and $4.3 million at December 31, 2011, and 2010, respectively, of which $2.7 million and $2.5 million, respectively, were in Federal Home Loan Bank stock and Federal Reserve Bank stock, as required by law.  (4) Loans and Allowance for Loan Losses  Loans  The Company's market area is generally Ontario County and Monroe County of New York State. Substantially all loans are made in its market area. Accordingly, the ultimate collectability of a substantial portion of the Company's loan portfolio is susceptible to changes in the economic conditions in this area. The Company's concentrations of credit risk are as disclosed in the following table of loan classifications. The concentrations of credit risk in related loan commitments and letters of credit parallel the loan classifications reflected. Other than general economic risks, management is not aware of any material concentrations of credit risk to any industry or individual borrower.  41   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    The major loan classifications of loans at December 31, 2011 and December 31, 2010, follow (in thousands), along with a description of their underwriting and risk characteristics:  20112010Commercial and industrial$198,744212,707Mortgages:Commercial467,413434,787Residential  - first lien256,173232,953Residential  - second lien101,87796,416Consumer:Automobile - indirect227,541181,481Other25,58326,437Loans held for sale7,55614,113Total loans1,284,8871,198,894Plus - Net deferred loan costs7,6345,962Less - Allowance for loan losses(16,095)(15,635)Loans - net$1,276,4261,189,221  Commercial and Industrial Loans: These loans generally include term loans and lines of credit.  Such loans are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisition of real estate, expansion and improvements) and equipment purchases. As a general practice, a collateral lien is placed on equipment or other assets owned by the borrower.  These loans carry a higher risk than commercial real estate loans by the nature of the underlying collateral, which can be business assets such as equipment and accounts receivable. To reduce the risk, management also attempts to secure secondary collateral, such as real estate, and obtain personal guarantees of the borrowers.  To further reduce risk and enhance liquidity, these loans generally carry variable rates of interest, repricing in three- to five-year periods, and have a maturity of five years or less. Lines of credit generally have terms of one year or less and carry floating rates of interest (e.g., prime plus a margin).  Commercial Mortgages: Commercial real estate loans are made to finance the purchases of real property which generally consists of real estate with completed structures. These commercial real estate loans are secured by first liens on the real estate, which may include apartments, commercial structures housing businesses, healthcare facilities, and other non-owner occupied facilities.  These loans are considered by the Company to be less risky than commercial and industrial loans, since they are secured by real estate and buildings. The loans typically have adjustable interest rates, repricing in three- to five-year periods, and require principal payments over a 10- to 25-year period.  Many of these loans include call provisions within 10 to 15 years of their origination. The Companys underwriting analysis includes credit verification, independent appraisals, a review of the borrower's financial condition, and the underlying cash flows. These loans are typically originated in amounts of no more than 80% of the appraised value of the property serving as collateral.  Residential First-Lien Mortgages: We originate adjustable-rate and fixed-rate, one-to-four-family residential real estate loans for the construction, purchase or refinancing of a mortgage.  These loans are collateralized by owner-occupied properties located in the Companys market area. They are amortized over five to 30 years. Substantially all residential loans secured by first mortgage liens are originated by CNB Mortgage and sold to either the Bank or third-party investors.  Generally, fixed-rate mortgage loans with a maturity or call date of ten years or less and a rate of 5% or more are retained in the Companys portfolio.  For longer term, fixed-rate residential mortgages without escrow, the Company generally retains the servicing, but sells the right to receive principal and interest to Federal Home Loan Mortgage Company, also known as Freddie Mac.  All loans not retained in the portfolio or sold to Freddie Mac are sold to unrelated third parties with servicing released.  This practice allows the Company to manage interest rate risk, liquidity risk, and credit risk.  From time to time, the Company may also purchase residential mortgage loans which are originated and serviced by third parties. In an effort to manage risk of loss and strengthen secondary market liquidity opportunities, management typically uses secondary market underwriting, appraisal, and servicing guidelines.  Loans on one-to-four-family residential real estate are mostly originated in amounts of no more than 85% of appraised value or have private mortgage insurance. Mortgage title insurance and hazard insurance are normally required. Construction loans have a unique risk, because they are secured by an incomplete dwelling. This risk is reduced through periodic site inspections, including at each loan draw period.  Residential Second-Lien Mortgages: The Company originates home equity lines of credit and second mortgage loans (loans secured by a second [junior] lien position on one-to-four-family residential real estate).  These loans carry a higher risk than first mortgage residential loans as they are in a second position relating to collateral.  Risk is reduced through underwriting criteria, which include credit verification, appraisals, a review of the borrower's financial condition, and personal cash flows.  A security interest, with title insurance when necessary, is taken in the underlying real estate.  Consumer Loans:  The Company funds a variety of consumer loans, including direct and indirect automobile loans, recreational vehicle loans, boat loans, aircraft loans, home improvement loans, and personal loans (collateralized and  42   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   uncollateralized). Most of these loans carry a fixed rate of interest with principal repayment terms typically ranging from one to ten years, based upon the nature of the collateral and the size of the loan. The majority of consumer loans are underwritten on a secured basis using the underlying collateral being financed or a customer's deposit account. A small amount of loans are unsecured, which carry a higher risk of loss.  Loans Held for Sale:  These are the Residential First-Lien Mortgages, discussed above, which are sold to Freddie Mac and other third parties. These loans are carried at their lower of cost or fair value, calculated on a loan-by-loan basis.  Commercial loan participations amounted to $114,969,000 and $116,111,000 at December 31, 2011 and 2010, respectively.  Residential mortgage loans serviced for FHLMC, amounted to $461,950,000 and $435,220,000 at December 31, 2011 and 2010, respectively.  None of these loans are included in the Consolidated Financial Statements or the tables within this Note.  Certain executive officers, directors and their business interests are customers of the Company. Transactions with these parties are based on substantially the same terms as similar transactions with unrelated third parties and do not carry more than normal credit risk. Borrowings by these related parties amounted to $5,366,000 and $6,324,000 at December 31, 2011, and 2010, respectively. During 2011, new borrowings amounted to $830,000 (including borrowings of executive officers and directors that were outstanding at the time of their election), and repayments and other reductions were $1,788,000. Additionally, the Bank has issued two letters of credit totaling $6,000,000 to the Companys majority-owned subsidiary in connection with its acquisition of OBS in 2011.   Allowance for Loan Losses  A summary of the changes in the allowance for loan losses follows (in thousands).  Years Ended December 31,201120102009Balance at the beginning of year$15,63514,23211,992Loans charged off(4,563)(5,998)(2,964)Recoveries of loans charged off1,2481,251859Provision charged to operations3,7756,1504,345Balance at end of year$16,09515,63514,232  The following table presents an analysis of the allowance for loan losses by loan type, including a summary of the loan types individually and collectively evaluated for impairment as of December 31, 2011 and 2010 (in thousands). Notwithstanding the estimated allocations set forth in any table, the entirety of the allowance is available to absorb losses in any portfolio. Loan balances included in the Unallocated column represent the balance of net deferred loan costs.  December 31, 2011ResidentialResidentialmortgage  -mortgage  -LoansCommercialCommercialfirstsecondConsumer -Consumer -held forand industrialmortgagepositionpositionindirectothersaleUnallocatedTotalBeginning Balance$6,3641,3711,3045634,1961,155-68215,635Charge-offs(2,082)(263)(324)(31)(1,345)(518)--(4,563)Recoveries153-1429700244--1,248Provision1,958(114)664(20)1,28835-(36)3,775Ending Balance$6,3939941,7865214,839916-64616,095of which:Amount for loans individuallyevaluated for impairment$895243------1,138Amount for loans collectivelyevaluated for impairment$5,4987511,7865214,839916-64614,957Balance of loans individuallyevaluated for impairment$3,8289,078-31----12,937Balance of loans collectivelyevaluated for impairment$194,916458,335256,173101,846227,54125,5837,5567,6341,279,584  43   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    December 31, 2010ResidentialResidentialmortgage  -mortgage  -LoansCommercialCommercialfirstsecondConsumer -Consumer -held forand industrialmortgagepositionpositionindirectothersaleUnallocatedTotalBeginning Balance$6,1341,4029774253,3301,169-79514,232Charge-offs(2,957)(678)(263)(23)(1,521)(556)--(5,998)Recoveries24347437714197--1,251Provision2,9446005471541,673345-(113)6,150Ending Balance$6,3641,3711,3045634,1961,155-68215,635of which:Amount for loans individuallyevaluated for impairment$4495112450----674Amount for loans collectivelyevaluated for impairment$5,9151,3201,1805134,1961,155-68214,961Balance of loans individuallyevaluated for impairment$4,48211,0312,905718-200--19,336Balance of loans collectivelyevaluated for impairment$208,225423,756230,04895,698181,48126,23714,1135,9621,185,520  The balance in the allowance for loan losses decreased to 1.25% of the loan portfolio at December 31, 2011 from 1.30% of the loan portfolio at December 31, 2010. This decrease was principally due to the lower level of net losses incurred in 2011. The reduced losses resulted in lower reserve base loss factors being applied to the various loan pools. The most significant allocation reduction as a result of these lower reserve loss factors was a reduction of approximately $1.9 million for the commercial loans. Offsetting some of the reduced level of reserve for the commercial loan portfolio, were increases to the consumer and  residential mortgage pools resulting from significant loan growth and higher base loss factors.  The base allocation for these consumer pools increased by $0.4 million driven by a slightly higher base loss factor.   The residential mortgage base allocation increased by $0.1 million due to growth in the portfolio and a higher base loss factor. In addition, there was a general increase in subjective factor upward adjustments applied to these pools as a result of recent credit analyses.  