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   2012 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 24 Management's Report on the Effectiveness of Internal Controls over Financial Reporting 26 Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting 27 Consolidated Financial Statement Report of Independent Registered Public Accounting Firm on Consolidated Financial Statements 28 Consolidated Balance Sheets 29 Consolidated Statements of Income 30 Consolidated Statements of Comprehensive Income 31 Consolidated Statements of Stockholders' Equity 32 Consolidated Statements of Cash Flows 33 Notes to Consolidated Financial Statements 34   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 24, 2013, 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, including under the heading Risk Factors in the Companys 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.  Some examples of forward-looking statements include statements related to our expectations on the direction of interest rates, demand for our loans, changes in customer transactions types, and the payment performance of our loan portfolio.  Our experience and assumptions we believe are reasonable to form the basis of our stated expectations, but results can also be impacted by other factors.  As described in our public filings, factors which may cause our results to vary materiality from our expectations include, among many others,  adverse changes in the global economy which may affect interest rates and as well as the stability of our local service areas, which may affect loan demand and credit quality; changes in fees related to servicing electronic transactions which may affect consumer usage, and continued focus of regulatory authorities at the state, federal and international level on bank regulation.  We present below a summary of selected financial highlights to help you see a snapshot of our performance for the past five years. Balance sheet information is as of the year end, while income statement and average balance information is for the full-year period.  (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)2012% Change2011201020092008Income Statement Information:Net interest income$65,6036.72%61,47361,14154,37447,485Provision for loan losses4,30013.91%3,7756,1504,3453,805Non-interest income35,12321.92%28,80826,72124,77022,454Operating expenses69,3757.72%64,40357,85154,20447,243Income taxes8,43436.52%6,1786,2055,4014,958Net income attributable to CNC18,83715.48%16,31217,65615,19413,933Balance Sheet Data:Total investments(1)$281,357(0.98)%284,139272,336280,797261,149Total loans, net1,441,45512.93%1,276,4261,189,2211,145,7071,076,620Total assets1,887,0287.17%1,760,7641,661,5041,566,0001,419,037Total deposits1,662,8637.52%1,546,6101,473,3301,377,6971,228,907Total borrowings(2)55,843(4.35)%58,38351,87761,38877,406Total equity144,3636.75%135,238123,794111,735100,438Average assets1,822,8677.52%1,695,3271,627,1131,535,2241,329,056Average equity138,1717.62%128,393116,696104,19695,004Asset Under Administration:(3)Book value (cost basis)$1,879,3978.88%1,726,1721,658,1111,591,9431,573,960Market value2,115,34613.84%1,858,1301,830,5491,651,7771,450,021Per Share Data:Net income, basic$9.9815.51%8.649.358.067.36Net income, diluted$9.7615.09%8.489.207.937.24Cash dividends(4)$4.7465.16%2.872.722.472.25Book Value$74.646.01%70.4165.5459.3353.21Closing stock price(5)$141.039.14%129.2295.8581.7878.98Weighted average share - diluted1,929,3600.29%1,923,7771,919,1921,917,5121,926,044Other ratios:Return on average assets1.03%7.29%0.96%1.09%0.99%1.05%Return on average equity13.63%7.32%12.70%15.13%14.58%14.67%Return on beginning equity13.93%5.69%13.18%15.80%15.13%15.11%Dividend payout(4)48.57%43.53%33.84%29.48%31.23%31.10%Average equity to average assets7.58%0.13%7.57%7.17%6.90%7.15%Net interest margin4.02%(0.74)%4.05%4.26%4.10%4.10%Efficiency(6)67.38%(3.77)%70.02%64.71%67.14%66.04%Employees (year end)Total5373.47%519481459430FTE's4804.58%459407379363  (1)Includes the Company's 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)Includes $1.63 per share accelerated to December 2012 from February 2013.(5)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 disclosed prices on OTC.BB.(6)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.  RESULT OF OPERATIONS  Messrs. Hamlin messages to shareholders in this Annual Report provide a further overview of the Company's 2012 results.  They include a discussion of the economy, the banking industry, the regulatory environment, and their impact on the Company, as well as activities internal to the Company.  For the year ended December 31, 2012, we reported a 15.5% improvement in net income to $18.8 million compared to $16.3 million for the year ended December 31, 2011, and $17.7 million for the year ended December 31, 2010.  Diluted earnings per share for each of these years were $9.76, $8.48, and $9.20, respectively.  The major components of these results, which include net interest income, provision for loan losses, non-interest 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 65% 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 2012, we saw our local economy continue the slow recovery from the 2009 recession. The national economy was showing signs of improved performance, but the expectation was a slow-down from the fourth quarter of 2011.  With slow growth, high unemployment, and little prospect for significant inflation, as previously noted, the FOMC signaled its willingness to maintain short-term interest rates at historically low levels into 2014.  The impact to our balance sheet would be continued downward pressure on asset yields combined with some reduction in liability costs.  This would erode both margin and spread.  Thus, net interest revenue growth would have to come from higher volumes of loans, a strategy we pursued in 2012.  Our predictions of an improving economy were generally accurate.  GDP growth was less than 2% in the first and second quarters of 2012, jumping to 3.1% for the third quarter, but the fourth quarter data showed a decline from the growth rate of the third quarter.  Unemployment remains above 7%, and inflation below 2%.  Given the continued relatively weak growth prospects, high unemployment, and low price inflation, the FOMC announced during the fourth quarter of 2012 that it expected to keep the target range for the federal funds rate at 0 to 1/4 percentthrough 2015, and possibly longer depending upon the unemployment rate.   2     As was seen in 2011, with rates remaining low for all of 2012, 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, despite being already at historical lows.  During 2012 we continued our strategy begun in the second half of 2011 to implement a multi-loan portfolio effort to increase originations of short- to medium-term duration, higher yielding loans to replace low yielding investments in federal funds (fed funds).  These efforts resulted in strong year-over-year growth in net interest income, despite a narrowing margin.  For 2012, tax-equivalent net interest income grew $3.8 million or 5.8%.  Impacting these results was a $102.1 million (6.4%) increase in average earning assets, all in higher-yielding loans, and a $52.4 million (3.9%) increase in average interest-bearing liabilities. During the year, the tax-equivalent yield on earning assets fell 26 basis points to 4.52%, while the cost of interest-bearing liabilities also fell by 26 basis points to 0.61%. The combination of these reductions led to stability of the net interest spread (the difference between rates earned and rates paid) at 3.91%, while net interest margin (net interest income divided by average earning assets, or balance sheet profit margin) fell to 4.02% from 4.05%. In 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 and a 21 basis point decline in margin from 2010.  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, 2012, 2011, and 2010.  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 $2,989,000 in 2012, $3,342,000 in 2011, and $3,646,000 in 2010.  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 $3,312,000 in 2012, $2,067,000 in 2011, and $2,043,000 in 2010.  The substantial increase in deferred costs in 2012 is related to loan costs incurred to originate indirect automobile loans, which tend to have relatively short average life, leading to faster cost amortization than the entire loan portfolio in general.  Average Balances and Interest for the Years Ended December 31,(dollars in thousands)201220112010AverageAverageAverageAverageAverageAverageBalanceInterestRateBalanceInterestRateBalanceInterestRateAssetsInterest-earning assets:Interest-bearing depositswith  others$6,953$130.19%$3,132$240.77%$1,729$362.06%Federal funds sold56,6931320.23145,5093540.2487,2032070.24Securities:Taxable59,4211,3272.2358,5411,5052.5748,3731,5473.20Tax-exempt217,2408,6773.99214,9859,7734.55224,27210,7504.79Loans, net1,365,95366,9634.901,178,13264,9075.511,161,17267,5715.82Total interest-earningassets1,706,26077,1124.521,600,29976,5634.781,522,74980,1115.26Non-interest-earningassets116,60796,859104,989Total assets$1,822,867$1,697,158$1,627,738Liabilities andStockholders' EquityInterest-bearing liabilities:Interest-bearing demand$179,9741150.06%$155,6881460.09%$139,1582550.18%Savings and moneymarket786,1961,6310.21692,2711,8310.26637,2152,3190.36Time deposits386,1153,9081.01449,4046,8661.53476,4869,5392.00Borrowings52,8782,8655.4251,5752,9055.6357,2563,2125.61Total interest-bearingliabilities1,405,1638,5190.611,348,93811,7480.871,310,11515,3251.17Non-interest-bearingdeposits252,751207,551187,957Other non-interest-bearingliabilities26,78212,27612,970Stockholders' equity138,171128,393116,696Total liabilities andstockholders' equity$1,822,867$1,697,158$1,627,738Interest rate spread3.91%3.91%4.09%Net interest margin$68,5934.02%$64,8154.05%$64,7864.25%  The following rate/volume analysis 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 net interest income 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  3     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.  We see from the analysis that substantially all of the interest income growth came from growth in loans.  Changes in rates reduced the overall increase in income.  As discussed previously, we had anticipated the potential impact of rate decreases, thus the reason why we set out in late 2011 to significantly increase total loans by reinvesting fed funds sold and new deposits. Deposit cost reductions provided an even greater benefit to net interest income.  Parsing the data, we see it was principally due to, as anticipated, rate and volume reductions in time deposits, a product generally less attractive to savers during low interest rate periods.  2012 compared to 20112011 compared to 2010Increase/(decrease)Increase/(decrease)Due to change inDue to change inVolumeRateTotalVolumeRateTotalInterest-earning assets:Interest-bearing deposits with others$16(27)(11)$19(31)(12)Federal funds sold(207)(15)(222)1425147Securities, taxable22(200)(178)292(334)(42)Securities, tax-exempt102(1,198)(1,096)(435)(542)(977)Loans, net9,673(7,617)2,056976(3,640)(2,664)Total9,606(9,057)549994(4,542)(3,548)Interest-bearing liabilities:Interest-bearing demand20(51)(31)27(136)(109)Savings and money market228(428)(200)187(675)(488)Time deposits(871)(2,087)(2,958)(517)(2,156)(2,673)Borrowings72(112)(40)(320)13(307)Total(551)(2,678)(3,229)(623)(2,954)(3,577)Net Change$10,157(6,379)3,778$1,617(1,588)29  Taking into account the results of 2012, and considering our expectation of continued low interest rates into 2015, we anticipate 2013 will be another year of narrowing net interest margin and spread as asset yields will continue to decline, and liability costs will have less and less opportunity for reduction. We remain encouraged that our local economy will grow, leading to opportunities for us to provide credit to growing business and households, resulting in loan and deposit growth.   However, overall net interest income growth will be in the low single digits due to the impact of asset yield declines.  Thus the contribution of net interest income to total revenues will fall below 65%.  We will see our greatest revenue growth in non-interest income sources, which is discussed hereafter.  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.  Non-Interest Income Non-interest income accounts for approximately 35% of total revenue, and growing, consistent with our strategy to broaden our revenue sources through providing comprehensive financial services.  It is composed mainly of revenues from: (a) service charges on deposit accounts, (b) fees for trust and investment services (asset management), (c) income from brokerage and investment subadvisory services, and (d) net revenues from mortgage banking.  For the year ended December 31, 2012, non-interest income increased $6.3 million or 22.0% from 2011, and for the year ended December 31, 2011, it increased $2.1 million or 7.8% from 2010. Service charges on deposit accounts increased 6.8% in 2012 from 2011, attributable to both increased revenues from our Courtesy Limit service and electronic transaction services associated with our debit card.  Service charges on deposit accounts increased 2.3% in 2011 from 2010 with growth only seen in electronic banking services.  Account maintenance service charges (included in service charges) have been relatively flat the last three years due to higher customer balances offsetting their periodic fees. Courtesy limit-related service fees and electronic banking revenues continued to increase with consumers shifting from cash and checks (paper-based) to electronic transactions. We expect a similar trend in 2013, and will be exploring opportunities for targeted price changes to enhance this revenue source.  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 market funds.  This income increased in 2012 by $0.5 million or 3.8% from 2011, and increased in 2011 by $1.5 million or 13.3% from 2010. For both 2012 and 2011, the increases in revenue were a result of an increase in the underlying fair value of assets under  4     administration (see table below), sales to new customers, and improved conditions in the stock market in general.  We expect similar positive results in 2013 from a growing customer base and rising stock market, which should contribute to a high single-digit increase in both revenues and fair value of assets under administration. The table below presents information about recent period-end actual and average balances of assets under administration and the related income for the respective years (dollars in thousands).  201220112010Book value of assets under administration (period end)$1,879,3971,726,1721,658,111Fair value of assets under administration (period end)$2,115,3461,858,1301,830,549Fair value of assets under administration (average)$1,988,0611,869,9001,685,694Trust and investment income$12,91612,44510,984  Brokerage and investment subadvisory services income increased by $2.5 million in 2012 from 2011. This increase as well as the increase from 2010 to 2011, were solely associated with our acquisition of OBS in late 2011. OBSs growing customer base and the related underlying assets are expected to contribute to revenue growth in excess of $1.0 million in 2013.  Mortgage banking income is another important source of non-interest 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), with results 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 grew over 85% in 2012 after having fallen 10.1% in 2011.  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 (new loans that change the terms of an already existing loan).  CNB Mortgage generally must originate approximately $150 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 expended as a result of regulatory changes, particularly enhanced disclosure requirements, appraisal requirements, and underwriting costs.  During years without significant refinance activity, the Company is more dependent upon purchase money mortgages.  Refinance activity in 2011 and 2010, while very strong, was much lower than in 2012 when mortgage interest rates kept falling. For the coming year we anticipate mortgage originations of about $300 to $330 million, somewhat lower than 2012s due to lower anticipated refinance activity. During each year, some of our originations are retained in the Banks portfolio.  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 past. For the years ended December 31, 2012, 2011 and 2010, CNB Mortgage originated and sold the following types of loans (dollars in thousands):  201220112010Purchase money mortgages$199,004115,529140,764Refinance mortgages151,531105,554114,012Total mortgage originations$350,535221,083254,776Of which:Sold to third parties$271,815166,240203,582Sold to (retained by) the Bank$78,72054,84351,194Percentage of total sold to Bank22.5%24.8%20.1%  Net loan servicing income fell by 5.6% in 2012, after having increased 5.8% in 2011. This income source is composed primarily of service fees earned on loans sold to Freddie Mac but serviced by us, and 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, since the interest income earned is not ours.) Net loan servicing income grew in 2011 due to higher underlying serviced loan balances and relatively lower amortization expense for loan servicing assets. Despite overall growth in serviced loans, the higher volume of refinancing in 2012 led to higher loan payoffs of previously-originated serviced loans, resulting in comparatively higher amortization of servicing rights.  Amortization expense was about $0.1 million higher in 2012 than either 2011 or 2010. With continuing  5     low interest rates, we expect loans serviced for Freddie Mac to increase further in 2013 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 should increase.   At each of the three years ended December 31, 2012, 2011, and 2010, we were servicing the following types of loans (dollars in thousands):  201220112010Residential mortgages (sold to Freddie Mac)$528,316461,950435,220Commercial loans and mortgages (participations sold)109,365114,969116,111Total loans serviced for others$637,681576,919551,331  The Companys contract to sell loans to Freddie Mac 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 non-interest income are losses on security transactions.  In each of the years 2011 and 2010, 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. The remainder was mostly due to losses on called securities resulting from recognition of unamortized premiums. No such write-downs occurred in 2012. 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 non-interest income rose $0.8 million in 2012 and $0.5 million in 2011.  Income grew in both years due to higher income from our investment in Cephas Capital Partners, a Small Business Investment Company. We expect these sources of non-interest income to be similar in 2013 as in 2012.  We expect continued earnings from Cephas, as it liquidates it positions, and we expect all other revenue sources to rise consistent with our underlying growth.  Operating Expenses  Operating expenses grew $5.0 million or 7.7% in 2012 from 2011.  Included in this growth figure is $3.9 million associated with the full-year impact of OBS, which compares to $1.3 million in operating expenses for OBS in 2011. In 2011, operating expenses increased $6.6 million, with half ($3.3 million) due to acquisition costs related to OBS (included in Professional and Other Services), and a higher accrual for the Stock Appreciation Rights Plan (SAR Plan) liability (included in Salaries and Employee Benefits). 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 highly service-oriented 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 2013, we expect further increases in total operating expenses due to our franchise growth.  Substantially all of the increase in salaries in the past two years has been due to wage increases and new staff, including OBS at a cost of $1.8 million in 2012.  Benefit costs declined in 2012 due to a lower accrual for the SAR Plan than in 2011.  The increase in 2011 was principally driven by significant SAR Plan accrual ($3.1 million in 2011 compared to $0.6 million in 2010) [See Note 14 to the Consolidated Financial Statements], which was a result of a combination of a higher stock price and lower long-term interest rates.  For 2013, salaries and benefit costs should increase about 2-4% from 2012.  Occupancy expenses increased $0.6 million (8.1%) in 2012 over 2011 and $0.7 million (10.7%) in 2011 over 2010. OBS accounted for $0.4 million of the increase in 2012. For all years, rent expense associated with our new offices  Greece-Latta, Jackson Ridge, and Alex-Park 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 2013, we expect to see higher occupancy expenses due to increases in rent and depreciation, as well as renovation costs associated with physical improvement investments in our facilities and related equipment.  Technology and data processing expenses increased $0.8 million or 18.5% in 2012 over 2011 and increased $0.6 million or 15.4% in 2011 over 2010 with OBS accounting for $0.2 million of the 2012 increase.  The 2012 and 2011 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. We are also incurring growing expenses for debit card processing services, but these costs are growing at a slower rate than their related income. In 2013 and forward we expect these same expenses to increase reflecting the Companys growth.   6     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 2012 compared to 2011, these fees fell, because those paid to OBS since its acquisition are eliminated in consolidation.  The drop in these fees was offset by an increase in credit reporting fees associated with the increased volume of loans originated.  However, the largest component of the decrease was due to fees incurred in 2011, not recurring in 2012.  In 2011 $1.1 million of professional fees were incurred related to the acquisition of OBS. For 2013 we expect this category to continue to rise with increases associated with growth in the market value of managed assets, and fees to consultants and professionals.  Marketing (advertising and promotion) and public relations (contributions and entertainment) expenses increased $0.2 million in 2012 from 2011 and $0.3 million in 2011 from 2010.  Increases in 2012 were associated with promotional activities associated with the Banks 125th anniversary celebration, as well as increased charitable contributions, and costs for on-boarding new deposit customers.  The increase in 2011 was mostly 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. Included in public relations expenses is our monetary commitment to our communities as measured by our contributions to community organizations which amounted to $390,000, $339,000, and $303,000 for 2012, 2011 and 2010, respectively. We expect marketing and public relations expenses will show a nearly 10% increase in 2013 for promotional activities surrounding the PGA Championship in Rochester, NY, and costs associated with re-branding at GVT and OBS.  Office-related expenses increased $0.1 million in 2012 due to check printing costs associated with new business deposit accounts, while in 2011 and 2010 they were relatively flat at $1.5 million.  Despite growth in customers, staff and physical locations, we have been able to manage the overall growth in these costs through continuing investment in cost-saving technology, including electronic communications. Notwithstanding these process improvements, for 2013 it is expected that these expenses will increase due to branding efforts at subsidiary companies combined with higher postage rates.  Intangible amortization expense was $1.5 million in 2012 and increased from $1.2 million in 2011 due to the addition of OBS intangible assets.  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 at GVT.  We believe this higher attrition rate was associated with customers transferring their accounts to a firm started by employees who left the Company. Similar attrition did not recur in 2012. Details of future amortization expense are found in Note 2 to the Annual Report.  Expenses associated with operating other real estate were $0.8 million in 2012, $1.0 million in 2011, and $1.3 million in 2010.  These comparatively high levels of historical expenses are mostly 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 2013.  Operating expenses for managing these and the handful of other properties approximated $0.7 million in 2012 and $0.8 million in both 2011 and 2010 with the balance of the expense associated with valuation writedowns.  We regularly review the carrying value of foreclosed 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 them.  Associated operating expenses will be directly impacted by the timing and number of properties sold, and new properties which might be acquired through future foreclosures.  Despite growth in deposits, FDIC insurance expenses in recent years have fallen due to changes in assessment methodologies.  In 2012, insurance costs fell $0.2 million, while they fell $0.7 million in 2011 and $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 $2.8 million remaining at December 31, 2012.  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 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 estimated our annualized premiums would fall as much as $1.0 million. In 2013, with our continued growth, premium expenses are expected to rise over 2012, but not to the extent seen prior to the rule change.  All other operating expenses grew $0.8 million in 2012 with about one-third due to OBS, and the remainder due to a variety of costs associated with our growth.  Expenses fell about $0.3 million in 2011 and grew about $0.4 million in 2010 with no particular material item.  For 2013, we expect to see some modest expense growth in this category consistent with the Companys growth.  7      Income Taxes  Our effective income tax rate was approximately 31%, 28%, and 26% 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 2012 and 2011 is directly attributable to lower tax-exempt income, which was caused by lower market interest rates. We anticipate our 2013 effective tax rate will be in the 30% to 33% 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, 2012, total assets of the Company were $1,887.0 million up $126.2 million or 7.2% from $1,760.8 million at year-end 2011. Substantially all of the asset increase occurred in the loan portfolio. Asset increases were principally funded by deposit inflows, continuing a multi-year trend as customers sought the safety and convenience of community banks, and to a lesser extent, redeployment of fed funds sold.  Cash and due from banks, including interest-bearing accounts, fell $2.7 million to $56.5 million, due to lower 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 $34.6 million at year end 2012, down from $67.5 million at year end 2011. 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 2012, we averaged about $56.7 million down from $145.5 million in 2011.  In 2011 the balance 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, and in 2012 we continued the loan growth with residential and commercial loans. For 2013, we expect federal funds sold balances to remain 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 fell $1.0 million in 2012 as depreciation expense exceeded new assets capitalized, while in 2011 it increased $1.7 million 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. For 2013 we expect to begin construction of a new office at CollegeTown at the University of Rochester, and an associated stand-alone drive-up ATM facility.  In total we anticipate investing about $3.0 million to $4.0 million for these and for existing facility renovations and equipment replacements with the remainder for computer hardware purchases. These investments have been, and will be, funded from current operating cash flow.  Goodwill and intangible assets fell due to amortization of the intangibles.  During 2012 we finalized our estimate of the fair value of assets acquired and liabilities assumed in connection with the acquisition of OBS.  Compared to our original estimates, the value of the technology and customer list intangibles increased, while the value of the non-controlling interest declined, and the net change impacted goodwill and deferred taxes.  However, in accordance with current accounting guidance, these changes were applied retrospectively to 2011.  More detail is presented in Note 2 to the Consolidated Financial Statements.  Prepaid FDIC assessment declined $1.1 million due to credits posted for the past four quarters assessments. At December 31, 2012, this balance was $2.8 million compared to $3.9 million at December 31, 2011. 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, 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 $3.2 million by year-end 2012 to $26.7 million. The increase was associated with mortgage servicing rights, which are more fully described in Note 6 of the 2012 Consolidated Financial Statements, and deferred taxes, which are more fully described in Note 10.  8      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 (U.S. GSEs or GSEs), 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, GSEs, 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, GSEs, etc.), issuers, credit quality 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 secure deposits in excess of FDIC insurance limits so these deposits are collateralized by eligible securities.  During 2012, total investment securities fell $2.9 million by year end. Throughout most of the year, as with 2011, 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.   Because market rates have been low for some time, and most of the portfolios higher yielding callable securities have already been called, we expect calls of current portfolio securities to slow, allowing us to continue to modestly increase the portfolio balance, but at interest rates lower than those maturing or called.  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, 2012, 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 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, 2012 the fair value of our securities exceeded their amortized cost basis by $5.9 million or 2.1%. We expect market rates to remain low in 2013, 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, 2012, the fair value of some individual securities remained below cost, as more fully discussed in Note 3 to the Consolidated Financial Statements.  None of these securities was considered to be other than temporarily impaired as of December 31, 2012, therefore no write-down of carrying value in the income statement was 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  9     assumptions from ours could produce significantly different results, which could have a material effect on out other comprehensive income.  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, 2012. 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. Some securities in the table below can be called by the issuer prior to their stated maturity.  Maturities and Yields of Debt Securities at December 31, 2012(dollars in thousands)AfterAfterOneFiveOnethroughthroughAfterYear orFiveTenTenLessYearsYearsYearsAmountYieldAmountYieldAmountYieldAmountYieldAvailable for SaleU.S. Treasury$4000.25%1000.21%--%--%U.S. GSE's2,0220.764,0001.3651,4221.442,7143.77State and municipal12,3953.2625,0022.941151.47--Corporate------1,0731.66Total$14,8172.84%29,1022.71%51,5371.44%3,7873.17%Held to MaturityU.S. GSE's$--%53.13%--%--%State and municipal31,6383.26133,9512.089,4761.30--Corporate------7805.51Total$31,6383.26%133,9562.08%9,4761.30%7805.51%  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, 2012, this limit for the Bank was approximately $26.0 million, and the Bank's largest committed borrowing relationship under these regulations was $15.7 million.  10      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.  Summary of Loans by CategoryAs of December 31,(dollars in thousands)20122011201020092008Commercial and industrial$213,467$198,744$212,707$214,841$205,818Mortgages:Commercial525,413467,413434,787429,955389,907Residential  - first lien286,972256,173232,953218,731213,411Residential  - second lien100,099101,87796,41683,23675,971Consumer:Automobile - indirect283,836227,541181,481171,902168,830Other18,32325,58326,43728,91925,999Other, including loans held for sale21,1137,55614,1136,6572,900Total loans1,449,2231,284,8871,198,8941,154,2411,082,836Plus - Net deferred loan costs9,5497,6345,9625,6985,776Less - Allowance for loan losses(17,317)(16,095)(15,635)(14,232)(11,992)Loans - net$1,441,455$1,276,426$1,189,221$1,145,707$1,076,620  As planned, gross loans increased significantly in 2012, rising $166.3 million (12.9%) with growth occurring in all major loan categories-commercial, mortgage, and indirect automobile. The largest dollar increases occurred in commercial mortgages and automobile loans, which were the focus of our origination efforts.  We also targeted significant residential loan growth for 2012, but with continued low interest rates, we sold most originations to the secondary market to reduce long-term interest rate risk in our balance sheet. Notwithstanding, we did grow that portfolio over $30 million through our 5-year and 10-year callable mortgages.  Excluded from the balances in the table are loans serviced for others, the balances of which are discussed in the Non-interest Income section. We sell many originated residential mortgage loans and sell participation interests in some large balance commercial loans to manage liquidity, interest rate, and credit 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 2013, a slower pace than in 2012, but we will adjust this rate depending upon corresponding growth in deposits, market interest rates for loans, and our level of capital formation. We expect to continue to manage the overall mix of loans -- commercial and individual (mortgage and consumer) -- near 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 51% / 49% at year-end 2012.  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.  In January 2013, the Consumer Financial Protection Bureau (CFPB) issued its final rule regarding Qualified Residential Mortgages (QRM). The CFPBs final rule, which takes effect Jan. 10, 2014, implements laws requiring mortgage lenders to consider consumers ability to repay home loans before extending them credit, a consideration we have always made prior to extending credit. Included in the rule is a definition of qualified mortgage loans, which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. Among its provisions, the rule provides a safe harbor for loans that satisfy the definition of a qualified mortgage and are not deemed to be higher-priced loans, which will help avoid unnecessary litigation. Further, the rule treats balloon-payment loans as qualified mortgages if they are originated and held in portfolio by small creditors operating predominantly in rural or underserved areas.  Unfortunately, this definition excludes our Company. We are evaluating these rules and their potential impact on our current products and our future balance sheet. We are particularly concerned about the potential for the proposed rule to impact our callable mortgage product (a $282 million portfolio at year-end 2012), which is not a balloon mortgage. The CFPB is also seeking comment on modifications to the final rule that would extend the safe harbor, qualified mortgage designation to additional loans originated and held in portfolio by community banks with less than $2 billion in assets, but we will quickly outgrow this measure.  11      Loan Quality  Poor credit quality can be devastating to a bank, as the world experienced during the end of the last decade. 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 increased $0.2 million from December 31, 2011 to December 2012, but declined to 1.28% of the loan portfolio from $1.42%, respectively.  At December 31, 2011, non-performing loans fell by $4.6 million  from 2010 when they stood at $22.8 million and were 1.90% of the loan portfolio. The highest balances of non-performing loans are concentrated within commercial relationships with about half of the balance primarily in the recreation sector  an industry 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 or liquidation.  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.  During the past three years we have also seen an increase in non-performing residential loans.  This increase is also tied to the effects of the recession, as a number of borrowers continue to struggle making monthly payments.  We work with each individually for a positive result, including short-term interest deferrals, financing in government-sponsored programs, and refinancing portfolio loans. Even with these community-focused strategies for troubled-loan resolution, borrowers circumstances can deteriorate rapidly and we could suffer significant losses.  As of December 31, 2012 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.  Interest can be earned on a cash basis for these loans in non-accrual status, and it was: $433,000 in 2012, $127,000 in 2011, and $35,000 in 2010.  The substantial increase in 2012 is related to the successful resolution of a long-standing non-accrual loan for which we recovered all past due interest owed.  Had non-accrual loans been current in accordance with their original terms, we would have recognized additional interest income approximating $596,000, $743,000 and $429,000 during 2012, 2011, and 2010, respectively. Instead these cash payments received 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, 2012, we had four commercial properties and 36 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 2012, 15 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. No subsequent writedowns have been taken on these properties.  As indicated by our current inventory, we have successfully liquidated most 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, 2012, there was one commercial relationship with a carrying value $4.3 million that was considered a TDR due to the nature of the concessions granted to the borrower. We have established no impairment reserve for the 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 this relationship, 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. At that  12     time, we renewed the forbearance agreement for an additional 24 months with higher monthly payments than under the previous agreement.  The borrower has paid as agreed. A loan totaling $0.3 million, previously classified as a TDR was liquidated in the second quarter of 2012. Additional information is set forth in Note 4 to the Consolidated Financial Statements.  Summary of Non-performing AssetsAs of December 31,(dollars in thousands)20122011201020092008Loans past due 90 days or more and accruing:Commercial, financial, and agricultural$4675225422106Real estate-commercial--413-121Real estate-residential250660658290326Consumer and other426234293375243Total past due 90 days or more and accruing7229691,5891,087796Loans in non-accrual status:Commercial, financial, and agricultural2,4293,9174,07010,2823,134Real estate-commercial10,1169,07811,0325,6562,617Real estate-residential5,2254,2126,1412,6093,018Consumer and other-100---Total non-accrual loans17,77017,30721,24318,5478,769Total non-performing loans18,49218,27622,83219,6349,565Other real estate owned:Commercial1,3732,5801,4002,607639Residential2,1831,6552,34016290Total other real estate owned3,5564,2353,7402,769729Total non-performing assets$22,04822,51126,57222,40310,294Restructured real-estatedebt (included in non-accrual loans)$4,3244,8264,885--Non-performing loans to total period-end loans1.28%1.42%1.90%1.70%0.88%Non-performing assets to totalperiod-end loans and other real estate1.52%1.75%2.21%1.94%0.95%Allowance to non-performing loans93.65%88.07%68.48%72.49%125.37%  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 incurred 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.  