Financial Institutions, Inc. 10-Q

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

FOR THE QUARTERLY PERIOD ENDED June 30, 2007

Commission File Number 0-26481

(Exact Name of Registrant as specified in its charter)


NEW YORK		16-0816610


(State or other jurisdiction of		(I.R.S. Employer Identification Number)
incorporation or organization)

220 Liberty Street Warsaw, NY		14569


(Address of Principal Executive Offices)		(Zip Code)

Registrant’s Telephone Number Including Area Code:

(585) 786-1100

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file reports) and (2) has been subject to such requirements for at least the past 90 days.

YES þ NO o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large Accelerated filer o Accelerated filer þ Non-accelerated filer o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

YES o NO þ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


CLASS		OUTSTANDING AT AUGUST 1, 2007
Common Stock, $0.01 par value		11,116,939 shares

Item 1. Financial Statements (Unaudited)

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)


	June 30,			December 31,
(Dollars in thousands, except per share amounts)	2007			2006
Assets

Cash and due from banks	$	44,309		$	47,166
Federal funds sold and interest-bearing deposits in other banks		5,720			62,606
Securities available for sale, at fair value		759,855			735,148
Securities held to maturity, at amortized cost (fair value of $52,049 at June 30, 2007 and $40,421 at December 31, 2006)		51,872			40,388
Loans held for sale		1,432			992

Loans		940,870			926,482
Less: Allowance for loan losses		16,522			17,048

Loans, net		924,348			909,434

Premises and equipment, net		34,720			34,562
Goodwill		37,369			37,369
Other assets		38,467			39,887


Total assets	$	1,898,092		$	1,907,552


Liabilities And Shareholders’ Equity

Liabilities:
Deposits:
Noninterest-bearing demand	$	263,801		$	273,783
Interest-bearing demand, savings and money market		670,253			674,224
Certificates of deposit		682,995			669,688

Total deposits		1,617,049			1,617,695

Short-term borrowings		22,521			32,310
Long-term borrowings		37,159			38,187
Junior subordinated debentures issued to unconsolidated subsidiary trust (“Junior subordinated debentures”)		16,702			16,702
Other liabilities		21,895			20,270


Total liabilities		1,715,326			1,725,164

Shareholders’ equity:
3% cumulative preferred stock, $100 par value, authorized 10,000 shares, issued and outstanding – 1,586 shares at June 30, 2007 and December 31, 2006		159			159
8.48% cumulative preferred stock, $100 par value, authorized 200,000 shares, issued and outstanding – 174,223 shares at June 30, 2007 and 174,639 shares at December 31, 2006		17,422			17,464
Common stock, $0.01 par value, authorized 50,000,000 shares, issued 11,348,122 shares at June 30, 2007 and December 31, 2006		113			113
Additional paid-in capital		24,631			24,222
Retained earnings		152,900			148,947
Accumulated other comprehensive loss		(8,701	)		(8,404	)
Treasury stock, at cost – 186,287 shares at June 30, 2007 and 5,351 shares at December 31, 2006		(3,758	)		(113	)


Total shareholders’ equity		182,766			182,388


Total liabilities and shareholders’ equity	$	1,898,092		$	1,907,552

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)


	Three Months Ended						Six Months Ended
	June 30,						June 30,
(Dollars in thousands, except per share amounts)	2007			2006			2007			2006
Interest income:
Interest and fees on loans	$	16,932		$	17,021		$	33,559		$	33,653
Interest and dividends on securities		8,952			8,244			17,379			16,596
Other interest income		574			485			1,326			776

Total interest income		26,458			25,750			52,264			51,025


Interest expense:
Deposits		11,338			9,121			22,101			17,342
Short-term borrowings		153			126			322			238
Long-term borrowings		483			1,059			969			2,090
Junior subordinated debentures		432			432			864			864