Finally, due to improving economic conditions in our market (lower unemployment, increased auto sales, increased home sales, stable median home price, and improving consumer confidence in the Rochester market from last year), a 12 basis point economic factor adjustment was applied to the majority of the portfolio pools.  This reduced the reserve requirement for the portfolio by approximately $0.3 million.  In monitoring the credit quality of the portfolio, management applies a credit quality indicator to substantially all commercial loans. These quality indicators range from one through eight in increasing risk of loss. These ratings are used as inputs to the calculation of the allowance for loan losses. Loans rated 1 through 4 are generally allocated a lesser percentage allocation in the allowance for loan losses than loans rated from 5 through 8. Residential Mortgage Loans are generally rated 9, unless they are used to partially collateralize commercial loans, in which case they carry the rating of the respective commercial loan relationship, or if management wishes to recognize a well defined weakness or loss potential to more accurately reflect credit risk. Unrated loans are allocated a percentage of the allowance for loan losses on a pooled-basis.  Loans rated 1 include borrowers whose financial condition, liquidity, capitalization, earnings, cash flow, management and capacity to repay are strong.  If deficient in any of these areas, a borrower may still be considered for a 1 rating, if fully secured by cash, or properly margined, listed stock, investment grade corporate bonds or U.S. Government Securities, (125% collateral value to loan commitment).  A loan rated 2 would include borrowers who are somewhat more of a credit risk than a 1 rated borrower and therefore require more frequent monitoring.  Those borrowers would have the following qualities: cash flow has been and is expected to be adequate to meet debt service requirements; financial statement is current, of good quality and in adequate detail; financial condition of company compares favorably with the industry averages; earnings are generally stable; borrower consistently adheres to repayment schedule for both principal and interest and covenants; management integrity and ability is considered sound; and industry outlook is acceptable.  Loans rated 3include credits whose performance is generally stable.  Also included in this category are credits where the guarantor is sufficiently strong to support operating losses and has demonstrated a willingness to do so. Additionally, loans risk rated 3 may include the following qualities: borrowers business is tied to more economically sensitive industries; borrower may have violated one or more financial covenants; occasional requirements for waivers, or amendments may occur, however liquidity and capitalization are expected to continue to be acceptable; integrity of management is acceptable but ability remains to be proven; borrower may not compare well to industry standards; relationship requires a high level of monitoring due to its complexity.  Also, financial data of affiliates may not be available or difficult to track; borrower may not provide sufficient documentation for confirming all taxable income/losses but consistently adheres to repayment schedules for both principal and interest.  Also, borrower may report a high level of contingent liabilities.   44   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   Loans rated 4 would include credits which demonstrate any or all of the following criteria: borrowers or guarantors financial performance shows negative trends and yet cash flow remains still adequate to repay debt; loans which continue to pay as agreed but the Bank has not received current financial statements to confirm repayment ability and to enable management to complete a timely annual review; commercial construction loans where the LTV is over 75%; loan has been processed through automated underwriting and does not meet managements scoring threshold; loans to start-up companies until the borrowers have achieved stabilized operations (i.e., 1-3 years); and loans recommended for upgrade from problem loan status (5 through 8) would generally pass through the watch category for 6 months to a year unless there are sufficient reasons to bypass the watch rating and be upgraded to a 3 or higher.  Loans risk rated 5 are currently protected but are potentially weak. These loans, in managements judgment, constitute an undue and unwarranted credit risk but not to the point of justifying a classification of substandard. The credit risk may be relatively minor yet constitute an unwarranted risk in light of the circumstances surrounding a specific asset. Loans in this category have potential weaknesses which may, if not checked or corrected, weaken the loan or inadequately protect the Bank's credit position at some future date.  This might include loans which the lending officer may be unable to supervise properly because of: lack of expertise, inadequate loan agreement, the poor condition of or lack of control over collateral, failure to obtain proper documentation or any other deviations from prudent lending practices.  Economic or market conditions which may, in the future, affect the obligor may warrant special mention of the asset. Loans for which an adverse trend in the borrower's operations or an imbalanced position in the balance sheet which has not reached a point where the liquidation is jeopardized may be included in this classification.  Loans risk rated 6 are considered substandard. A substandard loan is inadequately protected by the sound worth and paying capacity of the obligor or of the collateral pledged, if any.  Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected.  Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual loans classified substandard. Residential mortgages are not subject to substandard classification unless the following well defined weaknesses have occurred: the ability of the borrower to repay the debt is questionable as evidenced by delinquency of 90 days, and repayment of the debt is dependent on the sale of the underlying real estate. A consumer loan is considered a substandard asset only when it is 90 days past due.  Loans risk rated 7are categorized as doubtful. These loans have all the weaknesses inherent in one classified substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high but because of certain important and reasonably specific pending factors which may work to the advantage and strengthening of the loan, its classification as an estimated loss is deferred until its more exact status may be determined. Pending factors include proposed merger, acquisition, or liquidation procedures, capital injection, perfecting liens on additional collateral and refinancing plans. The entire amount of the loan might not be classified as doubtful when collection of a specific portion appears highly probable. Loans are generally not classified doubtful for an extended period of time (i.e., over a year).  Loans classified 8, or loss, are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may be affected in the future.  Losses are taken in the period in which they surface as uncollectible.  The following tables present the loan portfolio as of December 31,  2011 and December 31, 2010 by credit quality indicator (in thousands). Except for loans in the 9 and unrated categories, credit quality indicators are reassessed for each applicable loan at least annually, generally upon the anniversary of the loans origination or receipt and analysis of the borrowers financial statements, when applicable, or in the event that information becomes available that would cause us to re-evaluate.  Loans in category 9 and unrated are evaluated for credit quality after origination based upon delinquency status. (See Aging Analysis table). However, management is in the process of implementing a portfolio re-scoring tool, whereby credit scores will be updated on a periodic basis.  45   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    Credit Quality Indicator Analysis as of December 31,  2011ResidentialResidentialmortgage  -mortgage  -LoansDeferredCommercialCommercialfirstsecondConsumer -Consumer -held forFees andand industrialmortgagepositionpositionindirectothersaleCostsTotal1-Superior$9,814105---913--10,8322-Good8,82626,1951,7182,560----39,2993-Satisfactory68,246177,8821,409576----248,1134-Watch43,928210,9016,045269----261,1435-Special Mention7,8644,6451,127-----13,6366-Substandard29,44030,0184,496453-100--64,5077-Doubtful---7----78-Loss---------Subtotal$168,118449,74614,7953,865-1,013--637,5379 and not rated30,62617,667241,37898,012227,54124,5707,5567,634654,984Total$198,744467,413256,173101,877227,54125,5837,5567,6341,292,521  Credit Quality Indicator Analysis as of December 31, 2010ResidentialResidentialmortgage  -mortgage  -LoansDeferredCommercialCommercialfirstsecondConsumer -Consumer -held forFees andand industrialmortgagepositionpositionindirectothersaleCostsTotal1-Superior$11,367----155--11,5222-Good13,27324,2332173,678----41,4013-Satisfactory70,400165,3501,0151,338----238,1034-Watch50,579193,9605,829459-5--250,8325-Special Mention17,98417,235981844----37,0446-Substandard20,98517,5943,720881----43,1807-Doubtful---38----388-Loss---------Subtotal$184,588418,37211,7627,238-160--622,1209 and not rated28,11916,415221,19189,178181,48126,27714,1135,962582,736Total$212,707434,787232,95396,416181,48126,43714,1135,9621,204,856   A summary of information regarding nonaccruing loans and other nonperforming assets as of December 31, 2011, 2010, and 2009 follows (in thousands):  201120102009Accruing loans 90 days or more delinquent$9691,5891,087Nonaccruing loans17,30721,24318,547Total nonperforming loans18,27622,83219,634Other real estate owned4,6324,2912,883(less write-down of other real estate owned)(397)(551)(114)Total nonperforming assets$22,51126,57222,403  46   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    The following tables present, as of December 31,  2011 and December 31, 2010, additional details about the loan portfolio in the form of an aging analysis of the loan portfolio. Amounts exclude deferred fees and costs (in thousands).  Aging Analysis as of December 31,  201190 Days> 90 Days30-59 Days60-89 DaysOrTotalTotalandNon-AccrualPast DuePast DueGreaterPast DueCurrentLoansAccruingLoansCommercial and industrial$3954323,9924,819193,925198,744753,917Commercial mortgages2,184-9,07811,262456,151467,413-9,078Residential - first lien633554,4535,141251,032256,1736523,801Residential - junior lien44491419954100,923101,8778411Consumer:Automobile - Indirect1,7666531652,584224,957227,541165-Other2578816951425,06925,58369100Loans held-for-sale----7,5567,556--$5,6791,31918,27625,2741,259,6131,284,88796917,307  Aging Analysis as of December 31, 201090 Days> 90 Days30-59 Days60-89 DaysOrTotalTotalandNon-AccrualPast DuePast DueGreaterPast DueCurrentLoansAccruingLoansCommercial and industrial$2,5875424,2957,424205,283212,7072254,070Commercial mortgages2,720-11,44514,165420,622434,78741311,032Residential - first lien3,6211,4875,85110,959221,994232,9536275,224Residential - junior lien2161069481,27095,14696,41631917Consumer:Automobile - indirect1,7858152682,868178,613181,481268-Other3521602553725,90026,43725-Loans held-for-sale----14,11314,113--Total$11,2813,11022,83237,2231,161,6711,198,8941,58921,243   A summary of information regarding impaired loans follows (in thousands):


|                                                             |   |        |  |  |        |  |  |       
|------------------------------------------------------------ | - | ------ |  |  | ------ |  |  | ------
|                                                             |   | 2011   |  |  | 2010   |  |  | 2009  
|                                                             |   |        |  |  |        |  |  |       
|Recorded investment at period end                            | $ | 17,307 |  |  | 21,655 |  |  | 18,547