Summary of Changes in the Allowance for Loan LossesAs of and for the years ended December 31,(dollars in thousands)20122011201020092008Balance at beginning of year$16,09515,63514,23211,9929,679Provision charged to operations4,3003,7756,1504,3453,805Charge-offs:Commercial, financial and  agricultural(907)(2,082)(2,957)(1,063)(1,008)Real estate-commercial(746)(263)(678)(327)(28)Real estate-residential(721)(355)(286)(10)-Consumer and other(1,829)(1,863)(2,077)(1,564)(1,094)(4,203)(4,563)(5,998)(2,964)(2,130)Recoveries:Commercial, financial and agricultural16815324321654Real estate-commercial3-47590Real estate-residential65151502128Consumer and other8899449116174661,1251,2481,251859638Net charge-offs:(3,078)(3,315)(4,747)(2,105)(1,492)Balance at end of year$17,31716,09515,63514,23211,992Net charge-offs to average loans0.23%0.28%0.41%0.19%0.15%Allowance to total loans1.19%1.25%1.30%1.23%1.11%  The allowance for loan losses was $17.3 million at December 31, 2012, up from $16.1 million at December 31, 2011. We consider the allowance for loan losses at December 31, 2012 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 2012, continuing the downward trend from last year.  The largest dollar amounts of net charge-offs had been from commercial-related loans, but these have decreased due to improvements in the economy.  Consumer net charge-offs are generally stable in dollar terms, despite the increased portfolio.  On the other hand we are experiencing higher net charge-offs on residential-related loans.  The losses are occurring in loans to borrowers with sub-660 credit scores, and which were generally originated prior to 2008. Looking to 2013, we expect net charge-offs to stabilize around the 25 basis point level.  At December 31, 2012 we identified a total of 94 loans totaling $17.8 million that were considered impaired.  Of these, 5, with a balance of $1.2 million outstanding, had specific reserves associated with them amounting to $0.6 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 two-thirds of the related allowance associated with impaired loans.  The decrease in both the amount of impaired loans and the related reserve is due to improvements in and payoffs of formerly impaired loans.  The specific reserve associated with impaired and other loans was partially funded by the existing pool-based reserves. As more fully described in the Notes to the 2012 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 a loan become impaired and a specific impairment reserve is deemed necessary, a portion of the allowance becomes allocated for the specific reserve, and the total allowance is then adjusted upward or downward as necessary through the provision for loan losses. The pool-based reserve is then recalculated to determine whether additional provision is necessary on the remaining portfolio as part of the regular allowance estimation process.  As noted, we are seeing improvements in the economy.  Our local employment picture is generally faring better than the rest of the state, but is still relatively weak, just returning to a pre-recession state.  According to the New York State Department of Labor as of December 31, 2012, the Rochester MSA had an unemployment rate of 8.0%, compared to New York States of 8.2%, and the United States at 7.6%. While the nations unemployment rate declined, both New Yorks and the Rochester MSAs increased, which is likely a result of more laborers seeking to re-enter the workforce.  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 and the residential portfolio, while decreasing the allowance for the commercial portfolio.  14     The dollar amount in the mortgage portfolio has increased due mostly to the portfolios balance increases, but also due to higher year-over-year nonaccrual balances. The dollar amount in the commercial portfolio has fallen recognizing its declining percentage of the entire loan portfolio, overall improvement in credit quality, and an improved business climate.  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 year end 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.  Allocation of Allowance for Loan Loss and Categorical Percentage of Loan TypesAs of December 31,20122011201020092008$(1)%(2)$(1)%(2)$(1)%(2)$(1)%(2)$(1)%(2)Commercial(3)5,09851.07,38751.87,73554.07,53655.9$5,68955.0Residential3,10826.72,30727.91,86727.51,40226.21,38326.7Consumer7,67022.35,75520.35,35118.54,49917.93,74918.3Unallocated1,441-646-682-795-1,171-17,317100.016,095100.015,635100.014,232100.0$11,992100.0  (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  In December 2012, the Financial Accounting Standard Board (FASB) issued a proposed Accounting Standards Update (ASU) to Credit Losses Subtopic 825-15.  According to the FASB, the main objective in developing this proposal is to provide financial statement users with more decision-useful information about the expected credit losses on financial assets and other commitments to extend credit held by a reporting entity at each reporting date. This objective would be achieved by replacing the current impairment model, which reflects incurred credit events, with a model that recognizes expected credit risks and by requiring consideration of a broader range of reasonable and supportable information to inform credit loss estimates. These proposed amendments also would reduce complexity by replacing the numerous existing impairment models in current U.S. GAAP with a consistent measurement approach.  The proposed amendments would require an entity to impair its existing financial assets on the basis of the current estimate of contractual cash flows not expected to be collected on financial assets held at the reporting date. This impairment would be reflected as an allowance for expected credit losses. The proposed amendments would remove the existing ―”probable” threshold in U.S. GAAP for recognizing credit losses and broaden the range of information that must be considered in measuring the allowance for expected credit losses. More specifically, the estimate of expected credit losses would be based on relevant information about past events, including historical loss experience with similar assets, current conditions, and reasonable and supportable forecasts that affect the expected collectibility of the assets remaining contractual cash flows. An estimate of expected credit losses would always reflect both the possibility that a credit loss results and the possibility that no credit loss results. Accordingly, the proposed amendments would prohibit an entity from estimating expected credit losses solely on the basis of the most likely outcome (that is, the statistical mode).  As a result of the proposed amendments, financial assets carried at amortized cost less an allowance would reflect the current estimate of the cash flows expected to be collected at the reporting date, and the income statement would reflect credit deterioration (or improvement) that has taken place during the period. For financial assets measured at fair value with changes in fair value recognized through other comprehensive income, the balance sheet would reflect the fair value, but the income statement would reflect credit deterioration (or improvement) that has taken place during the period. An entity, however, may choose to not recognize expected credit losses on financial assets measured at fair value, with changes in fair value recognized through other comprehensive income, if both (1) the fair value of the financial asset is greater than (or equal to) the amortized cost basis; and (2) expected credit losses on the financial asset are insignificant.  We have not yet begun to evaluate the potential impact of this proposal.  However, if implemented as proposed, it might be possible that a higher allowance for loan losses would result, since losses would be recognized on an expected model, which takes into account the future in contrast to the current incurred model, which anticipates losses already incurred. Additionally we would need to consider the changes to and accounting for expected losses on investment securities.  15      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.  Average Deposits and Rates PaidFor the Years Ended December 31,(dollars in thousands)201220112010AmountRateAmountRateAmountRateNon-interest-bearing demand$252,751-%$207,551-%$187,957-%Interest-bearing demand179,9740.06155,6880.09139,1580.18Savings and money market786,1960.21692,2710.26637,2150.36Time386,1151.01449,4041.53476,4862.00$1,605,0360.35%$1,504,9140.59%$1,440,8160.84%  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, 2012 (dollars in thousands).  3 months or less$34,4994 through 6 months22,6967 through 12 months45,662Over 12 months54,732$157,589  Total deposits at December 31, 2012, were $1,663.0 million and were up $116.4 million from December 31, 2011.   Retail and commercial account deposits grew $117.8 million or 8.8%, 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 fell a modest $1.4 million.  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.  Substantially all of the retail and commercial deposit growth occurred in Monroe County, while substantially all of the municipal deposit reduction came in Ontario County, where we have a relatively larger long-term municipal deposit base of customers.  For 2013, we anticipate retail and commercial deposits to grow about 5% and municipal deposits to climb 3% from 2012. As in 2012, we expect the bulk 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 2012 and 2011, we found no need to borrow short-term funds during these years.  At December 31, 2012 we had no overnight borrowings.  Depending upon our liquidity needs, we might use short-term borrowings in 2013 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.  As of December 31, 2012, we had no short-term or medium-term borrowings beyond the payments due for the acquisition of OBS. These amount to $3.5 million due in November 2013, and a remaining contingent amount of $0.8 million with no stated maturity date.  Our long-term borrowings are in the form of junior subordinated debentures.  In 2007, we issued $20.6 million of fixed-to-floating-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.   16     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 2012, credit available to us under these lines increased by $135.9 million to $695.1 million at December 31, 2012, due partially to growth in the loan portfolios we pledge as collateral, and the addition of pledging commercial mortgages to the FHLB during the year. 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, 2012 we had none 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, impact a banks survival.  As measured using the Consolidated Statement of Cash Flows, for the year ended December 31, 2012, we used $35.6 million in net cash equivalents versus $11.5 million in net cash and equivalents in 2011.  Net cash provided by operating activities was $16.2 million in 2012 and $35.3 million in 2011.  Both the largest source and use of operating cash in each year were mortgage banking-related activities.  These activities were about 65% higher in 2012 than in 2011.  We expect 2013 operating activities to approximate levels experienced in 2012.  Cash used by investing activities in 2012 increased from 2011 to $157.2 million from $116.6 million 2011. Net portfolio loan originations were the largest user of cash.   Net purchases of securities used little cash in 2012 as purchases nearly equaled maturities and calls, while in 2011 net purchases used $12.3 million in cash. In 2011 we increased our portfolio to reinvest the high level of fed funds sold. Net portfolio loan originations were $158.3 million in 2012 and $99.4 million in 2011. The increases in both 2012 and 2011 were due to our efforts to reinvest liquid assets into higher yielding loans from fed funds sold.  In 2013, we expect net loan originations to be somewhat lower than 2011s as we slow our rate of loan growth from recent years.  Cash provided by financing activities was $105.4 million in 2012 compared to $69.7 million in 2011.  The largest source of financing funds in 2012 and 2011 was customer deposits.  Repayments of term borrowings used cash in both years.  For 2013, 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.  Payment due by periodAs of December 31, 2012(dollars in  thousands)AfterOneThreeYearYearsMoreLessThroughThroughThanThan oneThreeFiveFiveTotalYearYearsYearsYearsBorrowings$51,547---51,547Operating leases21,3162,4654,7374,5989,516WBI's acquisition payments4,3673,500867--Cephas Capital Partners II1,500---1,500Trillium Lakefront Partners4040---Total$78,7706,0055,6044,59862,563   17     Total obligations are $78.8 million at year-end 2012 compared to $82.7 million at year-end 2011.  The only significant change is WBIs commitment associated with the acquisition of OBS due to the scheduled May 2012 payment.  Except for the payments set forth in the table above, we are not aware of any material commitments in 2013.  Interest Rate Risk Management  Because our largest single 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, 2012.  Changes in InterestEstimatedRatesPercentage Change in(basis points)Future Net Interest Income200-%100(2)No change--100--200-   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, 2012, a relatively small upward shock (100 basis points) would cause an estimated 2% reduction in net interest income due to our gap position (discussed below), and a larger shock would have no measurable 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.   18     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, 2012. 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, 2012(dollars in thousands)Maturity/Repricing PeriodWithin 34 to 1213 to 3637 to 48Over 48MonthsMonthsMonthsMonthsMonthsInterest-earning assets:Interest-bearing deposits$91,159----Securities35,14911,89978,53240,439115,338Loans469,252180,111387,308180,238232,314Total interest-earnings assets595,560192,010465,840220,677347,652Interest-bearing liabilities:NOW accounts196,478----Savings and money market812,485----Time deposits65,555169,21997,20138,36513Borrowings51,5473,500867--Total interest-bearing liabilities1,126,065172,71998,06838,36513Interest rate swap affecting liabilities(51,547)---51,547Interest rate sensitivity gap$(478,958)19,291367,772182,312296,092Cumulative gap$(478,958)(459,667)(91,895)90,417386,509Cumulative gap ratio(1)55.4%63.1%93.2%106.5%126.9%Cumulative gap as percent of total assets(25.4)%(24.4)%(4.9)%4.8%20.5%  (1)Cumulative total interest-earning assets divided by cumulative total interest-bearing liabilities.  The table indicates that $479.0 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 $19.3 million more of interest-earning assets are repricing than interest-bearing liabilities.  For the entire one-year range, we are repricing $459.7 million more interest-bearing liabilities than assets and at 63.1% are within our gap ratio targets of 30% to 125%. We are asset sensitive at $367.8 million for the 13-36 month range, $182.3 million for the 37 to 48 month year range, and $296.1 million over 48 months. For the entire portfolio range, we are asset sensitive at $386.5 million versus asset sensitive of $324.9 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.  19      The following table provides additional detail of the interest sensitivity specifically of certain commercial and industrial loans as of December 31, 2012.  Maturity and Repricing of Commercial and Industrial LoansAs of December 31, 2012(dollars in thousands)AfterOneOneThroughAfterYear orFiveFiveLessYearsYearsTotalCommercial and industrial loans$167,958$39,465$6,044$213,467Maturing or repricing after one year:with a fixed interest rate$1,27839,4656,04446,787with a floating or adjustable rate$166,680--166,680  Capital and Dividends  The Company and Bank are each subject to certain regulatory capital requirements.  As of December 31, 2012, the Company and Bank each substantially 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 2013.  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.  On June 7, 2012, the US banking regulators published their Notice of Proposed Rule Making (NPRM) to implement changes in capital rules. In two different actions, both the Federal Reserve and the Federal Deposit Insurance Corporation have proposed new capital requirements for all banks that essentially accept all recommendations from the Basel III accord. While we had anticipated some changes for community banks, we were surprised that non-international banks like us would be within the scope of much of the proposal. The proposed rule will increase required capital and change risk-weightings for many assets. The proposed rule will apply across all institutions regardless of their systematic risk profile.  While the proposed rule was to be effective as of January 1, 2013, full compliance with most aspects would not be required until January 1, 2019.  In late 2012, the regulators indefinitely delayed implementation of the proposal. We have not determined the financial impact of the proposed rule on us, because of the regulatory uncertainty and the deferred implementation.   The key features that generally relate to banks like ours are:  · New minimum regulatory capital ratio requirements o A newly-introduced common equity tier 1 ratio of 4.5%, o Tier 1 capital ratio of 6% (increased from the current requirement of 4%), o Total capital ratio of 8% of risk-weighted assets (unchanged from the current requirement), and o Tier 1 leverage ratio of 4%.  · New capital conservation buffer: To avoid restrictions on capital distributions (e.g. distributing dividends) and discretionary bonus payments to executive officers, a bank will be required to hold an additional buffer of common equity Tier 1 capital in an amount above 2.5% of total risk-weighted assets in addition to the minimum common equity Tier 1, Tier 1, and total risk-based capital ratios.  · Capital is redefined, what is included in Tier 1 capital will change: o Cumulative preferred and trust preferred instruments would be excluded from Tier 1 capital. o Regulatory capital deductions would be stricter than those currently required. Examples of the more stringent requirements for common equity Tier 1 capital are: § Unrealized gains and losses on all available-for-sale securities and gains and losses associated with certain cash flow hedges will now flow through to common equity Tier 1 capital. Currently, these gains and losses are neutralized when calculating regulatory capital; § Goodwill and net defined benefit pension plan assets will be deducted; § Deferred tax assets (DTAs) arising from operating losses and tax credit carry forwards will be deducted;  20     § Mortgage servicing assets, deferred tax assets arising from temporary differences that an organization could not realize through net operating loss carry backs, and the common stock of unconsolidated financial institutions each would be individually limited to 10% of common equity Tier 1 capital, and, in the aggregate, to 15% of common equity Tier 1 capital; and § The amount of minority interests permitted in capital would be more limited.  · Asset risk-weighting changed: The most significant changes to the calculation of risk-weighted assets are: o The treatment of exposures to the U.S. government, U.S. public sector entities (such as states and municipalities), U.S. government-sponsored entities, and U.S. depository institutions would be unchanged from the current rules. However, the risk weight for an exposure to a foreign bank or public-sector entity (PSE), such as a state or municipality, would be assigned based on the rating of its home country. o Residential mortgage exposures would be assigned to a range of risk weight categories (between 35 and 200%) based upon the loan-to-value (LTV) ratio of the mortgage and certain mortgage product features. Currently, most residential mortgages are assigned a 50% risk weight despite the broad range of risk profiles associated with mortgage exposures. o Certain commercial real estate loans are assigned a 150% risk weight. o Nonaccrual loans and loans greater than 90 days past due are assigned a 150% risk weight.  We expect capital to increase in 2013 by a greater amount than in 2012 due to a combination of higher net income and lower dividends.  In December 2012, with uncertainty caused by the so-called fiscal cliff, we accelerated a $1.63 per share dividend that would have been paid in February 2013. So, per share dividends in 2013 will reflect only the semi-annual dividend paid in the summer, while 2012 included both semi-annual dividends and the December 2012 dividend.  Total dividends thus were $4.74 per outstanding common share or $9.0 million in 2012 and $5.4 million or $2.87 per outstanding common share in 2011. 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.  From time to time the Company purchases shares for treasury and re-issues shares from treasury.  In 2012, activity was much higher than in recent years, and generally related to stock option exercises.  This was due to employee retirements and tax planning activities of option holders in connection with the fiscal cliff uncertainty.  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.  In 2013, we expect to purchase more shares into treasury for past stock option exercises than in recent years due to 2012s higher activity.  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, 2012, there were no material commitments to extend credit which represent unusual risks outside of our normal course of business.   Legislative and Regulatory 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, which does not include us). A summary of the Financial Reform Acts principal provisions that have impacted or 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 ineffective 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  21     insured institutions with assets over $10 billion until the new reserve ratio is reached. We discussed the impact of this provision under Operating Expenses 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. 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. While not previously enforced by regulation, this has been our consistent practice.  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. That notwithstanding, we are able to satisfy the escrow requirements as proposed.  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.  ASU 2011-11 Disclosures about Offsetting Assets and Liabilities, issued December 2011, and ASU 2013-01 Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities, issued January 2013. The amendments in these Updates 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 ASU applies to derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset in accordance with Section 210-20-45 or Section 815-10-45 or subject to an enforceable master netting arrangement or similar agreement.The amendments are effective for us beginning in 2013. Because we do not currently engage in these types of transactions, we do not anticipate any material impact to our financial statements.  ASU 2012-02 Testing Indefinite-Lived Intangible Assets for Impairment, issued July 2012. The amendments in this update permit an entity first to assess qualitative factors to determine whether it is more likely than not that an indefinite-lived intangible asset is impaired as a basis for determining whether it is necessary to perform the quantitative impairment test in accordance with Subtopic 350-30, IntangiblesGoodwill and OtherGeneral Intangibles Other than Goodwill. The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent. Previous guidance in Subtopic 350-30 required an entity to test indefinite-lived intangible assets for  22     impairment, on at least an annual basis, by comparing the fair value of the asset with its carrying amount. If the carrying amount of the intangible asset exceeds its fair value, an entity should recognize an impairment loss in the amount of that excess. In accordance with the amendments in this Update, an entity will have an option not to calculate annually the fair value of an indefinite-lived intangible asset if the entity determines that it is not more likely than not that the asset is impaired. Permitting an entity to assess qualitative factors when testing indefinite-lived intangible assets for impairment results in guidance that is similar to the goodwill impairment testing guidance in Update 2011-08.  This update is effective for us beginning in 2013, although earlier adoption is permitted. Since we have recorded no indefinite-lived intangible assets, implementation of this update will have no impact on the financial condition or results of operations of the Company.  ASU 2013-02 Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, issued February 2013. The amendments in this Update seek to improve the reporting of reclassifications out of accumulated other comprehensive income by requiring an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. generally accepted accounting principles (GAAP) to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. This would be the case when a portion of the amount reclassified out of accumulated other comprehensive income is reclassified to a balance sheet account (for example, inventory) instead of directly to income or expense in the same reporting period. The amendments do not change the current requirements for reporting net income or other comprehensive income in financial statements. The amendments are effective for us beginning in 2013, and will result in additional disclosures, but no change in accounting for the relevant transactions.  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, 2012, and 2011.  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).  2012 Quarters:1st2nd3rd4thNet interest income$16,193$16,038$16,357$17,015Provision for loan losses(1,150)(1,150)(1,500)(500)Non-interest income8,1828,7588,9109,273Operating expenses(18,144)(17,243)(16,692)(17,296)Income taxes(1,510)(1,955)(2,138)(2,831)Noncontrolling interests(42)10851103Net income$3,529$4,556$4,988$5,764Basic earnings per share$1.87$2.41$2.64$3.06Diluted earnings per share$1.83$2.36$2.58$2.992011 Quarters:Net 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$0.99  The fourth quarter of 2012s results were positively impacted by growth in both net interest income and non-interest income, and lower provision for loan losses due to credit improvements.  This was offset by higher operating expenses associated with higher bonus accruals based upon full-year earnings and general expenses associated with growth. 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, acquisition costs of OBS, and higher intangible amortization.  23     Our Common Stock  At December 31, 2012, we had approximately 1,500 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 2013 Annual Meeting of Shareholders. Market value and dividend information is set forth in table below.  The Company currently pays a semi-annual dividend in February and August (exclusive of the acceleration of February 2013s dividend to December 2012).  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 2012, 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, 2012TotalAverageSharesPrice PerDatePurchased (Sold) (#)Share ($)PurposeApril100$152.56TreasuryJune(243)$153.53CompensationJune1,336$154.86TreasuryJuly222$149.24TreasuryNovember623$149.75TreasuryDecember7,434$147.07TreasuryDecember(21)$147.07CompensationTotal  purchases9,715Total sales(264)  24       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 2010. The $1.63 per share dividend paid in December 2012 was accelerated from the semi-annual dividend payment that would have been paid in February 2013.  #QuarterlyQuarterlyQuarterlySharesAverageHighLowBookDividendSoldSales PriceSales PriceSales PriceValuePaid20124th Quarter5,034$145.51$170.00$125.00$74.64$1.633rd Quarter2,748$148.70$190.00$138.00$73.42$1.612nd Quarter10,635$152.17$185.00$137.51$72.57-1st Quarter1,926$147.48$165.78$141.93$71.00$1.5020114th Quarter1,492$129.22$150.00$123.75$71.95-3rd Quarter3,216$111.34$118.13$107.50$69.55$1.442nd Quarter3,036$103.87$110.00$102.50$69.34-1st Quarter2,948$99.89$107.21$98.69$66.71$1.4320104th Quarter2,528$95.85$102.90$93.91$65.54-3rd Quarter3,172$91.89$100.00$90.03$63.55$1.432nd Quarter3,200$88.44$92.50$87.53$62.99-1st Quarter3,040$85.37$91.75$83.75$59.93$1.29  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 Price20124th Quarter1,963$123.24$130.00$115.003rd Quarter3,055$130.97$200.01$120.002nd Quarter1,897$112.01$135.00$105.001st Quarter5,603$93.56$105.00$87.5020114th 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$70.00  25     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, 2012.  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, 2012, 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, 2012.  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, 2012.   February 21, 2013   /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   26     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, 2012, 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 (Form 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, 2012, 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, 2012 and 2011, and the related consolidated statements of income, comprehensive income, stockholders equity, and cash flows for each of the years in the three-year period ended December 31, 2012, and our report dated February 21, 2013 expressed an unqualified opinion on those consolidated financial statements.  /s/ KPMG LLP Rochester, New York February 21, 2013  27     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, 2012 and 2011, and the related consolidated statements of income, comprehensive income, stockholders equity, and cash flows for each of the years in the three-year period ended December 31, 2012. 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, 2012 and 2011, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2012, 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, 2012, 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 21, 2013 expressed an unqualified opinion on the effectiveness of the Companys internal control over financial reporting.  /s/ KPMG LLP Rochester, New York February 21, 2013  28   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETSDecember 31, 2012 and December 31, 2011
(dollars in thousands, except per share data)   20122011AssetsCash and due from banks$47,74852,715Interest-bearing deposits with other financial institutions8,7676,490Federal funds sold34,64467,535Securities:- Available for sale, at fair value102,774114,258- Held-to-maturity (fair value of $180,015 in 2012 and $172,517 in 2011)175,850167,225Loans - net1,441,4551,276,426Premises and equipment  net15,11916,101Accrued interest receivable6,5966,627Federal Home Loan Bank stock and Federal Reserve Bank stock2,7332,656Goodwill15,57015,570Intangible assets  net6,2337,737Prepaid FDIC assessment2,8243,905Other assets26,71523,519Total Assets$1,887,0281,760,764Liabilities and Stockholders' EquityDeposits:DemandNon-interest bearing$283,547227,284Interest bearing196,478175,409Savings and money market812,485745,713Time370,353398,204Total deposits1,662,8631,546,610Borrowings4,2966,836Junior subordinated debentures51,54751,547Accrued interest payable and other liabilities23,95920,533Total Liabilities1,742,6651,625,526Canandaigua 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 2012 and 20119,7329,732Additional paid-in-capital9,9748,834Retained earnings129,502120,675Treasury stock, at cost (40,993 shares at December 31, 2012and 59,242 at December 31, 2011)(4,046)(4,912)Accumulated other comprehensive income, net(2,937)(1,455)Total Canandaigua National Corporation Stockholders' Equity142,225132,874Non-controlling interests2,1382,364Total Equity144,363135,238Total Liabilities and Equity$1,887,0281,760,764  See accompanying notes to consolidated financial statements.  29   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOMEYears Ended December 31, 2012, 2011 and 2010 (dollars in thousands, except per share data)   201220112010Interest income:Loans, including fees$66,96364,90767,571Securities7,0147,9368,652Federal funds sold132354207Other132436Total interest income74,12273,22176,466Interest expense:Deposits5,6548,84312,113Borrowings92-207Junior subordinated debentures2,7732,9053,005Total interest expense8,51911,74815,325Net interest income65,60361,47361,141Provision for loan losses4,3003,7756,150Net interest income after provision for loan losses61,30357,69854,991Non-interest income:Service charges on deposit accounts11,71310,97210,725Trust and investment services income12,91612,44510,984Brokerage and investment subadvisory services income2,81928086Net gain on sale of mortgage loans3,9592,1262,366Loan servicing income, net876928877Loan-related fees431267351Loss on securities transactions, net(118)(191)(170)Other non-interest income2,5271,9811,502Total non-interest income35,12328,80826,721Operating expenses:Salaries and employee benefits38,40735,01930,526Occupancy, net8,1427,5306,805Technology and data processing5,3094,4803,881Professional and other services3,8124,7513,297Marketing and public relations3,0772,8292,515Office supplies, printing and postage1,6651,5561,470Intangible amortization1,5041,187995Other real estate operations8541,0491,297FDIC insurance1,1861,4052,152Other operating expenses5,4194,5974,913Total operating expenses69,37564,40357,851Income before income taxes27,05122,10323,861Income taxes8,4346,1786,205Net income attributable to noncontrolling interests andCanandaigua National Corporation18,61715,92517,656Less: Net loss attributable to noncontrolling interests(220)(387)-Net income attributable to Canandaigua National Corporation$18,83716,31217,656Basic earnings per share$9.988.649.35Diluted earnings per share$9.768.489.20  See accompanying notes to consolidated financial statements.  30   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME [WITH RESPECTIVE TAX INFORMATION PRESENTED PARENTHETICALLY]Years Ended December 31, 2012, 2011 and 2010
(dollars in thousands)   201220112010Net income$18,61715,92517,656Other comprehensive income:Change in fair value ofinterest rate swaps,net of taxes of ($760), ($1,341) and $180 respectively(987)(2,141)324Change in unrealized gain onon securities available for sale,net of taxes of ($329), $180 and ($483) respectively(468)346(971)Plus reclassification adjustmentfor realized gains and losses included innet income on called securities,net of taxes of ($9), $69 and $44 respectively(27)14186Other comprehensive income$(1,482)(1,654)(561)Total comprehensive income17,13514,27117,095Comprehensive income attributableto the noncontrolling interest$(220)(387)-Comprehensive income attributable to the Company$17,35514,65817,095  See accompanying notes to consolidated financial statements.  31   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF STOCKHOLDERS EQUITYYears Ended December 31, 2012, 2011 and 2010 (dollars in thousands, except share data)    AccumulatedNumber ofAdditionalOtherNon-SharesCommonPaid-inRetainedTreasuryComprehensivecontrollingOutstandingStockCapitalEarningsStockIncome (Loss)InterestTotalBalance 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 incomePurchase 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 gains and 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 income--16,312-(1,654)(387)14,271Purchase 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-----2,7572,757Dividend to non-controlling interests-----(6)(6)Balance at December 31, 20111,887,254$9,7328,834120,675(4,912)(1,455)2,364135,238Comprehensive income:Change in fair value ofinterest rate swaps,net of taxes of ($760)----(987)-(987)Change in unrealized gain onon securities available for sale,net of taxes of ($329)----(468)-(468)Plus reclassification adjustmentfor realized gains and losses included innet income on called securities,net of taxes of ($9)----(27)-(27)Net income (loss) attributable to non-controlling interest andCanandaigua National Corporation--18,837--(220)18,617Total comprehensive income--18,837-(1,482)(220)17,135Purchase of treasury stock(9,715)---(1,442)--(1,442)Shares issued as compensation264-18-21--39Exercise of stock options ($1,122 tax benefit)27,700-1,122(1,035)2,287--2,374Cash dividend - $ 4.74 per share--(8,975)---(8,975)Dividend to non-controlling interests-----(6)(6)Balance at December 31, 20121,905,503$9,7329,974129,502(4,046)(2,937)2,138144,363  See accompanying notes to consolidated financial statements.  32   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIESCONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2012, 2011 and 2010
(dollars in thousands)   201220112010Cash flow from operating activities:Net income attributable to Canandaigua National Corporation$18,83716,31217,656Adjustments to reconcile net income toNet cash provided by operating activities:Depreciation, amortization and accretion7,2166,0975,285Provision for loan losses4,3003,7756,150Gain on sale of premises and equipment and other real estate, net(213)(105)(32)Writedown of other real estate200208493Deferred income tax benefit(1,328)(574)(763)Income from equity-method investments, net(336)(363)59Loss on calls of securities and write-down, net118191170Gain on sale of mortgage loans, net(3,959)(2,126)(2,366)Originations of loans held for sale(271,815)(166,240)(203,582)Proceeds from sale of loans held for sale262,217174,923198,492Increase in other assets(689)3043,564Increase in all other liabilities1,6792,930(2,857)Net cash provided by operating activities16,22735,33222,269Cash flow from investing activities:Securities available-for-sale:Proceeds from maturities and calls103,84280,15665,844Purchases(93,322)(79,888)(62,409)Securities held to maturity:Proceeds from maturities and calls36,32942,61333,256Purchases(46,632)(55,228)(31,076)Loan originations in excess of principal collections, net(158,306)(99,398)(45,135)Purchase of premises and equipment, net(1,597)(4,044)(4,428)Calls of FHLB stock, net of purchases of FHLB and FRB stock(95)(196)229Other investments  - net(679)(5)(752)Acquisition of WBI net of cash acquired-(1,725)-Proceeds from sale of other real estate3,2611,1581,144Net cash used by investing activities(157,199)(116,557)(43,327)Cash flow from financing activities:Net increase in demand, savings and money market deposits144,104163,46696,846Net decrease in time deposits(27,851)(90,186)(1,213)Principal repayments of term borrowings(2,632)(330)(9,534)Proceeds from sale of treasury stock394654Payments to acquire treasury stock(1,442)(219)(511)Proceeds from issuance of treasury stock under stock option plan1,252-310Tax benefit from stock option exercise1,122-232Change in noncontrolling interest, net(226)2,364-Dividends paid(8,975)(5,405)(5,121)Net cash provided by financing activities105,39169,73681,063Net (decrease) increase in cash and cash equivalents(35,581)(11,489)60,005Cash and cash equivalents - beginning of period126,740138,22978,224Cash and cash equivalents - end of period$91,159126,740138,229Supplemental disclosure of cash flow information:Interest paid$8,57512,25115,444Income taxes paid8,3367,3958,029Supplemental schedule of noncash investing activitiesReal estate acquired in settlement of loans$2,5341,8612,927Acquisitions:Fair value of assets acquired (noncash)-8,878-Fair value of liabilities assumed-8,454-  See accompanying notes to consolidated financial statements.  33


CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   (1) Summary of Significant Accounting Policies  Business  Canandaigua National Corporation (the Company) provides a full range of financial services, including banking, trust, investment, brokerage, 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. Although the Company owns 65% of OBS, pursuant to U.S. Generally Accepted Accounting Principles, the Company is required to consolidate 100% of OBS within the financial statements.  The 35% of OBS, which the Company does not own is separately accounted for as Non-controlling interests within the consolidated financial statements. All significant intercompany accounts and transactions have been eliminated in consolidation. The Company accounts for investments in less-than-majority-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 (OTTI) 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.  34   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    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 incurred 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  35   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   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.  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 non-interest income and operating 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. A qualitative assessment of goodwill is first performed, factoring company-specific and economic characteristics that might impact its carrying value. If the assessment indicates goodwill might be impaired, a quantitative test is performed in which 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, technology, and trade name intangibles, are amortized over their useful lives. Customer relationship intangibles are generally amortized over 15 years using an accelerated method. Technology is generally amortized over a five year period also using an accelerated method. Trade name intangible  36   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   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 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 wholly-owned subsidiaries file income tax returns in the U.S. Federal jurisdiction and principally in 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  37   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   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.  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 (Loss)  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 generally 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 as of January 1, 2012 with no material impact to the financial condition or results of operations. However, a new statement was added and some footnotes were revised:  ASU 2011-03.Reconsideration of Effective Control for Repurchase Agreements, issued April 2011. The main objective in developing this Update was 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 removed 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 were not changed by the amendments in this Update.  ASU 2011-04 Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs, issued May 2011. The amendments were 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 did not modify the requirements for when fair value measurements apply; rather, they generally represented clarifications on how to measure and disclose fair value under ASC 820, Fair Value Measurement.  ASU 2011-05 Presentation of Comprehensive Income, issued June 2011. The objective of this Update was to improve the comparability, consistency, and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income. The amendments required 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 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  indefinitely deferred certain reporting requirements for reclassifications out of accumulated other comprehensive income on a components basis.  ASU 2011-08 Testing Goodwill for Impairment, issued September 2011. The objective of this Update was to simplify how entities, both public and non-public, 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  38   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   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 following Accounting Standards Updates (ASU) were implemented in 2011 with no material impact to the Companys financial condition or results of operations:  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 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.  In addition to the Updates enumerated above, the Financial Accounting Standards Board issues, from time to time, updates containing technical amendments.  These updates are generally effective immediately upon their issuance, but have no practical impact on our financial condition or results of operations.  Because these are technical in nature, and have no material impact, a summary is not included herein.  (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 brokerage and investment sub-advisory services to the Bank and several other financial institutions, primarily community banks and credit unions, and had 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 in May 2012, a $3.5 million payment in November 2013, and $1 million cumulative quarterly non-maturity payments contingent upon net revenue improvements at OBS, all of which was included in Borrowings 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 is to pay an additional $0.2 million.  Additionally, the company funded the $2.5 million payment due May 31, 2012 for a total of $5.0 million.  Future 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.  The results of WBIs consolidated operations are included in the Consolidated Statements of Income from the date of acquisition.  In 2011, WBI reported an approximate $1.1 million loss, which was a result of merger-related legal and advisory expenses.  The acquisition resulted in the recording of certain intangible assets (customer list: $2.3 million and technology: $0.9 million), related deferred tax liabilities of $1.3 million, and goodwill of $6.8 million. In addition, a non-interest bearing note payable totaling $7.0 million was recorded along with a discount on the note of $0.2 million. The fair value of the non-controlling interest was estimated at $2.7 million. The customer list intangible is being amortized on an accelerated basis over twelve years and technology over five years.  The note discount is being amortized over three years to interest expense.   39   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   The allocation of the purchase price was based on the fair value of assets acquired and liabilities assumed as of the acquisition date.  During 2012, the Company completed its comprehensive analysis of the fair value of assets acquired and liabilities assumed.  In addition to changes in those assets and liabilities, the revisions resulted in a reduction in goodwill of approximately $0.2 million.  The December 31, 2011 consolidated balance sheet has been adjusted to reflect the results of this analysis.  The following table presents a summary of the fair value of assets acquired and liabilities assumed (in thousands):  Consideration paid:Cash to be paid to WBI$5,000Fair value of non-controlling interest2,700Total consideration$7,700Estimated recognized amounts of identifiable assets acquired:Cash and equivalents$525Premises and equipment61Other assets5,617Customer list intangible2,300Technology900Due to seller, net of discount(6,836)Accrued expenses(338)Deferred tax liability(1,280)Total identifiable net assets949Goodwill:$6,751  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 was 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. 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 was 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.  40   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    Acquisition-related identifiable intangible assets were comprised of the following at December 31, (in thousands):  20122011Gross carrying amountsCustomer list intangible from 2006$1,4201,420Customer list intangible from GVT6,8706,870Trade name from GVT100100Customer list intangible from investment company665665Customer list intangible from OBS2,3002,300Technology intangible from OBS900900Total12,25512,255Less accumulated amortization(6,022)(4,518)Intangible asset  net$6,2337,737  Amortization expense amounted to $1,504,000, $1,187,000, and $995,000 for the years ended December 31, 2012, 2011, and 2010, respectively. Amortization expense is projected over the next five years as follows: 2013: $1,241,000, 2014: $1,095,000; 2015: $991,000; 2016: $875,000 and 2017: $643,000.  (3) Securities  Amortized cost and fair value of available-for-sale and held-to-maturity securities at 2012 are summarized as follows:


|                               |                                                  |                                                                                                              |        |                   |       |                  |  |       |        |  |        |        
|------------------------------ | ------------------------------------------------ | ------------------------------------------------------------------------------------------------------------ | ------ | ----------------- | ----- | ---------------- |  | ----- | ------ |  | ------ | -------
|                               |                                                  |                                                                                                              |        | December 31, 2012
|                               |                                                  |                                                                                                              |        |                   |       | Gross Unrealized |  |       |       
|                               |                                                  |                                                                                                              |        | Amortized         |       |                  |  |       |        |  |        | Fair   
|                               |                                                  |                                                                                                              |        | Cost (1)          |       | Gains            |  |       | Losses |  |        | Value  
|                               |                                                  |                                                                                                              |        |                   |       |                  |  |       |        |  |        |        
|Securities Available for Sale: |                                                  |                                                                                                              |        |                   |       |                  |  |       |        | 
|                               | U.S. Treasury                                    | $                                                                                                            | 500    |                   | -     |                  |  | -     |        |  | 500   
|                               | U.S. government sponsored enterprise obligations |                                                                                                              | 60,158 |                   | 214   |                  |  | (196) |        |  | 60,176
|                               | State and municipal obligations                  |                                                                                                              | 37,512 |                   | 1,196 |                  |  | (22)  |        |  | 38,686
|                               | Corporate obligations(1)                         |                                                                                                              | 1,073  |                   | 23    |                  |  | (185) |        |  | 911   
|                               | Equity securities                                |                                                                                                              | 2,293  |                   | 208   |                  |  | -     |        |  | 2,501 
|                               |                                                  |                                                                                                              |        |                   |       |                  |  |       |        |  |        |        
|                               |                                                  | Total Securities Available for Sale                                                                          | $      | 101,536           |       | 1,641            |  |       | (403)  |  |        | 102,774
|                               |                                                  |                                                                                                              |        |                   |       |                  |  |       |        |  |        |        
|                               |                                                  | (1)Amortized cost includes cumulative $360,000 write-down prior to 2010 for other-than-temporary impairment.