|Impaired loans with specific related allowance at period end | $ | 2,453  |  |  | 3,116  |  |  | 7,771 
|Amount of specific related allowance at period end           | $ | 1,138  |  |  | 674    |  |  | 2,799 
|Average investment during the period                         | $ | 20,394 |  |  | 21,862 |  |  | 14,306
|Interest income recognized on a cash basis during the period | $ | 127    |  |  | 35     |  |  | 35    

47   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    The details of impaired loans as of December 31,  2011 and December 31, 2010 follow (in thousands)


|                           |                                        |          |       |            |       |           |     |           |       |            |     |           
|-------------------------- | -------------------------------------- | -------- | ----- | ---------- | ----- | --------- | --- | --------- | ----- | ---------- | --- | ----------
|                           |                                        |          |       |            |       |           |     |           |       |            |     |           
|December 31, 2011         
|                           |                                        |          |       |            |       |           |     |           |       |            |     |           
|                           |                                        |          |       |            |       | Unpaid    |     | Specific  |       | Average    |     | Interest  
|                           |                                        |          |       | Recorded   |       | principal |     | Related   |       | Recorded   |     | income    
|                           |                                        |          |       | Investment |       | balance   |     | Allowance |       | Investment |     | Recognized
|With no specific allowance |                                        |          |       |            |       |           |     |           |       |           
|                           | Commercial and industrial              | $        | 2,542 |            | 3,048 |           | -   |           | 1,401 |            | -  
|                           | Commercial mortgage                    |          | 8,001 |            | 9,440 |           | -   |           | 6,578 |            | 114
|                           | Residential mortgage - first position  |          | 3,800 |            | 3,968 |           | -   |           | 3,366 |            | 13 
|                           | Residential mortgage - second position |          | 411   |            | 439   |           | -   |           | 390   |            | -  
|                           | Consumer - other                       |          | 100   |            | 102   |           | -   |           | 76    |            | -  
|                           |                                        | Subtotal |       | 14,854     |       | 16,997    |     | -         |       | 11,811     |     | 127       
|With specific allowance    |                                        |          |       |            |       |           |     |           |       |           
|                           | Commercial and industrial              |          | 1,376 |            | 1,454 |           | 895 |           | 3,079 |            | -  
|                           | Commercial mortgage                    |          | 1,077 |            | 1,153 |           | 243 |           | 3,988 |            | -  
|                           | Residential mortgage - first position  |          | -     |            | -     |           | -   |           | 1,265 |            | -  
|                           | Residential mortgage - second position |          | -     |            | -     |           | -   |           | 201   |            | -  
|                           | Consumer - other                       |          | -     |            | -     |           | -   |           | 50    |            | -  
|                           |                                        | Subtotal |       | 2,453      |       | 2,607     |     | 1,138     |       | 8,583      |     | -         
|                           |                                        | Total    | $     | 17,307     |       | 19,604    |     | 1,138     |       | 20,394     |     | 127       
|Summary by portfolio:      |                                        |          |       |            |       |           |     |           |       |           
|Commercial                 | $                                      | 12,996   |       | 15,095     |       | 1,138     |     | 15,046    |       | 114       
|Residential                |                                        | 4,211    |       | 4,407      |       | -         |     | 5,222     |       | 13        
|Consumer and other         |                                        | 100      |       | 102        |       | -         |     | 126       |       | -         
|                           |                                        | Total    | $     | 17,307     |       | 19,604    |     | 1,138     |       | 20,394     |     | 127       




|                            |                                        |            |        |          |        |           |     |            |        |            |    |         
|--------------------------- | -------------------------------------- | ---------- | ------ | -------- | ------ | --------- | --- | ---------- | ------ | ---------- | -- | --------
|                            |                                        |            |        |          |        |           |     |            |        |            |    |         
|                            |                                        |            |        |          |        |           |     |            |        |            |    |         
|December 31, 2010          
|                            |                                        |            |        |          |        |           |     |            |        |            |    |         
|                            |                                        |            |        |          |        | Unpaid    |     | Specific   |        | Average    |    | Interest
|                            |                                        |            |        | Recorded |        | principal |     | Related    |        | Recorded   |    | income  
|With  no specific allowance |                                        | Investment |        | balance  |        | Allowance |     | Investment |        | Recognized
|                            | Commercial and industrial              | $          | 3,177  |          | 3,598  |           | -   |            | 5,741  |            | - 
|                            | Commercial mortgage                    |            | 10,107 |          | 10,446 |           | -   |            | 9,949  |            | 34
|                            | Residential mortgage - first position  |            | 4,391  |          | 4,476  |           | -   |            | 1,988  |            | 1 
|                            | Residential mortgage - second position |            | 664    |          | 668    |           | -   |            | 642    |            | - 
|                            | Consumer - other                       |            | 200    |          | 200    |           | -   |            | 100    |            | - 
|                            |                                        | Subtotal   |        | 18,539   |        | 19,388    |     | -          |        | 18,420     |    | 35      
|With  specific allowance    |                                        |            |        |          |        |           |     |            |        |           
|                            | Commercial and industrial              |            | 1,305  |          | 1,343  |           | 449 |            | 2,037  |            | - 
|                            | Commercial mortgage                    |            | 924    |          | 2,489  |           | 51  |            | 1,070  |            | - 
|                            | Residential mortgage - first position  |            | 833    |          | 835    |           | 124 |            | 291    |            | - 
|                            | Residential mortgage - second position |            | 54     |          | 56     |           | 50  |            | 44     |            | - 
|                            |                                        | Subtotal   |        | 3,116    |        | 4,723     |     | 674        |        | 3,442      |    | -       
|                            |                                        | Total      | $      | 21,655   |        | 24,111    |     | 674        |        | 21,862     |    | 35      
|Summary by portfolio:       |                                        |            |        |          |        |           |     |            |        |           
|                            | Commercial                             | $          | 15,513 |          | 17,876 |           | 500 |            | 18,797 |            | 34
|                            | Residential                            |            | 5,942  |          | 6,035  |           | 174 |            | 2,965  |            | 1 
|                            | Consumer and other                     |            | 200    |          | 200    |           | -   |            | 100    |            | - 
|                            |                                        | Total      | $      | 21,655   |        | 24,111    |     | 674        |        | 21,862     |    | 35      

Troubled Debt Restructurings As of December 31, 2011 there were two relationships, one totaling $4.9 million and one totaling $0.3 million that were considered TDRs due to the nature of the concessions granted to the borrower. We have established no impairment reserve for either relationship in light of the value of underlying collateral and managements recovery expectations. The balances of the underlying loans are included in non-performing loans. For the largest one, we renegotiated certain terms of their loans in 2010.  The significant term modified was the monthly principal and interest payment amount.  We agreed to forbear our rights under default provisions in the loan agreements on the condition that the borrower made monthly payments which were significantly less than those required under the terms of the original loan agreements. The customer was in compliance with the terms of the forbearance agreement which expired in March 2011. We have renewed the forbearance agreement for an additional 24 months with higher monthly payments than under the previous agreement.  The borrower has paid as agreed.   48   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (5) Premises and Equipment  A summary of premises and equipment at December 31, 2011, and 2010, follows (in thousands):  20112010Land and land improvements$948892Buildings and leasehold improvements24,17221,794Furniture, fixtures and equipment19,52018,00944,64040,695Less accumulated depreciation and amortization28,53926,325Premises and equipment - net$16,10114,370  Depreciation and amortization expense amounted to $2,419,000, $2,099,000, and $1,954,000, for the years ended December 31, 2011, 2010, and 2009, respectively.  In June 2008, the Company completed the sale and subsequent lease-back of six banking offices.  The gross gain of $1,558,000 was deferred and included in Accrued Interest Payable and Other Liabilities in the Consolidated Balance Sheet and is amortized as a credit to Occupancy expenses on a straight-line basis for 15 years through 2023, the term of the underlying leases.  (6)   Loan Servicing Assets  Changes in loan servicing assets for each of the years presented, and the respective period-end estimated fair values were as follows (in thousands):  201120102009EstimatedEstimatedEstimatedBookFairBookFairBookFairValueValueValueValueValueValueBalance at January 1,$2,222$3,418$1,797$2,893$855$2,893Originations7629141,463Amortization(495)(489)(521)Balance at December 31,$2,489$3,244$2,222$3,418$1,797$2,893   Included in Loan servicing income, net, are gross servicing fees earned of $1,424,000, $1,366,000, and $1,103,000, for the years ended December 31, 2011, 2010, and 2009, respectively.  Amortization expense of loan servicing assets for the next five years is estimated to be $521,000, $492,000, $478,000, $455,000, and $310,000.  The estimated fair value of loan servicing rights may vary significantly in subsequent periods due to changing interest rates and the effect thereof on prepayment speeds. Additionally, estimated fair value assumes there are a willing buyer and willing seller in the transaction. Management does not intend to sell these servicing rights.  The key economic assumptions used to determine the fair value of loan servicing rights at December 31, 2011 and 2010 were a discount rate of 9.00% in each year and weighted average portfolio maturity of 19.3 years in 2011 and 19.5 years in 2010. The sensitivity of fair value to changes in certain portfolio characteristics at each year end are summarized in the table that follows (dollars in thousands). These calculated sensitivities are hypothetical, and actual changes in the fair value of loan servicing rights may differ significantly from the amounts presented herein. The effect of a variation in a particular assumption or characteristic on the fair value of the servicing rights is calculated without changing any other assumption. However, in practice, changes in one factor may result in changes in another which may magnify or counteract the sensitivities. The changes in assumptions are presumed to be instantaneous.  49   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    20112010Weighted-average prepayment speed326%243%Impact on fair value of 20% adverse change$(278)$(389)Impact on fair value of 20% positive change371519Weighted-average current coupon for similar loans4.74%4.95%Impact on fair value of 100 basis point adverse change$(695)$(952)Impact on fair value of 100 basis point positive change602433  (7) Time Deposits  At December 31, 2011, the scheduled maturity of time deposits was as follows (in thousands):  2012$274,473201371,980201451,5322015219$398,204  Time deposits of $100,000 or more amounted to $165,311,000 at December 31, 2011, and $215,820,000 at December 31, 2010. Interest expense on all time deposits of $100,000 or more was as follows: $2,737,000 in 2011, $4,118,000 in 2010, and $6,528,000 in 2009.  (8) Borrowings  There were no borrowings outstanding at December 31, 2011.  Borrowings at December 31, 2010 consisted only of non-interest bearing acquisition debt of $330,000, which was paid in January 2011. There were no short-term borrowings during 2011 or 2010.  The following table presents information about short-term borrowings during and at year-end 2009 (dollars in thousands):  2009Amount outstanding at December 31,$-Highest amount at a month end$-Daily average amount outstanding$4Weighted average interest rate paid0.48%  The following table presents information about the Company's formal available lines of credit and related loan collateral at December 31, 2011 (in thousands).  Amounts utilized include borrowings, and undrawn letters of credit in the Company's favor of $2,501,000.  Amount UtilizedUnusedCollateralized byCarrying Value Of CollateralResidential mortgage loans andFederal Home Loan Bank of New York$2,501$127,686FHLB Stock$156,502Federal Reserve Bank of New York$-$431,474Indirect automobile loans$208,251Commercial loans$431,499  Advances under the overnight line of credit with the FHLB of New York are payable on demand and generally bear interest at the federal funds rate plus .10%. The Company also has access to the FHLB's Term Advance Program, which allows the Bank to borrow up to $100,000,000 at various terms and rates, subject to the Banks pledging of eligible collateral. Advances under the Federal Reserve Bank of New York are payable the following business day and bear interest at the Federal Reserve Bank of New Yorks discount rate for primary credit, which is generally 0.25% to 1.00% above the target federal funds rate.  50   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (9) Junior Subordinated Debentures and Interest Rate Swap  In September 2007, the Company issued $20,619,000 of unsecured, 30-year junior subordinated deferrable interest debentures (T3) through a wholly-owned business trust. The debentures carry a fixed interest rate of 6.32% per annum through December 2012, floating thereafter for twenty-five years at LIBOR plus 1.44% per annum, adjustable quarterly. Interest is payable quarterly. The debentures' final maturity is December 2037, and is callable, in whole or in part, at par beginning December 2012 at the Company's option, and subject to Federal Reserve Bank of New York approval. Interest payments can be deferred for up to five years, but would restrict the Company's ability to pay dividends. At December 31, 2011, these debentures were considered Tier I for regulatory purposes.  In December 2012, the Company will be exposed to interest rate risk as a result of the timing of changes in interest rates associated with this debenture.  In consideration of the end of the fixed-rate period, the Company entered into a forward interest rate swap agreement on December 22, 2011.  The Company designated the swap as a cash flow hedge, and it is intended to protect against the variability of cash flows associated with T3. This swap becomes effective on December 15, 2012 and expires on December 15, 2022.  This interest rate swap agreement will modify the repricing characteristics of T3 from a floating-rate debt (LIBOR +1.44%) to a fixed-rate debt (3.859%).The swap agreement was entered into with a counterparty that met the Companys credit standards, and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in this contract is not significant. At December 31, 2011, the Company pledged $330,000 cash collateral to the counter party.  In June, 2006, the Company issued $30,928,000 of unsecured, 30-year floating rate junior subordinated deferrable interest debentures (T2) through a wholly-owned business trust. The debentures carry an interest rate of 3-month LIBOR plus 1.40% (1.946% at December 31, 2011). Interest is payable quarterly. The debentures' final maturity is June 2036, and is callable, in whole or in part, at par after commencing June 2012 at the Company's option, and subject to Federal Reserve Bank of New York approval. Interest payments can be deferred for up to five years, but would restrict the Company's ability to pay dividends. At December 31, 2011, these debentures were considered Tier I capital of the Company.  In December 2007, the Company entered into an interest rate swap agreement (swap). The Company designated the swap as a cash flow hedge and it was intended to protect against the variability of cash flows associated with T2. The swap modified the repricing characteristic of T2, wherein the Company received interest at LIBOR plus 1.40% from a counterparty and paid a fixed rate of interest of 5.54% to the same counterparty calculated on a notional amount of $30,928,000. This agreement expired in June 2011.  In consideration of the pending expiration of the aforementioned agreement, the Company entered into a forward starting interest rate swap agreement on July 1, 2010.  This swap became effective on June 15, 2011 and expires on June 15, 2021.  This interest rate swap agreement modifies the repricing characteristics of T2 from a floating-rate debt (LIBOR +1.40%) to a fixed-rate debt (4.81%).The swap agreement was entered into with a counterparty that met the Companys credit standards, and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in this contract is not significant. At December 31, 2011, the Company pledged $4,100,000 cash collateral to the counter party.  At December 31, 2011, the fair value of the swap agreements was a negative (loss) $4,415,000 (December 31, 2010: $577,000 (loss)), and was the amount the Company would have expected to pay to terminate the agreements.  The net effect of the swaps increased interest expense by $1,065,000 in 2011, $1,157,000 in 2010, and $960,000 in 2009. There was no hedge ineffectiveness for these swaps.  (10) Income Taxes  Total income taxes for the each of the years ended December 31, were allocated as follows (in thousands):  201120102009Income from operations$6,1786,2055,401Stock option exercise included in stockholders equity-(232)-Change in stockholders' equity for unrealizedgain (loss) on securities available for sale180(483)502Change in stockholders' equity for unrealizedgain (loss) on fair value of interest rate swap(1,341)180170$5,0175,6706,073  51   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    The components of income tax expense (benefit) relating to income from operations follow (in thousands):  Years ended December 31,201120102009Current:Federal$5,7065,8824,920State1,0461,0861,0706,7526,9685,990Deferred:Federal(347)(513)(468)State(227)(250)(121)(574)(763)(589)$6,1786,2055,401  Income tax expense differed from the amounts computed by applying the applicable U.S. Federal corporate tax rates to pretax income from operations as follows (dollars in thousands):  Years ended December 31,201120102009Tax expense at statutory rate of 35% (34.33% in 2009)$7,8418,3517,070Tax-exempt interest(2,251)(2,487)(2,612)Interest expense disallowance78117186State taxes, net of Federal benefit532543621Nondeductible operating expenses623321Change in valuation allowance for deferred tax assets(2)(2)(2)Recovery of state allowance for loan losses-(167)-Other(82)(183)117Total$6,1786,2055,401Effective tax rate28.0%26.0%26.2%  52   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2011, and 2010, are presented below (in thousands):  20112010Deferred tax assets:Allowance for loan losses - books$6,3776,194Incentive stock and retirement plans1,825596Stock options7575Interest on nonaccrual loans1,0651,197Retirement and other reserves44419Gain on sale of premises and equipment  books671515Write-down of available-for-sale securities184382Minority-owned entities28196Net unrealized loss on interest rate swap1,722381Other307-Deferred tax assets before allowance12,5519,855Valuation allowance(78)(80)Deferred tax assets12,4739,775Deferred tax liabilities:Loan servicing rights986880Intangible assets1,027128Depreciation969291Net unrealized gain on available for sale securities789540Deferred tax liabilities3,7711,839Net deferred tax asset$8,7027,936  Realization of deferred tax assets is dependent upon the generation of future taxable income or the existence of sufficient taxable income within the carryback period. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, management considers the scheduled reversal of deferred tax liabilities, the level of historical taxable income, and projected future taxable income over the periods in which the temporary differences comprising the deferred tax assets are deductible. Based on its assessment, management determined that no valuation allowance was needed except for that related to its nonbank subsidiaries' mortgage tax credits.  No material amount of interest expense was recognized during 2011 or 2010 for any unrecognized tax benefits.  The Company is not subject to U.S. Federal tax examinations or state tax examinations for years before 2008.  (11) Stockholders Equity  Payment of dividends by the Bank to the Company is limited or restricted in certain circumstances. According to federal banking law, the approval of the Office of the Comptroller of the Currency (OCC) is required for the declaration of dividends in any year in which dividends exceed the total of net income for that year plus retained income for the preceding two years. At December 31, 2011, approximately $30,063,000 was available for dividends to the Company without the approval of the OCC. Payment of dividends by the Companys non-bank subsidiaries is also restricted by their respective regulatory agencies. The amount of dividends available for payment by these companies without regulatory approval is insignificant.  53   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (12)   Earnings Per Share  Basic and diluted earnings per share for the years ended December 31, 2011, 2010, and 2009, were computed as follows (dollars in thousands, except share and per-share data):