|                             |                                                  |                                   |         |         |       |       |  |       |       |  |         |        
|---------------------------- | ------------------------------------------------ | --------------------------------- | ------- | ------- | ----- | ----- |  | ----- | ----- |  | ------- | -------
|                             |                                                  |                                   |         |         |       |       |  |       |       |  |         |        
|Securities Held to Maturity: |                                                  |                                   |         |         |       |       |  |       |       | 
|                             | U.S. government sponsored enterprise obligations | $                                 | 5       |         | -     |       |  | -     |       |  | 5      
|                             | State and municipal obligations                  |                                   | 175,065 |         | 3,858 |       |  | (112) |       |  | 178,811
|                             | Corporate obligations                            |                                   | 780     |         | 419   |       |  | -     |       |  | 1,199  
|                             |                                                  |                                   |         |         |       |       |  |       |       |  |         |        
|                             |                                                  | Total Securities Held to Maturity | $       | 175,850 |       | 4,277 |  |       | (112) |  |         | 180,015

41   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    Amortized cost and fair value of available-for-sale and held-to-maturity securities at December 31, 2011 are summarized as follows:  December 31, 2011Gross UnrealizedAmortizedFairCost (1)GainsLossesValueSecurities 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 obligations1,0932(296)799Equity securities1,295112-1,407Total securities Available for Sale$112,1872,408(337)114,258(1)Amortized cost includes cumulative write-downs of $360,000 prior to 2010 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  The amortized cost and fair value of debt securities by years to maturity as of December 31, 2012, follow (in thousands). Maturities of amortizing securities are classified in accordance with their contractual repayment schedules. Expected maturities will differ from contractual maturities since issuers may have the right to call or prepay obligations without penalties.  Available for SaleHeld to MaturityAmortizedAmortizedCost(1)Fair ValueCostFair ValueYearsUnder 1$14,81714,97631,63832,0761 to 529,10230,187133,956137,2045 to 1051,53751,3619,4769,53610 and over3,7873,7497801,199Total$99,243100,273175,850180,015(1)Amortized cost includes a cumulative $360,000 write-down prior to 2010 for other-than-temporary impairment.  At December 31, 2012, and 2011, securities at amortized cost of $208.0 million and $209.8 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 2012 or 2010.  Interest on securities segregated between taxable interest and tax-exempt interest for the years ended December 31, 2012, 2011, and 2010, follows (in thousands):  201220112010Taxable$1,3271,5051,547Tax-exempt5,6876,4317,105Total$7,0147,9368,652  42   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    The following table presents the fair value of securities with gross unrealized losses at December 31, 2012, 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 | $                                     | 28,787 |        |                | 187 |            |       | 1,615 |       |        | 9   |            |       | 30,402 |        |        | 196
|                               | State and municipal obligations                  |                                       | 801    |        |                | 8   |            |       | 992   |       |        | 14  |            |       | 1,793  |        |        | 22 
|                               | Corporate obligations                            |                                       | -      |        |                | -   |            |       | 873   |       |        | 185 |            |       | 873    |        |        | 185
|                               |                                                  |                                       |        |        |                |     |            |       |       |       |        |     |            |       |        |        |        |     |           
|                               |                                                  | Total temporarily impaired securities | $      | 29,588 |                |     | 195        |       |       | 3,480 |        |     | 208        |       |        | 33,068 |        |     | 403       
|                               |                                                  |                                       |        |        |                |     |            |       |       |       |        |     |            |       |        |        |        |     |           