|                                             |  |   |           |  |           |  |          
|-------------------------------------------- |  | - | --------- |  | --------- |  | ---------
|                                             |  |   | 2011      |  | 2010      |  | 2009     
|Basic Earnings Per Share:                    |  |   |           |  |           |  |          
|Net income applicable to common shareholders |  | $ | 16,312    |  | 17,656    |  | 15,194   
|Weighted average common shares outstanding   |  |   | 1,888,229 |  | 1,888,080 |  | 1,885,500
|Basic earnings per share                     |  | $ | 8.64      |  | 9.35      |  | 8.06     
|                                             |  |   |           |  |           |  |          
|                                             |  |   | 2011      |  | 2010      |  | 2009     
|Diluted Earnings Per Share:                  |  |   |           |  |           |  |          
|Net income applicable to common shareholders |  | $ | 16,312    |  | 17,656    |  | 15,194   
|Weighted average common shares outstanding   |  |   | 1,888,229 |  | 1,888,080 |  | 1,885,500
|Effect of assumed exercise of stock options  |  |   | 35,548    |  | 31,112    |  | 32,012   
|Total                                        |  | $ | 1,923,777 |  | 1,919,192 |  | 1,917,512
|Diluted earnings per share                   |  | $ | 8.48      |  | 9.20      |  | 7.92     

(13)  Retirement Plans  Retirement Plans  The Company has a combined profit sharing and 401(k) plan covering substantially all Bank employees and a 401(k) plan for non-Bank employees upon completion of 1,000 hours of service. Contributions to the Bank plan are determined by a mathematical formula which takes into account average net income of the Bank for the current and prior year, the level of the Bank's stockholders' equity and average Bank employee compensation. Both plans are subject to a minimum contribution of 3% of eligible compensation. It is the Company's policy to annually fund current costs as they accrue. Expenses of these plans amounted to $2,841,000, $2,480,000, and $2,336,000, for the years ended December 31, 2011, 2010, and 2009, respectively.  Employee Stock Ownership Plan  The Company has an employee stock ownership plan (ESOP) for employees of the Company. Annual contributions are made at the discretion of the Board of Directors. ESOP expense amounted to $266,000, $220,000, and $211,000, for the years ended December 31, 2011, 2010, and 2009, respectively. Shares distributed to a participant upon termination of service are subject to a put option whereby the participant may cause the Plans Trust to purchase the shares at fair value. At December 31, 2011, and 2010, the plan held 29,995 and 28,736 shares with an estimated fair value, at the respective dates, of $3,876,000 and $2,754,000.  Supplemental Executive Retirement Plans  The Company has two un-funded, non-qualified, supplemental executive retirement plans (SERP) covering certain executives designed to compensate for the portion of cash compensation unable to be included in the profit sharing and 401(k) plan, because of limitations in the plans design and in the Internal Revenue Code.  The Company had accrued a liability of $718,000 and $749,000 at December 31, 2011 and 2010, respectively, for these SERPs. Expenses of these plans amounted to a credit of $31,000 for 2011, and expense of $162,000, and $103,000 for the years 2010 and 2009, respectively.  54   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (14) Stock-Based Compensation Plans  The Company has two stock-based compensation plans (Stock Option Plan and Stock Appreciation Rights Plan) for executives, which are described below.  Amounts recognized in the Consolidated Financial Statements with respect to these plans are as follows (in thousands):  201120102009Stock option plan$---Incentive stock plan3,124606(154)Pre-tax cost of plans included in salaries and employee benefits expenses$3,124606(154)Amount of related income tax (expense)benefit recognized in income$(1,250)(242)62  The significant increase in costs of the incentive stock plan in both 2011 and 2010 were a result of increases in the market value of the Companys common stock.  Stock Option Plan  The Company's stock option plan authorized grants of options to purchase up to 192,000 shares of common stock.  All 192,000 options available were granted by year-end 2004. There are no future expenses associated with the unvested options.  The options were granted with an exercise price equal to the fair value of the common stock on the grant date based on the most recent public stock sale known to the Company immediately preceding the grant. The options are exercisable either five years from the date of grant, or at the later of age 55 or 15 years of continuous employment with the Company, or at normal retirement age (65).  The following summarizes outstanding and exercisable options at December 31, 2011:  2011Weighted Average#Exercise PriceOptions outstanding at beginning of the year106,542$42.25Granted--Expired--Options outstanding at year end106,542$42.25Options exercisable at year end92,826$43.43Options available for future grantsnone  At December 31, 2011, the intrinsic value of all outstanding options was approximately $9,054,000, while the intrinsic value of vested options included in this total was approximately $7,964,000.  No options were exercised in 2011 or 2009. The intrinsic value of options exercised during the year ended December 31, 2010 was $585,000.  No options vested in 2011 or 2010.  The fair value of options vested in 2009 was $116,000.  Options outstanding (both exercisable and unexercisable) at December 31, 2011, had exercise prices ranging from $30.04 to $73.46. The weighted average expected life of the options is four years. Since the options have no stated expiration date, the expected life is calculated as the number of years from grant date to the grantee's 65th birthday.  The source of shares issued upon exercise has historically been, and is expected to be, treasury shares.  From time to time, the Company expects to purchase shares for treasury to be used for these exercises.  The amount of shares, timing and cost of these purchases cannot be determined, as the Company does not know when and in what quantity participants will exercise their options.  Stock Appreciation Rights Plan  The Company has an incentive stock appreciation rights plan for executives which allows for the award of Stock Appreciation Rights (SAR) awards. The number of awards issued is based upon return on beginning equity in each year. SARs represent the right to receive payment in cash or stock equal to the amount, if any, by which the market value per share of common stock on the date of exercise exceeds the SARs grant price. Long-term SARs are exercisable at the later of age 55 or 15 years of continuous employment with the Company or at normal retirement age (65). Medium-term SARs are exercisable five years from the date of grant or upon retirement. The following summarizes the activity of these awards as of and for the year ended December 31, 2011.   55   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    Long-term SARsMedium-term SARsWeighted AverageWeighted Average#Grant Price#Grant PriceAwards outstanding, January 1, 201155,912$82.5534,338$83.12Granted41,772$95.8527,856$95.85Exercised-$--$-Forfeited-$--$-Expired-$--$-Awards outstanding at December 31, 201197,684$88.2462,194$88.82Awards exercisable at December 31, 201142,338$87.404,803$90.07  In February 2011, certain executives were awarded a total of 41,772 long-term SARs and 27,856 medium-term SARs, all at a grant price of $95.85 per share, the then-current market value (based on the most recent public stock sale known to the Company immediately preceding the grant) of the Company's common stock.  No awards were exercised in 2011 or 2010. The fair value of awards vested during years ended December 31, 2011 and 2010, and amounted to $182,000 and $28,000, respectively.  The weighted average estimated per-award fair values, as of December 31, 2011 and 2010 are presented below.  Fair value was estimated using the Black-Scholes-Merton option-pricing model with the following assumptions. No forfeitures are assumed, as none are anticipated.  20112010Award TypeLTSMTSLTSMTSPer-award fair value$29.71$29.19$8.75$8.37Expected dividend yield2.58%2.58%3.00%3.00%Risk-free interest rate0.91%0.91%2.01%2.01%Expected Life5.0 years5.0 years5.4 years5.4 yearsVolatility8.23%8.23%5.50%5.50%  Long-term SARs outstanding and medium-term SARs outstanding (both exercisable and unexercisable) at December 31, 2011, had exercise prices ranging from $78.98 to $95.85. The weighted average expected life of these awards is five years. Since these awards have no stated expiration date, the expected life is calculated as the number of years from grant date to the grantee's 60th birthday, which is the historical life for similar past awards.  Based upon current assumptions, the estimated compensation cost related to non-vested awards not yet recognized is $1,968,000, which is expected to be recognized over a weighted average period of five years. The Company had accrued a liability of $3,887,000 and $763,000 at December 31, 2011 and 2010, respectively, representing the accumulated fair-value vested obligation of these awards under the plan.  (15) Leases  The Company leases certain buildings and office space under operating lease arrangements. Rent expense, net of rent received and deferred-gain on sale-leaseback, under these arrangements amounted to $2,358,000 in 2011, $2,148,000 in 2010, and $1,842,000 in 2009. Real estate taxes, insurance, maintenance, and other operating expenses associated with leased buildings and office space are generally paid by the Company.  A summary of non-cancellable, long-term operating lease commitments as of December 31, 2011, follows (in thousands):  Years ending December 31,Amount2012$2,44020132,35020142,28220152,14820162,1192017 and after11,848Total$23,187  56   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (16) Commitments and Contingencies  In the normal course of business, various commitments and contingent liabilities are outstanding. The following table presents the notional amount of the Company's significant commitments and their respective carrying amount, where applicable. Most of these commitments are not included in the Company's Consolidated Balance Sheet (in thousands).  Year ended December 31,20112010NotionalCarryingNotionalCarryingAmountAmountAmountAmountCommitments to extend credit:Commercial lines of credit$138,072-101,481-Commercial real estate and construction$37,174-31,826-Residential real estate at fixed rates$5,269-3,871-Home equity lines of credit$186,902-150,085-Unsecured personal lines of credit$16,326-16,662-Standby and commercial letters of credit$15,563(233)8,180(127)Commitments to sell real estate loans$7,556-14,113-  Commitments to extend credit are agreements to lend to customers and generally have fixed expiration dates or other termination clauses that may require payment of a fee, the amount of which is immaterial. Standby and commercial letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party and also require payment of a fee. Standby letters of credit generally are contingent upon the failure of the customer to perform according to the terms of an underlying contract with a third party, whereas commercial letters of credit are issued to facilitate commerce and typically result in the commitment being funded when the underlying transaction is consummated between the customer and third party. Because many commitments and almost all letters of credit expire without being funded in whole or in part, the notional amounts are not estimates of future cash flows. The credit risk associated with commitments to extend credit and standby and commercial letters of credit is essentially the same as that involved with extending loans to customers and is subject to normal credit policies. The Company's credit policy generally requires customers to provide collateral, usually in the form of customers' operating assets or property, prior to disbursement of approved loans.  Commitments to originate fixed-rate loans are made when a borrower executes a rate-lock agreement. At the time of execution, the Company generally charges a rate-lock fee, which approximates the fair value of the Company's commitment. These commitments usually have terms ranging from 30 to 45 days. Concurrently, the Company enters into commitments to sell certain fixed-rate residential real estate loans (usually those subject to the foregoing rate-locks). These commitments to sell are recorded in the consolidated balance sheet at estimated fair value.  The Company has committed $3,000,000 as a limited partnership investment to Cephas Capital Partners, II.  This Small Business Investment Company (SBIC) is a community-bank backed mezzanine finance company.  It is a follow-on investment to our current investment in Cephas Capital Partners.  At December 31, 2011, the Company had a remaining unfunded commitment of $2,250,000. This investment is carried in Other Assets on the Consolidated Balance Sheet.  The Company has committed $500,000 for an investment in Trillium Lakefront Partners, LLC.  This venture capital fund is a community-backed initiative in support of new business and job growth in the Company's market area.  At December 31, 2011, the Company had a remaining unfunded commitment of $135,000. This investment is carried in Other Assets on the Consolidated Balance Sheet.  As discussed in Note 2 under the terms of the OBS purchase agreement, the Company is obligated to make future payments totaling $5,425,000, of which $2,500,000 is due in May 2012.  As a member bank using its clearing operations, the Bank is required to maintain a $2,500,000 reserve balance in cash on hand or with the Federal Reserve Bank of New York.  In the normal course of business, the Company has various contingent liabilities outstanding that are not included in the Consolidated Financial Statements. Management does not anticipate any material losses as a result of these contingent liabilities.  57   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (17) Regulatory Matters  The Company and its subsidiaries 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 additional 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 and its subsidiaries must meet specific capital guidelines that involve quantitative measures of the Company's and Bank's assets, liabilities, and certain off-balance-sheet items calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weightings, and other factors.  Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (as set forth in the table following) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital to average assets (as defined). Management believes, as of December 31, 2011, that the Company and Bank met all capital adequacy requirements to which they are subject. The Companys trust subsidiaries, Genesee Valley Trust Company and Canandaigua National Trust Company of Florida, must also meet minimum capital requirements as set forth by their regulators.  As of December 31, 2011, these companies complied with their minimum capital requirements.  As of December 31, 2011, and as of the most recent notification from regulators, the Company and the Bank are well-capitalized under the regulatory framework for prompt corrective action. To be categorized as well-capitalized, the Company and Bank must maintain a minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the table below. Subsequently, there have been no conditions or events which management believes has changed the Company's or Bank's category.  Regulatory Capital as of December 31, 2011Actual Regulatory CapitalMinimum RequirementWell-Capitalized(Dollars in thousands)AmountRatioAmountRatioAmountRatioLeverage capital (Tier 1) as percent ofthree-month average assets:Company$167,1369.90%$67,5254.00%$84,4065.00%Bank$147,6178.75%$67,4714.00%$84,3395.00%As percent of risk-weighted,period-end assetsCore capital (Tier 1)Company$167,13612.42%$53,8504.00%$80,7746.00%Bank$147,61711.20%$52,7004.00%$79,0496.00%Total capital (Tiers 1 and 2)Company$183,25713.61%$107,6998.00%$134,62410.00%Bank$163,73812.43%$105,3998.00%$131,74910.00%  Regulatory Capital as of December 31, 2010Actual Regulatory CapitalMinimum RequirementWell-Capitalized(Dollars in thousands)AmountRatioAmountRatioAmountRatioLeverage capital (Tier 1) as percent ofthree-month average assets:Company$151,0239.10%$66,3524.00%$82,9405.00%Bank$140,0618.50%$65,9134.00%$82,3925.00%As percent of risk-weighted,period-end assetsCore capital (Tier 1)Company$151,02312.32%$49,0374.00%$73,5566.00%Bank$140,06111.60%$48,3144.00%$72,4716.00%Total capital (Tiers 1 and 2)Company$176,39914.39%$98,0758.00%$122,59310.00%Bank$155,17512.85%$96,6278.00%$120,78410.00%  58   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (18)   Segment Information  As of December 31, 2011, the Company is organized into four reportable segments: the Company and its banking and Florida trust subsidiaries (Bank), CNB Mortgage Company (CNBM), Genesee Valley Trust Company (GVT), and WBI OBS and subsidiaries (OBS). These have been segmented due to differences in their distribution channels, the volatility of their earnings, and internal and external financial reporting requirements.  The Bank segment provides a wide range of credit products and banking services to retail and commercial customers, largely within the markets the Company serves. Among the services provided by this segment are commercial and consumer lending, including residential mortgage loans, loan servicing, deposit products, cash management services, investment management and retirement services, securities custodial services, and other related products and services. These products and services are offered through several delivery channels which include traditional community banking offices, automated teller machines, telephone banking, and internet banking. CNB Mortgage originates residential mortgage loans for consumers and sells all of those loans either to the Bank or to third-party investors in the secondary market. Genesee Valley Trust Company provides investment management and retirement services. OBS provides investment sub-advisory services to the Bank and several other financial institutions, primarily community banks and credit unions.  The financial information of these segments has been compiled utilizing the accounting policies described in Note 1. Intersegment revenue, mainly servicing release premiums, is earned on the basis of similar third-party transactions. Indirect administrative expenses are allocated among segments based upon the segments' use of indirect resources. Income taxes are allocated to segments based on the Company's marginal statutory tax rate adjusted for any tax-exempt income or non-deductible expenses.  The accounting policies and processes utilized in compiling segment financial information is based on U.S. generally accepted accounting principles, as most of these companies are subject to stand-alone external financial reporting. The reportable segment information as of, and for the years ended, December 31, 2011, 2010, and 2009 follows (in thousands):  The operating results for the Bank for the year ended December 31, 2011 were negatively affected by a $2.2 million fourth quarter accrual to account for the increased liability of the stock appreciation rights plan following the rise in the Companys stock price, while the operating results for OBS were negatively affected by $1.1 million of merger-related expenses. The operating results of GVT for the year ended December 31, 2011 were negatively affected by a $0.3 million increase in amortization of customer intangibles, while in 2009 the results were negatively affected by a $0.8 million retirement expense accrual upon the presidents early retirement.  2011BankCNBMGVTOBSIntersegmentTotalNet interest income$61,473711-(18)61,473Non-interest income24,5103,8903,863187(3,642)28,808Total revenues85,9833,8973,874187(3,660)90,281Provision for loan losses3,775----3,775Intangible amortization250-937--1,187Other operating expenses57,3362,2723,0781,309(779)63,216Total expenses61,3612,2724,0151,309(779)68,178Income (loss) before tax24,6221,625(141)(1,122)(2,881)22,103Income tax6,178651(69)-(582)6,178Net income attributable to noncontrolling interestsand Canandaigua National Corporation18,444974(72)(1,122)(2,299)15,925Less: Net income attributable to noncontrolling interests6--(393)-(387)Net income attributable toCanandaigua National Corporation$18,438974(72)(729)(2,299)16,312Total identifiable assets$1,738,99410,18014,45015,625(17,779)1,761,470  59   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    2010BankCNBMGVTIntersegmentTotalNet interest income$61,16112(8)(24)61,141Non-interest income22,5534,1873,873(3,892)26,721Total revenues83,7144,1993,865(3,916)87,862Provision for loan losses6,150---6,150Intangible amortization217-778-995Other operating expenses51,8602,1223,471(597)56,856Total expenses58,2272,1224,249(597)64,001Income (loss) before tax25,4872,077(384)(3,319)23,861Income tax6,20577562(837)6,205Net income (loss)$19,2821,302(446)(2,482)17,656Total identifiable assets$1,646,73313,53716,786(15,552)1,661,504  2009BankCNBMGVTIntersegmentTotalNet interest income$54,46912(68)(39)54,374Non-interest income20,8475,2703,678(5,025)24,770Total revenues75,3165,2823,610(5,064)79,144Provision for loan losses4,345---4,345Intangible amortization228-835-1,063Other operating expenses47,5611,7464,289(455)53,141Total expenses52,1341,7465,124(455)58,549Income (loss) before tax23,1823,536(1,514)(4,609)20,595Income tax5,4011,371(589)(782)5,401Net income (loss)$17,7812,165(925)(3,827)15,194Total identifiable assets$1,551,0476,01319,142(10,202)1,566,000  60   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   (19) Condensed Financial Information - Parent Company Only  The following are the condensed balance sheets, statements of income, and statements of cash flows for Canandaigua National Corporation (in thousands).  Balance SheetsDecember 31,20112010Assets:Cash in subsidiary bank$6,8257,992Cash in other banks4,4301,260Securities available for sale9461,105Investment in Bank150,301142,313Investment in nonbank subsidiaries27,99320,873Other assets7,5263,419Total assets$198,021176,962Liabilities:Junior subordinated debentures$51,54751,547Other liabilities10,6941,621Total liabilities62,24153,168Stockholders' Equity135,780123,794Total liabilities and stockholders' equity$198,021176,962  Statements of IncomeYears ended December 31,201120102009Dividends from Bank$12,9607,2007,200Dividends from nonbank subsidiaries--500Other income1556264Loss on securities available for sale(34)(40)(120)Interest and other expenses(2,743)(3,105)(3,376)Income before undistributed income of subsidiaries10,1984,1114,468Undistributed current year income of subsidiaries6,07113,5409,744Income before taxes16,26917,65114,212Income tax benefit435982Net income$16,31217,65615,194  61   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009