Securities Held to Maturity:State and municipal obligations$10,044665,8094615,853112Total temporarily impaired securities$10,044665,8094615,853112  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, and is likely to be, maturity, the Company does not consider these securities to be other-than-temporarily impaired at December 31, 2012, except as discussed below.  In the available-for-sale portfolio, the Company holds approximately $0.9 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 $0.8 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 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, 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
|                               |                                                  |                                       |       |                     |        |            |                |       |       |       |        |            |     |       |        |        |        |            |    

The aggregate cost of the Company's cost-method investments totaled $4.5 million at December 31, 2012 and 2011, of which $2.7 million at each year end were in Federal Home Loan Bank stock and Federal Reserve Bank stock, as required by law.  43   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   (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 this 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.  The major classifications of loans at December 31, 2012 and December 31, 2011, follow (in thousands), along with a description of their underwriting and risk characteristics:  20122011Commercial and industrial$213,467198,744Mortgages:Commercial525,413467,413Residential  - first lien286,972256,173Residential  - second lien100,099101,877Consumer:Automobile - indirect283,836227,541Other18,32325,583Other, including loans held for sale21,1137,556Total loans1,449,2231,284,887Plus - Net deferred loan costs9,5497,634Less - Allowance for loan losses(17,317)(16,095)Loans - net$1,441,4551,276,426  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- and non-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 4% 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  44   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   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 processed by automobile dealers on behalf of the Bank) loans, recreational vehicle loans, boat loans, aircraft loans, home improvement loans, and personal loans (collateralized and 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 $109,365,000 and $114,969,000 at December 31, 2012 and 2011, respectively.  Residential mortgage loans serviced for Freddie Mac, amounted to $528,316,000 and $461,950,000 at December 31, 2012 and 2011, 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 $8,386,000 and $5,366,000 at December 31, 2012, and 2011, respectively. During 2012, new borrowings amounted to $4,519,000 (including borrowings of executive officers and directors that were outstanding at the time of their election), and repayments and other reductions were $1,499,000. Additionally, the Bank has issued a letter of credit totaling $3,500,000 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). Notwithstanding the estimated allocations set forth in any table, the entirety of the allowance is available to absorb losses in any portfolio.  Years Ended December 31,201220112010Balance at the beginning of year$16,09515,63514,232Loans charged off(4,203)(4,563)(5,998)Recoveries of loans charged off1,1251,2481,251Provision charged to operations4,3003,7756,150Balance at end of year$17,31716,09515,635  45   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    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, 2012 and 2011 (in thousands). Loan balances included in the Unallocated column represent the balance of net deferred loan costs.


|                              |   |                |  |             |  |             |  |             |  |            |  |            |  |          |  |             |  |          
|----------------------------- | - | -------------- |  | ----------- |  | ----------- |  | ----------- |  | ---------- |  | ---------- |  | -------- |  | ----------- |  | ---------
|December 31, 2012             |   |                |  | Residential |  | Residential |  |             |  |            |  |            |  |          |  |            
|                              |   |                |  |             |  | mortgage  - |  | mortgage  - |  |            |  |            |  | Loans    |  |             |  |          
|                              |   | Commercial     |  | Commercial  |  | first       |  | second      |  | Consumer - |  | Consumer - |  | held for |  |             |  |          
|                              |   | and industrial |  | mortgage    |  | position    |  | position    |  | indirect   |  | other      |  | sale     |  | Unallocated |  | Total    
|Beginning Balance             | $ | 6,393          |  | 994         |  | 1,786       |  | 521         |  | 4,839      |  | 916        |  | -        |  | 646         |  | 16,095   
|Charge-offs                   |   | (907)          |  | (746)       |  | (673)       |  | (48)        |  | (1,341)    |  | (488)      |  | -        |  | -           |  | (4,203)  
|Recoveries                    |   | 168            |  | 3           |  | 18          |  | 47          |  | 544        |  | 345        |  | -        |  | -           |  | 1,125    
|Provision                     |   | (2,393)        |  | 1,586       |  | 1,511       |  | (54)        |  | 2,688      |  | 167        |  | -        |  | 795         |  | 4,300    
|Ending Balance                | $ | 3,261          |  | 1,837       |  | 2,642       |  | 466         |  | 6,730      |  | 940        |  | -        |  | 1,441       |  | 17,317   
|                              |   |                |  |             |  |             |  |             |  |            |  |            |  |          |  |             |  |          
|of which:                     |   |                |  |             |  |             |  |             |  |            |  |            |  |          |  |             |  |          
|Amount for loans individually |   |                |  |             |  |             |  |             |  |            |  |            |  |          |  |             |  |          
|evaluated for impairment      | $ | 515            |  | 88          |  | -           |  | -           |  | -          |  | -          |  | -        |  | -           |  | 603      
|Amount for loans collectively |   |                |  |             |  |             |  |             |  |            |  |            |  |          |  |             |  |          
|evaluated for impairment      | $ | 2,746          |  | 1,749       |  | 2,642       |  | 466         |  | 6,730      |  | 940        |  | -        |  | 1,441       |  | 16,714   
|Balance of loans individually |   |                |  |             |  |             |  |             |  |            |  |            |  |          |  |             |  |          
|evaluated for impairment      | $ | 2,429          |  | 10,116      |  | -           |  | 50          |  | -          |  | -          |  | -        |  | -           |  | 12,595   
|Balance of loans collectively |   |                |  |             |  |             |  |             |  |            |  |            |  |          |  |             |  |          
|evaluated for impairment      | $ | 211,038        |  | 515,297     |  | 286,972     |  | 100,049     |  | 283,836    |  | 18,323     |  | 21,113   |  | 9,549       |  | 1,446,177

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  The balance in the allowance for loan losses decreased to 1.19% of the loan portfolio at December 31, 2012 from 1.25% of the loan portfolio at December 31, 2011. This decrease was principally due to the lower level of specific loan impairment reserves compared to 2011 combined with several key credit quality measurements: Internally classified loans (loans rated 6,7,8) decreased, the percentage of non-performing loans to total loans decreased, and net charge-offs to average loans decreased. These improvements offset higher reserve requirements due to year-over-year portfolio growth. The most significant allocation reduction as a result of these improvements was a reduction of approximately $2.4 million for commercial and industrial loans. Offsetting some of these reduced levels were increases to the consumer and  residential mortgage pools resulting from significant loan growth and higher base loss factors associated with increases in the volume of past due loans.  Finally, due to improving economic conditions in our market (increased auto sales, increased home sales, stable median home prices, and improving consumer confidence in the Rochester area from last year) an 11 basis point economic factor adjustment was applied to the majority of the portfolio pools, down from 14 basis points in 2011.   46   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    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.  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; most commercial construction loans; 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).  47   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    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.  Loans in category 9 and unrated are evaluated for credit quality after origination principally based upon delinquency status, but may also include credit scores and collateral valuations.  The following tables present the loan portfolio as of December 31, 2012 and December 31, 2011 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.  Credit Quality Indicator Analysis as of December 31, 2012ResidentialResidentialmortgage  -mortgage  -LoansDeferredCommercialCommercialfirstsecondConsumer -Consumer -held forFees andand industrialmortgagepositionpositionindirectothersaleCostsTotal1-Superior$15,422----386--15,8082-Good15,42228,2361,409--974--46,0413-Satisfactory76,473219,7481,506253----297,9804-Watch44,633213,2676,192389----264,4815-Special Mention9,52721,581------31,1086-Substandard17,16416,8955,063377----39,4997-Doubtful---------8-Loss---------Subtotal$178,641499,72714,1701,019-1,360--694,9179 and not rated34,82625,686272,80299,080283,83616,96321,1139,549763,855Total$213,467525,413286,972100,099283,83618,32321,1139,5491,458,772  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  48   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010     The table below presents a summary of information regarding nonaccruing loans and other nonperforming assets as of the end of the respective periods (in thousands):  December 31,December 31,December 31,201220112010Accruing loans 90 days or more delinquent$7229691,589Nonaccruing loans17,77017,30721,243Total nonperforming loans18,49218,27622,832Other real estate owned3,7594,6324,291(less write-down of other real estate owned)(203)(397)(551)Total nonperforming assets$22,04822,51126,572  The following tables present, as of December 31, 2012 and December 31, 2011, additional details about the loan portfolio in the form of an aging analysis. Amounts exclude deferred fees and costs (in thousands).  Aging Analysis as of December 31, 201290 Days> 90 Days30-59 Days60-89 DaysOrTotalTotalandNon-AccrualPast DuePast DueGreaterPast DueCurrentLoansAccruingLoansCommercial and industrial$2,4783,8112,4758,764204,703213,467462,429Commercial mortgages1,3651,16710,11612,648512,765525,413-10,116Residential - first lien4,3691,0135,04810,430276,542286,9722014,847Residential - junior lien6165114271,55498,545100,09949378Consumer:Automobile - Indirect2,7587014123,871279,965283,836412-Other3081141443617,88718,32314-Loans held-for-sale----21,11321,113--$11,8947,31718,49237,7031,411,5201,449,22372217,770  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--Total$5,6791,31918,27625,2741,259,6131,284,88796917,307  49   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    A summary of information regarding impaired loans follows (in thousands):


|                                                             |   |               |  |  |               |  |  |              
|------------------------------------------------------------ | - | ------------- |  |  | ------------- |  |  | -------------
|                                                             |   | As of and for |  |  | As of and for |  |  | As of and for
|                                                             |   | the year      |  |  | the year      |  |  | the year     
|                                                             |   | ended         |  |  | ended         |  |  | ended        
|                                                             |   | December 31,  |  |  | December 31,  |  |  | December 31, 
|                                                             |   | 2012          |  |  | 2011          |  |  | 2010         
|                                                             |   |               |  |  |               |  |  |              
|Recorded investment at period end                            | $ | 17,770        |  |  | 17,307        |  |  | 21,655       
|Impaired loans with specific related allowance at period end | $ | 1,200         |  |  | 2,453         |  |  | 3,116        
|Amount of specific related allowance at period end           | $ | 603           |  |  | 1,138         |  |  | 674          
|Average investment during the period                         | $ | 19,014        |  |  | 20,394        |  |  | 21,862       
|Interest income recognized on a cash basis during the period | $ | 433           |  |  | 127           |  |  | 35           
|Interest income forgone on impaired loans                    | $ | 596           |  |  | 743           |  |  | 429          