|                                                       |   |                          |  |  |          |  |  |        
|------------------------------------------------------ | - | ------------------------ |  |  | -------- |  |  | -------
|                                                       |   |                          |  |  |          |  |  |        
|Statements of Cash Flow                                |   |                          |  |  |          |  |  |        
|                                                       |   | Years ended December 31,
|                                                       |   |                          |  |  |          |  |  |        
|                                                       |   | 2011                     |  |  | 2010     |  |  | 2009   
|Cash flows from operating activities                   |   |                          |  |  |          |  |  |        
|Net income                                             | $ | 16,312                   |  |  | 17,656   |  |  | 15,194 
|Adjustments to reconcile net income to net cash        |   |                          |  |  |          |  |  |        
|from operating activities:                             |   |                          |  |  |          |  |  |        
|Depreciation, amortization and accretion               |   | -                        |  |  | 24       |  |  | 24     
|Undistributed current year earnings of subsidiaries    |   | (6,071)                  |  |  | (13,540) |  |  | (9,744)
|Loss on securities available for sale                  |   | 34                       |  |  | 40       |  |  | 120    
|Other                                                  |   | (3,407)                  |  |  | 1,432    |  |  | (1,068)
|                                                       |   |                          |  |  |          |  |  |        
|Net cash provided by operating activities              |   | 6,868                    |  |  | 5,612    |  |  | 4,526  
|                                                       |   |                          |  |  |          |  |  |        
|Cash flows from investing activities:                  |   |                          |  |  |          |  |  |        
|Proceeds transactions of securities available for sale |   | 62                       |  |  | 1,499    |  |  | -      
|Acquisition of company                                 |   | (2,250)                  |  |  | -        |  |  | -      
|Investment in subsidiaries                             |   | (5)                      |  |  | (501)    |  |  | (8,055)
|Purchases of other investments, net                    |   | -                        |  |  | (331)    |  |  | (37)   
|Fixed assets sold to subsidiary                        |   | -                        |  |  | 453      |  |  | -      
|                                                       |   |                          |  |  |          |  |  |        
|Net cash (used in) provided by  investing activities   |   | (2,193)                  |  |  | 1,120    |  |  | (8,092)
|                                                       |   |                          |  |  |          |  |  |        
|Cash flows from financing activities:                  |   |                          |  |  |          |  |  |        
|Payments for treasury stock transactions, net          |   | (173)                    |  |  | (147)    |  |  | (327)  
|Tax benefit from stock option exercise                 |   | -                        |  |  | 232      |  |  | -      
|Change in noncontrolling interest, net                 |   | 2,906                    |  |  | -        |  |  | -      
|Dividends paid                                         |   | (5,405)                  |  |  | (5,121)  |  |  | (4,669)
|                                                       |   |                          |  |  |          |  |  |        
|Net cash (used in) provided by financing activities    |   | (2,672)                  |  |  | (5,036)  |  |  | (4,996)
|                                                       |   |                          |  |  |          |  |  |        
|Net increase (decrease) in cash                        |   | 2,003                    |  |  | 1,696    |  |  | (8,562)
|Cash at beginning of year                              |   | 9,252                    |  |  | 7,556    |  |  | 16,118 
|                                                       |   |                          |  |  |          |  |  |        
|Cash at end of year                                    | $ | 11,255                   |  |  | 9,252    |  |  | 7,556  
|                                                       |   |                          |  |  |          |  |  |        
|                                                       |   |                          |  |  |          |  |  |        

(20) Fair Values of Financial Instruments  Current accounting pronouncements require disclosure of the estimated fair value of financial instruments. Fair value is generally defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly, non-distressed sale between market participants at the measurement date. With the exception of certain marketable securities and one-to-four-family residential mortgage loans originated for sale, the Companys financial instruments are not readily marketable and market prices do not exist. The Company, in attempting to comply with accounting disclosure pronouncements, has not attempted to market its financial instruments to potential buyers, if any exist. Since negotiated prices in illiquid markets depend upon the then present motivations of the buyer and seller, it is reasonable to assume that actual sales prices could vary widely from any estimate of fair value made without the benefit of negotiations.  Additionally, changes in market interest rates can dramatically impact the value of financial instruments in a short period of time. Finally, the Company expects to retain substantially all assets and liabilities measured at fair value to their maturity or call date.  Accordingly, the fair values disclosed herein are unlikely to represent the instruments liquidation values, and do not, with the exception of securities, consider exit costs, since they cannot be reasonably estimated by management.  62   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    The estimated fair values of the Company's financial instruments are as follows (in thousands):  December 31,  2011December 31, 2010CarryingFairCarryingFairFinancial Assets:AmountValueAmountValueCash and equivalents$126,740126,740138,229138,229Securities, available-for-sale and held-to-maturity(1)$284,139289,431272,336276,856Loans-net$1,276,4261,308,5311,189,2211,245,838Loan servicing assets$2,4893,2442,2223,418Financial Liabilities:Deposits:Demand, savings andmoney market accounts$1,148,4061,148,406984,940984,940Time deposits$398,204393,583488,390494,654Borrowings$--330328Junior subordinated debentures$51,54752,18551,54752,866Other financial instruments:Interest rate swap agreements$(4,415)(4,415)(933)(933)Letters of credit$(233)(233)(127)(127)(1)Includes the Company's required investments in Federal Reserve Bank stock and Federal Home Loan Bank stock.  The following methods and assumptions were used to estimate the fair value of each class of financial instrument:  Cash and Equivalents  For these short-term instruments that generally mature in 90 days or less, or carry a market rate of interest, the carrying value approximates fair value.  Securities (Available-for-Sale and Held-to-Maturity)  Fair values for securities are determined using independent pricing services and market-participating brokers, or matrix models using observable inputs. The pricing service and brokers use a variety of techniques to arrive at fair value including market maker bids, quotes and pricing models.  Inputs to their pricing models include recent trades, benchmark interest rates, spreads, and actual and projected cash flows. Management obtains a single market quote or price estimate for each security.  None of the quotes or estimates is considered a binding quote, as management would only request a binding quote if management had the positive intent to sell the securities in the foreseeable future and management believed the price quoted represented one from a market participant with the intent and the ability to purchase. Management evaluates the supplied price quotes against expectations of general price trends associated with changes in the yield curve and by comparing prices to the last periods price quote. Management employs an internal matrix model are used for non-traded municipal securities.  The matrix model considers observable inputs, such as benchmark interest rates and spreads.  Certain securities fair values are determined using unobservable inputs and include bank-debt-based CDOs. There is a very limited market and limited demand for these CDOs due to imbalances in marketplace liquidity and the uncertainty in evaluating the credit risk in these securities. In determining fair value for these securities, management considered various inputs. Management considered fair values from brokerage firms which were determined using assumptions as to expected cash flows and approximate risk-adjusted discount rates.  Loans  Fair values are estimated for portfolios of loans with similar financial characteristics. Loans are segregated by interest type such as floating, adjustable, and fixed-rate, and by portfolios such as commercial, mortgage, and consumer.  The fair value of performing loans is calculated by discounting scheduled cash flows through the loans' estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan category. The estimate of maturity is based on the average maturity for each loan classification.  Delinquent loans (not in foreclosure) are valued using the method noted above, and also consider the fair value of collateral for collateral-dependent loans. While credit risk is a component of the discount rate used to value loans, delinquent loans are presumed to possess additional risk. Therefore, the calculated fair value of loans is reduced by the allowance for loan losses.   63   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009   The fair value of loans held for sale is estimated based on outstanding investor commitments or in the absence of such commitments, is based on current yield requirements or quoted market prices.  Loan Servicing Assets  Fair value is determined through estimates provided by a third party. To estimate the fair value, the third party considers market prices for similar assets and the present value of expected future cash flows associated with the servicing assets calculated using assumptions that market participants would use in estimating future servicing income and expense. Such assumptions include estimates of the cost of servicing loans, loan default rates, an appropriate discount rate, and prepayment speeds.  Deposits  The fair value of demand deposits, savings accounts, and money market accounts is the amount payable on demand at the reporting date. The fair value of fixed maturity time deposits is estimated using a discounted cash flow approach that applies current market rates to a schedule of aggregated expected maturities of time deposits.  Borrowings  The fair value of borrowings is based on quoted market prices for the identical debt when traded as an asset in an active market.  If a quoted market price is not available, fair value is calculated by discounting scheduled cash flows through the borrowings' estimated maturity using current market rates.  Junior Subordinated Debentures  There is no trading market for the Companys debentures.  Therefore the fair value of junior subordinated debentures is determined using an expected present value technique. The fair value of the adjustable-rate debentures approximates their face amount, while the fair value of fixed-rate debentures is calculated by discounting scheduled cash flows through the debentures estimated maturity using current market rates.  Interest Rate Swap Agreement (Swap)  The fair value of the swap is the amount the Company would expect to pay to terminate the agreement and is based upon the present value of expected future cash flows using the LIBOR swap curve, the basis for the underlying interest rate.  Other Financial Instruments The fair values of letters of credit and unused lines of credit approximate the fee charged to make the commitments.  (20) Fair Values Measurements  Some of the financial instruments disclosed in the previous note are measured at fair value in the consolidated financial statements. Accounting principles establish a three-level valuation hierarchy for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instruments categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels are defined as follows.  · Level 1  inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. · Level 2  inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. · Level 3  inputs to the valuation methodology are unobservable and significant to the fair value measurement.   64   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    The following table presents for each of the fair-value hierarchy levels the carrying value of the Companys assets and liabilities that are measured at fair value on a recurring and non-recurring basis at December 31,  2011, by caption on the Condensed Consolidated Balance Sheet (dollars in thousands).


|                                   |             |                                |                                     |                        |     |                  |       |        |                   |   |       |                     |       |        |               
|---------------------------------- | ----------- | ------------------------------ | ----------------------------------- | ---------------------- | --- | ---------------- | ----- | ------ | ----------------- | - | ----- | ------------------- | ----- | ------ | --------------
|                                   |             |                                |                                     |                        |     |                  |       |        | Internal models   |   |       | Internal models     |       |        |               
|                                   |             |                                |                                     |                        |     | Quoted market    |       |        | with significant  |   |       | with significant    |       |        | Total carrying
|                                   |             |                                |                                     |                        |     | prices in active |       |        | observable market |   |       | unobservable market |       |        | value in the  
|                                   |             |                                |                                     |                        |     | markets          |       |        | parameters        |   |       | parameters          |       |        | Consolidated  
|                                   |             |                                |                                     |                        |     | (Level 1)        |       |        | (Level 2)         |   |       | (Level 3)           |       |        | Balance Sheet 
|Measured on a recurring basis:     |             |                                |                                     |                        |     |                  |       |        |                   |   |      
|                                   | Assets      |                                |                                     |                        |     |                  |       |        |                   |   |       |                    
|                                   |             | Securities available-for-sale: |                                     |                        |     |                  |       |        |                   |   |       |                     |      
|                                   |             |                                | U.S. Treasury                       | $                      | 502 |                  |       | -      |                   |   | -     |                     |       | 502   
|                                   |             |                                | U.S. government sponsored           |                        |     |                  |       |        |                   |   |       |                     |       |       
|                                   |             |                                |                                     | enterprise obligations |     | -                |       |        | 56,125            |   |       | -                   |       |        | 56,125        
|                                   |             |                                | State and municipal obligation      |                        | -   |                  |       | 55,425 |                   |   | -     |                     |       | 55,425
|                                   |             |                                | All other                           |                        | -   |                  |       | 1,407  |                   |   | 799   |                     |       | 2,206 
|                                   |             |                                |                                     | Total assets           | $   | 502              |       |        | 112,957           |   |       | 799                 |       |        | 114,258       
|                                   |             |                                |                                     |                        |     |                  |       |        |                   |   |       |                     |       |        |               
|                                   | Liabilities |                                |                                     |                        |     |                  |       |        |                   |   |       |                    
|                                   |             | Interest rate swap agreement   | $                                   | -                      |     |                  | 4,415 |        |                   | - |       |                     | 4,415
|                                   |             | Letters of credit              |                                     | -                      |     |                  | 233   |        |                   | - |       |                     | 233  
|                                   |             |                                |                                     | Total liabilities      | $   | -                |       |        | 4,648             |   |       | -                   |       |        | 4,648         
|                                   |             |                                |                                     |                        |     |                  |       |        |                   |   |       |                     |       |        |               
|Measured on a non-recurring basis: |             |                                |                                     |                        |     |                  |       |        |                   |   |      
|                                   | Assets      |                                |                                     |                        |     |                  |       |        |                   |   |       |                    
|                                   |             | Loans                          |                                     |                        |     |                  |       |        |                   |   |       |                     |      
|                                   |             |                                | Loans-held-for-sale                 | $                      | -   |                  |       | 7,556  |                   |   | -     |                     |       | 7,556 
|                                   |             |                                | Collateral dependent impaired loans |                        | -   |                  |       | -      |                   |   | 2,453 |                     |       | 2,453 
|                                   |             |                                | Other real estate owned             |                        | -   |                  |       | -      |                   |   | 4,235 |                     |       | 4,235 
|                                   |             |                                | Loan servicing assets               |                        | -   |                  |       | -      |                   |   | 2,489 |                     |       | 2,489 
|                                   |             |                                |                                     | Total assets           | $   | -                |       |        | 7,556             |   |       | 9,177               |       |        | 16,733        

The following table shows a reconciliation of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2011 (in thousands).


| |                                                        |  |  |  |   |       | 
| | ------------------------------------------------------ |  |  |  | - | ----- | 
| | Securities available for sale, beginning of period     |  |  |  | $ | 958   | 
| | Realized loss included in operations                   |  |  |  |   | (34)  | 
| | Unrealized loss included in other comprehensive income |  |  |  |   | (125) | 
| | Securities available for sale, end of period           |  |  |  | $ | 799   | 

65   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2011, 2010 and 2009    The following table presents for each of the fair-value hierarchy levels the Companys assets and liabilities that were measured at fair value on a recurring and non-recurring basis at December 31, 2010, by caption on the Consolidated Balance Sheet (dollars in thousands).  Internal modelsInternal modelsQuoted marketwith significantwith significantTotal carryingprices in activeobservable marketunobservable marketvalue in themarketsparametersparametersConsolidated(Level 1)(Level 2)(Level 3)Balance SheetMeasured on a recurring basis:AssetsSecurities available-for-sale:U.S. Treasury$503--503U.S. government sponsoredenterprise obligations-43,209-43,209State and municipal obligation-67,958-67,958All other-1,3679582,325Total assets$503112,534958113,995LiabilitiesInterest rate swap agreement$-933-933Letters of credit-127-127Total liabilities$-1,060-1,060Measured on a non-recurring basis:AssetsLoansLoans-held-for-sale$-14,113-14,113Collateral dependent impaired loans--3,1163,116Other assetsOther real estate owned--3,7403,740Loan servicing assets--2,2222,222Total assets$-14,1139,07823,191   The following table shows a reconciliation of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2010 (in thousands).  Securities available for sale, beginning of period$972Unrealized gain included in other comprehensive income26Impairment charges included in earnings(40)Securities available for sale, end of period$958   66