The details of impaired loans as of December 31, 2012 and December 31, 2011 follow (in thousands):  December 31, 2012


|                           |                                        |          |       |            |        |           |     |           |       |            |     |           
|-------------------------- | -------------------------------------- | -------- | ----- | ---------- | ------ | --------- | --- | --------- | ----- | ---------- | --- | ----------
|                           |                                        |          |       |            |        | Unpaid    |     | Specific  |       | Average    |     | Interest  
|                           |                                        |          |       | Recorded   |        | Principal |     | Related   |       | Recorded   |     | Income    
|                           |                                        |          |       | Investment |        | Balance   |     | Allowance |       | Investment |     | Recognized
|With no specific allowance |                                        |          |       |            |        |           |     |           |       |           
|                           | Commercial and industrial              | $        | 1,592 |            | 2,042  |           | -   |           | 1,604 |            | 202
|                           | Commercial mortgage                    |          | 9,753 |            | 11,407 |           | -   |           | 8,830 |            | 112
|                           | Residential mortgage - first position  |          | 4,847 |            | 5,110  |           | -   |           | 4,663 |            | 84 
|                           | Residential mortgage - second position |          | 378   |            | 391    |           | -   |           | 329   |            | 33 
|                           | Consumer - other                       |          | -     |            | -      |           | -   |           | -     |            | 2  
|                           |                                        | Subtotal |       | 16,570     |        | 18,950    |     | -         |       | 15,426     |     | 433       
|With specific allowance    |                                        |          |       |            |        |           |     |           |       |           
|                           | Commercial and industrial              |          | 837   |            | 924    |           | 515 |           | 1,759 |            | -  
|                           | Commercial mortgage                    |          | 363   |            | 445    |           | 88  |           | 1,829 |            | -  
|                           | Residential mortgage - first position  |          | -     |            | -      |           | -   |           | -     |            | -  
|                           | Residential mortgage - second position |          | -     |            | -      |           | -   |           | -     |            | -  
|                           | Consumer - other                       |          | -     |            | -      |           | -   |           | -     |            | -  
|                           |                                        | Subtotal |       | 1,200      |        | 1,369     |     | 603       |       | 3,588      |     | -         
|                           |                                        | Total    | $     | 17,770     |        | 20,319    |     | 603       |       | 19,014     |     | 433       
|Summary by portfolio:      |                                        |          |       |            |        |           |     |           |       |           
|Commercial                 | $                                      | 12,545   |       | 14,818     |        | 603       |     | 14,022    |       | 314       
|Residential                |                                        | 5,225    |       | 5,501      |        | -         |     | 4,992     |       | 117       
|Consumer and other         |                                        | -        |       | -          |        | -         |     | -         |       | 2         
|                           |                                        | Total    | $     | 17,770     |        | 20,319    |     | 603       |       | 19,014     |     | 433       




|                            |                                        |            |        |          |        |           |       |            |        |            |     |         
|--------------------------- | -------------------------------------- | ---------- | ------ | -------- | ------ | --------- | ----- | ---------- | ------ | ---------- | --- | --------
|December 31, 2011          
|                            |                                        |            |        |          |        | Unpaid    |       | Specific   |        | Average    |     | Interest
|                            |                                        |            |        | Recorded |        | Principal |       | Related    |        | Recorded   |     | Income  
|With  no specific allowance |                                        | Investment |        | Balance  |        | Allowance |       | Investment |        | Recognized
|                            | Commercial and industrial              | $          | 2,541  |          | 3,048  |           | -     |            | 1,401  |            | -  
|                            | Commercial mortgage                    |            | 8,001  |          | 9,440  |           | -     |            | 6,578  |            | 114
|                            | Residential mortgage - first position  |            | 3,801  |          | 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                             | $          | 12,995 |          | 15,095 |           | 1,138 |            | 15,046 |            | 114
|                            | Residential                            |            | 4,212  |          | 4,407  |           | -     |            | 5,222  |            | 13 
|                            | Consumer and other                     |            | 100    |          | 102    |           | -     |            | 126    |            | -  
|                            |                                        | Total      | $      | 17,307   |        | 19,604    |       | 1,138      |        | 20,394     |     | 127     

50   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    Troubled Debt Restructurings As of December 31, 2012, there was one commercial relationship totaling $4.3 million that was considered a TDR due to the nature of the concessions granted to the borrower. We have established no impairment reserve for the 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 this relationship, 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. At that time, we renewed the forbearance agreement for an additional 24 months with higher monthly payments than under the previous agreement.  To date, the borrower has paid as agreed. A loan totaling $0.3 million, previously classified as a TDR was paid-off in the second quarter of 2012.  (5) Premises and Equipment  A summary of premises and equipment at December 31, 2012, and 2011, follows (in thousands):  20122011Land and land improvements$948948Buildings and leasehold improvements24,75024,172Furniture, fixtures and equipment20,87819,52046,57644,640Less accumulated depreciation and amortization31,45728,539Premises and equipment - net$15,11916,101  Depreciation and amortization expense amounted to $2,550,000, $2,419,000, and $2,099,000, for the years ended December 31, 2012, 2011, and 2010, 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):  201220112010EstimatedEstimatedEstimatedBookFairBookFairBookFairValueValueValueValueValueValueBalance at January 1,$2,489$3,244$2,222$3,418$1,797$2,893Originations1,332762914Amortization(600)(495)(489)Balance at December 31,$3,221$3,382$2,489$3,244$2,222$3,418  Included in Loan servicing income, net, are gross servicing fees earned of $1,477,000, $1,410,000, and $1,355,000, for the years ended December 31, 2012, 2011, and 2010, respectively.  Amortization expense of loan servicing assets for the next five years is estimated to be $674,000, $663,000, $645,000, $509,000, and $372,000.  The estimated fair value of loan servicing rights may vary significantly in subsequent periods due to changing interest rates and the effect thereof on prepayment speeds. Additionally, estimated fair value assumes there are a willing buyer and willing seller in the transaction. Management does not intend to sell these servicing rights.  The key economic assumptions used to determine the fair value of loan servicing rights at December 31, 2012 and 2011 were a discount rate of 10.00% and 9.00%, respectively, in each year and weighted average portfolio maturity of 19.6 years in 2012 and 19.3 years in 2011. The sensitivity of fair value to changes in certain portfolio characteristics at each year end are  51   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   summarized in the table that follows (dollars in thousands). These calculated sensitivities are hypothetical, and actual changes in the fair value of loan servicing rights may differ significantly from the amounts presented herein. The effect of a variation in a particular assumption or characteristic on the fair value of the servicing rights is calculated without changing any other assumption. However, in practice, changes in one factor may result in changes in another which may magnify or counteract the sensitivities. The changes in assumptions are presumed to be instantaneous.  20122011Weighted-average prepayment speed338%326%Impact on fair value of 20% adverse change$(268)$(278)Impact on fair value of 20% positive change376371Weighted-average current coupon for similar loans4.07%4.74%Impact on fair value of 100 basis point adverse change$(591)$(695)Impact on fair value of 100 basis point positive change698602  (7) Time Deposits  At December 31, 2012, the scheduled maturity of time deposits was as follows (in thousands):  2013$234,774201497,201201538,2042016161201713$370,353  Time deposits of $100,000 or more amounted to $157,589,000 at December 31, 2012, and $165,311,000 at December 31, 2011. Interest expense on all time deposits of $100,000 or more was as follows: $1,678,000 in 2012, $2,737,000 in 2011, and $4,118,000 in 2010.  (8) Borrowings  Borrowings at December 31, 2012 included, net of discount, a $3.5 million non-interest bearing payment due November 19, 2013 for the acquisition of OBS, and a $0.9 million non-interest bearing contingent payment with no stated maturity.  At December 31, 2011, borrowings included, net of discount, a $6.0 million of non-interest bearing payments for the acquisition of OBS, and a $1.0 million non-interest bearing contingent payment with no stated maturity.  There were no short-term borrowings during 2012 or 2011.   The following table presents information about the Company's formal available lines of credit and related loan collateral at December 31, 2012 (in thousands).  Amounts utilized include borrowings, and undrawn letters of credit in the Company's favor of $2,389,000.  AmountCarrying ValueUtilizedUnusedCollateralized byof CollateralFederal Home Loan Bank$2,389$232,646Residential mortgages$168,817of New YorkCommercial mortgages$66,218FHLB stock$1,604Federal Reserve Bank$-$460,020Indirect automobile loans$272,208of New YorkCommercial loans and mortgages$364,012  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.   52   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   (9) Junior Subordinated Debentures and Interest Rate Swap Agreements  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 carried a fixed interest rate of 6.32% per annum through December 2012, floating thereafter for twenty-five years at LIBOR plus 1.44% (1.748% at December 31, 2012) 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, 2012, these debentures were considered Tier I for regulatory purposes.  In December 2012, the Company became exposed to interest rate risk as a result of the timing of changes in interest rates associated with T3.  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 this debenture. This swap became effective on December 15, 2012 and expires on December 15, 2022.  This interest rate swap agreement modifies the repricing characteristics of the debenture from a floating-rate debt (LIBOR +1.44%) to a fixed-rate debt (3.859%).  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% (1.708% at December 31, 2012). Interest is payable quarterly. The debentures' final maturity is June 2036, and is callable, in whole or in part, at par after 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, 2012, these debentures were considered Tier I capital of the Company.  The Company is exposed to interest rate risk as a result of both the timing of changes in interest rates of assets and liabilities, and the magnitude of those changes.  In order to reduce this risk for T2, the Company entered into an interest rate swap agreement in 2007, which expired on June 15, 2011.  This interest rate swap agreement modified the repricing characteristics of the debentures from a floating-rate debt (LIBOR +1.40%) to a fixed-rate debt (5.54%). For this swap agreement, amounts receivable or payable were recognized as accrued under the terms of the agreement, and the net differential was recorded as an adjustment to interest expense of the related debentures. The interest rate swap agreement was designated as a cash flow hedge. Therefore, the effective portion of the swaps unrealized gain or loss was recorded as a component of other comprehensive income. The ineffective portion of the unrealized gain or loss, if any, was immediately reported in other operating income.  The swap agreement was carried at fair value in Other Liabilities on the Consolidated Statement of Condition.  In consideration of the expiration of the aforementioned agreement, the Company entered into a forward 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 accounting for this is the same as the expired swap agreement.  (10) Income Taxes  Total income taxes for the each of the years ended December 31, were allocated as follows (in thousands):  201220112010Income from operations$8,4346,1786,205Stock option exercise included in stockholders equity(1,122)-(232)Change in stockholders' equity for unrealizedgain (loss) on securities available for sale(329)180(483)Change in stockholders' equity for unrealizedgain (loss) on fair value of interest rate swap(760)(1,341)180$6,2235,0175,670  53   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    The components of income tax expense (benefit) relating to income from operations follow (in thousands):  Years ended December 31,201220112010Current:Federal$8,2605,7065,882State1,5021,0461,0869,7626,7526,968Deferred:Federal(1,262)(347)(513)State(66)(227)(250)(1,328)(574)(763)$8,4346,1786,205  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 31,201220112010Tax expense at statutory rate of 35%$9,4687,8418,351Tax-exempt interest(1,991)(2,251)(2,487)Interest expense disallowance4878117State taxes, net of Federal benefit933532543Nondeductible operating expenses596233Change in valuation allowance for deferred tax assets(2)(2)(2)Recovery of state allowance for loan losses--(167)Other(81)(82)(183)Total$8,4346,1786,205Effective tax rate31.2%28.0%26.0%  54   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2012, and 2011, are presented below (in thousands):  20122011Deferred tax assets:Allowance for loan losses - books$6,8616,377Incentive stock and retirement plans2,3871,825Stock options7575Interest on nonaccrual loans1,0541,065Retirement and other reserves4444Gain on sale of premises and equipment  books612671Write-down of available-for-sale securities184184Minority-owned entities343285Net unrealized loss on interest rate swap2,4821,722Other197342Deferred tax assets before allowance14,23912,590Valuation allowance(76)(78)Deferred tax assets14,16312,512Deferred tax liabilities:Loan servicing rights1,276986Intangible assets1,2621,390Depreciation370969Net unrealized gain on available for sale securities495833Deferred tax liabilities3,4034,178Net deferred tax asset$10,7608,334  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 2012 or 2011 for any unrecognized tax benefits.  The Company is not subject to U.S. Federal tax examinations or state tax examinations for years before 2010.  (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, 2012, approximately $27,721,000 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.  55   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   (12)   Earnings Per Share  Basic and diluted earnings per share for the years ended December 31, 2012, 2011, and 2010, were computed as follows (dollars in thousands, except share and per-share data):  201220112010Basic Earnings Per Share:Net income applicable to common shareholders$18,83716,31217,656Weighted average common shares outstanding1,887,1021,888,2291,888,080Basic earnings per share$9.988.649.35Diluted Earnings Per Share:Net income applicable to common shareholders$18,83716,31217,656Weighted average common shares outstanding1,887,1021,888,2291,888,080Effect of assumed exercise of stock options42,25835,54831,112Total1,929,3601,923,7771,919,192Diluted earnings per share$9.768.489.20  (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 $3,165,000, $2,841,000, and $2,480,000, for the years ended December 31, 2012, 2011, and 2010, 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 $281,000, $266,000, and $220,000, for the years ended December 31, 2012, 2011, and 2010, 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, 2012, and 2011, the plan held 31,405 and 29,995 shares with an estimated fair value, at the respective dates, of $4,429,000 and $3,876,000.  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 $795,000 and $718,000 at December 31, 2012 and 2011, respectively, for these SERPs. Expenses of these plans amounted to $144,000 in 2012, a credit of $31,000 for 2011, and expense of $162,000, and in 2010.  (14) Stock-Based Compensation Plans  The Company has two stock-based compensation plans (Stock Option Plan and Stock Appreciation Rights Plan) for executives, which are described below.  Amounts recognized in the Consolidated Financial Statements with respect to these plans are as follows (in thousands):  201220112010Stock option plan$---Stock appreciation rights plan2,3523,124606Pre-tax cost of plans included in salaries and employee benefits expenses$2,3523,124606Amount of related income tax recognized in income$(941)(1,250)(242)  The significant increase in costs of the stock appreciation rights plan in both 2012 and 2011 were a result of increases in the market value of the Companys common stock.  56   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    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, 2012:  2012# SharesWeighted AverageSubjectto OptionsExercise PriceOptions outstanding at beginning of the year106,542$42.25Granted--Exercised27,70045.13Expired1,51673.46Options outstanding at year end77,326$43.35Options exercisable at year end63,610$41.97Options available for future grantsnone  At December 31, 2012, the intrinsic value of all outstanding options was approximately $7,553,000, while the intrinsic value of vested options included in this total was approximately $6,301,000.  No options were exercised in 2011. The intrinsic value of options exercised during the years ended December 31, 2012 and 2010 were $2,832,000 and $585,000, respectively.  No options vested in 2012, 2011 or 2010.  Options outstanding (both exercisable and unexercisable) at December 31, 2012, 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, at the Compensation Committee of the Board of Directors option, 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, 2012.  57   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    Long-term SARsMedium-term SARsWeightedWeightedAverageAverage#Grant Price#Grant PriceAwards outstanding, January 1, 201297,684$88.2462,194$88.82Granted15,781$129.2210,521$129.22Exercised7,403$92.355,136$86.77Forfeited-$-6,799$88.27Expired-$--$-Awards outstanding at December 31, 2012106,062$94.0560,780$96.05Awards exercisable at December 31, 201250,705$92.565,786$87.68  In February 2012, certain executives were awarded a total of 15,781 long-term SARs and 10,521 medium-term SARs, all at a grant price of $129.22 per share, the then-current market value (based on the most recent public stock sale known to the Company immediately preceding the effective grant date) of the Company's common stock.  During 2012, 7,403 long-term SARs were exercised with a fair value of $399,000, and 5,136 medium-term SARs were exercised with a fair value of $314,000.  No awards were exercised in 2011 or 2010.  The fair value of awards vested during years ended December 31, 2012 and 2011 amounted to $796,000 and $182,000, respectively.  The weighted average estimated per-award fair values, as of December 31, 2012 and 2011 are presented below.  Fair value was estimated using the Black-Scholes-Merton option-pricing model with the following assumptions. No forfeitures are assumed, as generally none are anticipated.  20122011Award TypeLTSMTSLTSMTSPer-award fair value$37.29$35.51$29.71$29.19Expected dividend yield2.12%2.12%2.58%2.58%Risk-free interest rate0.72%0.72%0.91%0.91%Expected Life5.0 years5.0 years5.0 years5.0 yearsVolatility10.00%10.00%8.23%8.23%  Long-term SARs outstanding and medium-term SARs outstanding (both exercisable and unexercisable) at December 31, 2012, had exercise prices ranging from $78.98 to $129.22. 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 $1,857,000, which is expected to be recognized over a weighted average period of five years. The Company had accrued a liability of $5,230,000 and $3,887,000 at December 31, 2012 and 2011, 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 $2,430,000 in 2012, $2,358,000 in 2011, and $2,148,000 in 2010. 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, 2012, follows (in thousands):  Years ending December 31,Amount2013$2,46520142,42120152,31620162,30120172,2972018 and after9,516Total$21,316  (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 31,20122011NotionalCarryingNotionalCarryingAmountAmountAmountAmountCommitments to extend credit:Commercial lines of credit$134,054-123,749-Commercial real estate and construction$36,257-37,174-Residential real estate at fixed rates$5,261-5,269-Home equity lines of credit$210,236-186,902-Unsecured personal lines of credit$23,492-16,326-Standby and commercial letters of credit$13,100(192)15,563(233)Commitments to sell real estate loans$21,113-7,556-  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, 2012, the Company had a remaining unfunded commitment of $1,500,000. 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, 2012, the Company had a remaining unfunded commitment of less than $100,000. 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, OBS is obligated to make future payments totaling $4,367,000, of which $3,500,000 is due in November 2013.  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.  (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  58   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   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, 2012, 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, 2012, these companies complied with their minimum capital requirements.  As of December 31, 2012, 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, 2012Actual Regulatory CapitalMinimum RequirementWell-Capitalized(Dollars in thousands)AmountRatioAmountRatioAmountRatioLeverage capital (Tier 1) as percent ofthree-month average assets:Company$176,7389.59%$73,7454.00%$92,1815.00%Bank$155,6958.51%$73,1754.00%$91,4695.00%As percent of risk-weighted,period-end assetsCore capital (Tier 1)Company$176,73811.77%$60,0684.00%$90,1026.00%Bank$155,69510.57%$58,9374.00%$88,4056.00%Total capital (Tiers 1 and 2)Company$194,08512.92%$120,1368.00%$150,17010.00%Bank$173,04211.74%$117,8748.00%$147,34210.00%  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%  59   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   (18)   Segment Information  As of December 31, 2012, 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 brokerage and 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, 2012, 2011, and 2010 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.


|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|------------------------------------------------------- | ------------------------------------------------ | --------------------------------------------- | ------ | ------ | ----- | ------ | ----- | ------ | ----- | -------- | ------- | ------------ | ------- | ------
|                                                        |                                                  | 2012                                         
|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|                                                        |                                                  |                                               |        | Bank   |       | CNBM   |       | GVT    |       | OBS      |         | Intersegment |         | Total 
|Net interest income                                     | $                                                | 65,695                                        |        | 7      |       | 9      |       | (92)   |       | (16)     |         | 65,603      
|Non-interest income                                     |                                                  | 29,760                                        |        | 7,171  |       | 3,688  |       | 3,064  |       | (8,560)  |         | 35,123      
|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|                                                        | Total revenues                                   |                                               | 95,455 |        | 7,178 |        | 3,697 |        | 2,972 |          | (8,576) |              | 100,726
|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|Provision for loan losses                               |                                                  | 4,300                                         |        | -      |       | -      |       | -      |       | -        |         | 4,300       
|Intangible amortization                                 |                                                  | 182                                           |        | -      |       | 630    |       | 692    |       | -        |         | 1,504       
|Other operating expenses                                |                                                  | 59,344                                        |        | 2,974  |       | 3,114  |       | 3,169  |       | (730)    |         | 67,871      
|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|                                                        | Total expenses                                   |                                               | 63,826 |        | 2,974 |        | 3,744 |        | 3,861 |          | (730)   |              | 73,675 
|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|                                                        |                                                  | Income (loss) before tax                      |        | 31,629 |       | 4,204  |       | (47)   |       | (889)    |         | (7,846)      |         | 27,051
|Income tax                                              |                                                  | 8,677                                         |        | 1,641  |       | (19)   |       | (243)  |       | (1,622)  |         | 8,434       
|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|                                                        | Net income (loss) attributable to noncontrolling |                                               |        |        |       |        |       |        |       |          |         |              |        
|                                                        |                                                  | interest and Canandaigua National Corporation |        | 22,952 |       | 2,563  |       | (28)   |       | (646)    |         | (6,224)      |         | 18,617
|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|Less: Net loss attributable to noncontrolling interests |                                                  | 6                                             |        | -      |       | -      |       | (226)  |       | -        |         | (220)       
|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|                                                        | Net income (loss) attributable to                |                                               |        |        |       |        |       |        |       |          |         |              |        
|                                                        |                                                  | Canandaigua National Corporation              | $      | 22,946 |       | 2,563  |       | (28)   |       | (420)    |         | (6,224)      |         | 18,837
|                                                        |                                                  |                                               |        |        |       |        |       |        |       |          |         |              |         |       
|Total identifiable assets                               | $                                                | 1,863,603                                     |        | 11,711 |       | 16,352 |       | 10,464 |       | (15,102) |         | 1,887,028   

60   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    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 (loss) attributable to noncontrollinginterest and Canandaigua National Corporation$18,444974(72)(1,122)(2,299)15,925Less: Net loss attributable to noncontrolling interests6--(393)-(387)Net income (loss) attributable toCanandaigua National Corporation18,438974(72)(729)(2,299)16,312Total identifiable assets$1,738,99410,18014,45014,919(17,779)1,760,764  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  61   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   (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 31,20122011Assets:Cash in subsidiary bank$5,8156,825Cash in other banks6,3114,430Securities available for sale1,145946Investment in Bank157,512150,301Investment in nonbank subsidiaries26,05427,993Other assets5,7096,984Total assets$202,546197,479Liabilities:Junior subordinated debentures$51,54751,547Other liabilities6,63610,694Total liabilities58,18362,241Equity144,363135,238Total liabilities and stockholders' equity$202,546197,479  Statements of IncomeYears ended December 31,201220112010Dividends from Bank$15,60012,9607,200Other income796456Loss on securities available for sale-(34)(40)Interest and other expenses(2,461)(2,722)(3,105)Income before undistributed income of subsidiaries13,21810,2684,111Undistributed current year income of subsidiaries6,0126,00113,540Income before taxes19,23016,26917,651Income tax (expense) benefit(393)435Net income$18,83716,31217,656  62   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    Statements of Cash FlowYears ended December 31,201220112010Cash flows from operating activitiesNet income$18,83716,31217,656Adjustments to reconcile net income to net cashfrom operating activities:Depreciation, amortization and accretion--24Undistributed current year earnings of subsidiaries(6,012)(6,001)(13,540)Loss on securities available for sale-3440Other(1,224)(2,935)1,432Net cash provided by operating activities11,6017,4105,612Cash flows from investing activities:Proceeds from transactions of securities available for sale-621,499Payment for acquisition of WBI net of cash acquired(2,500)(2,250)-Investment in subsidiaries-(5)(501)Purchases of other investments, net--(331)Fixed assets sold to subsidiary--453Net cash (used in) provided by  investing activities(2,500)(2,193)1,120Cash flows from financing activities:Payments for treasury stock transactions, net(151)(173)(147)Tax benefit from stock option exercise1,122-232Change in noncontrolling interest, net(226)2,364-Dividends paid(8,975)(5,405)(5,121)Net cash used in financing activities(8,230)(3,214)(5,036)Net increase in cash8712,0031,696Cash at beginning of year11,2559,2527,556Cash at end of year$12,12611,2559,252  (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.  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.   63   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   The estimated fair values and the valuation hierarchy of the Company's financial instruments are as follows (in thousands):  December 31, 2012December 31, 2011Fair ValueCarryingFairCarryingFairFinancial Assets:HierarchyAmountValueAmountValueCash and equivalents1$91,15991,159126,740126,740Securities, available-for-sale1, 2, 3$102,774102,774114,258114,258Securities, held-to-maturity2$175,850180,015167,225172,517FHLB stock and Federal Reserve Bank stock3$2,7332,7332,6562,656Loans-net3$1,441,4551,505,0031,276,4261,308,531Loan servicing assets3$3,2213,3822,4893,244Financial Liabilities:Deposits:Demand, savings andmoney market accounts3$1,292,5101,292,5101,148,4061,148,406Time deposits3$370,353372,226398,204393,583Borrowings2$4,2964,312--Junior subordinated debentures2$51,54751,54751,54752,185Other financial instruments:Interest rate swap agreements2$(6,162)(6,162)(4,415)(4,415)Letters of credit2$(192)(192)(233)(233)(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  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 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 CDOs. There is a very limited market and limited demand for these CDOs 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.  There is no market for stock issued by the Federal Home Loan Bank or the Federal Reserve Bank. Member banks are required to hold this stock.  Shares can only be sold to the issuer at par. Fair value is estimated to equal book value.  64   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    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.  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.  The key economic assumptions used to determine the fair value of mortgage servicing rights and the sensitivity of such values to changes in those assumptions are summarized in Note 6.  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 active 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 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 Agreements (Swaps)  The fair value of swaps is the amount the Company would expect to pay to terminate the agreements and is based upon the present value of expected future cash flows using the LIBOR swap curve, the basis for the underlying interest rates.  Other Financial Instruments The fair values of letters of credit and unused lines of credit approximate the fee charged to make the commitments.  65   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010   (21) Fair Values Measurements   The following table presents for each of the fair-value hierarchy levels discussed in Note 20  the Companys assets and liabilities that are measured at fair value on a recurring and non-recurring basis at December 31, 2012, 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$500--500U.S. government sponsoredenterprise obligations-60,176-60,176State and municipal obligation-38,686-38,686All other-3,2921203,412Total assets$500102,154120102,774LiabilitiesInterest rate swap agreement$-6,162-6,162Letters of credit-192-192Total liabilities$-6,354-6,354Measured on a non-recurring basis:AssetsLoansLoans-held-for-sale$-21,113-21,113Collateral dependent impaired loans--1,2001,200Other assetsOther real estate owned--3,5563,556Loan servicing assets--3,2213,221Total assets$-21,1137,97729,090  The Company values impaired loans and other real estate owned at the time the loan is identified as impaired or when title to the property passes to the Company.  The fair values of such loans and real estate owned are estimated using Level 3 inputs in the fair value hierarchy.  Each loans collateral and real estate property has a unique appraisal and managements consideration of any discount of the value is based on factors unique to each impaired loan and real estate property.  The significant unobservable input in determining the fair value is managements subjective discount on appraisals of the collateral securing the loan or real estate property, which ranges from 10%-50%.  Collateral for impaired loans may consist of real estate and/or business assets including equipment, inventory and/or accounts receivable and the value of these assets is determined based on appraisals by qualified licensed appraisers hired by the Company.  Appraised and reported values may be discounted based on managements historical knowledge, changes in market conditions from the time of valuation, estimated costs to sell, and/or managements expertise and knowledge of the client and the clients business.  As more fully described in the prior note, the Company evaluates and values loan servicing assets on a quarterly basis at their lower of amortized cost or fair value.  The fair values of these assets are estimated using Level 3 inputs in the fair value hierarchy. Fair value is determined through estimates provided by a third party or by management by reference to rights sold on similar loans during the quarter. When values are estimated by management using market prices for similar servicing assets, certain discounts may be applied to reflect the differing rights underlying the loan servicing contract. These discounts may range from 25 to 75 basis points of the principal balance of the underlying loan. Such discounts represent the significant unobservable input.  66   CANANDAIGUA NATIONAL CORPORATION AND SUBSIDIARIES Notes to Consolidated Financial Statements December 31, 2012, 2011, 2010    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  December 31, 2012 (in thousands).  During the first quarter of 2012 certain securities were transferred to Level 2 classification.  These securities show an active trading market, which resulted in fair values with significant observable elements.  Securities available for sale, beginning of period$799Securities transferred to Level 2 during period(704)Unrealized gain included in other comprehensive income25Securities available for sale, end of period$120  The following table presents for each of the fair-value hierarchy levels discussed in Note 20 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 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$502--502U.S. government sponsoredenterprise obligations-56,125-56,125State and municipal obligation-55,425-55,425All other-1,4077992,206Total assets$502112,957799114,258LiabilitiesInterest rate swap agreement$-4,415-4,415Letters of credit-233-233Total liabilities$-4,648-4,648Measured on a non-recurring basis:AssetsLoansLoans-held-for-sale$-7,556-7,556Collateral dependent impaired loans--2,4532,453Other assetsOther real estate owned--4,2354,235Loan servicing assets--2,4892,489Total assets$-7,5569,17716,733   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  December 31, 2011 (in thousands).  Securities available for sale, beginning of period$958Realized loss included in operations(34)Unrealized loss included in other comprehensive income(125)Securities available for sale, end of period$799   67