Total interest expense		12,406			10,738			24,256			20,534


Net interest income		14,052			15,012			28,008			30,491

Credit for loan losses		(153	)		(1,601	)		(153	)		(1,351	)


Net interest income after credit for loan losses		14,205			16,613			28,161			31,842


Noninterest income:
Service charges on deposits		2,767			2,833			5,336			5,505
ATM and debit card income		724			553			1,344			1,087
Broker-dealer fees and commissions		347			376			730			807
Trust fees		—			67			—			261
Mortgage banking income		301			306			555			614
Income from corporate owned life insurance		29			432			49			452
Net gain on sale of securities		51			—			51			—
Net gain on sale of student loans held for sale		58			30			170			177
Net gain on sale of commercial-related loans held for sale		—			—			—			82
Net gain on sale and disposal of premises and equipment		7			3			15			14
Net gain on sale of other real estate and repossessed assets		24			20			73			107
Net gain on sale of trust relationships		—			—			13			—
Other		298			561			1,008			1,031

Total noninterest income		4,606			5,181			9,344			10,137

Noninterest expense:
Salaries and employee benefits		8,008			8,064			16,362			16,784
Occupancy and equipment		2,450			2,428			4,898			4,790
Supplies and postage		402			451			840			1,010
Amortization of other intangible assets		76			107			153			215
Computer and data processing		589			438			1,046			843
Professional fees and services		577			876			1,072			1,549
Other		2,246			2,217			3,905			4,665

Total noninterest expense		14,348			14,581			28,276			29,856


Income before income taxes		4,463			7,213			9,229			12,123

Income tax expense		1,020			1,839			2,171			3,010


Net income	$	3,443		$	5,374		$	7,058		$	9,113


Earnings per common share (Note 3):
Basic	$	0.27		$	0.44		$	0.56		$	0.74
Diluted	$	0.27		$	0.44		$	0.56		$	0.74

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF CHANGES IN

SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
(Unaudited)


														Accumulated
	3%		8.48%					Additional						Other						Total
(Dollars in thousands,	Preferred		Preferred			Common		Paid-in			Retained			Comprehensive			Treasury			Shareholders’
except per share amounts)	Stock		Stock			Stock		Capital			Earnings			Loss			Stock			Equity
Balance – December 31, 2006	$	159	$	17,464		$	113	$	24,222		$	148,947		$	(8,404	)	$	(113	)	$	182,388

Purchase 195,395 shares of common stock		—		—			—		—			—			—			(3,944	)		(3,944	)

Issue 9,140 shares of common stock - exercised stock options, net of tax		—		—			—		(18	)		—			—			192			174

Purchase of 416 shares of 8.48% preferred stock		—		(42	)		—		—			—			—			—			(42	)

Issue 5,319 shares of common stock - directors plan		—		—			—		(2	)		—			—			107			105

Excess tax benefit from stock options exercised		—		—			—		8			—			—			—			8

Amortization of unvested stock options		—		—			—		371			—			—			—			371

Amortization of unvested restricted stock awards		—		—			—		50			—			—			—			50

Comprehensive income:

Net income		—		—			—		—			7,058			—			—			7,058

Net unrealized loss on securities available for sale (net of tax of $(157))		—		—			—		—			—			(326	)		—			(326	)

Reclassification adjustment for net gain included in net income (net of tax of $20)		—		—			—		—			—			31			—			31

Defined benefit pension plan (net of tax of $9)		—		—			—		—			—			13			—			13

Postretirement benefit plan (net of tax of $(9))		—		—			—		—			—			(15	)		—			(15	)


Other comprehensive loss																					(297	)


Total comprehensive income																					6,761


Cash dividends declared:

3% Preferred — $1.50 per share		—		—			—		—			(2	)		—			—			(2	)

8.48% Preferred — $4.24 per share		—		—			—		—			(740	)		—			—			(740	)

Common — $0.21 per share		—		—			—		—			(2,363	)		—			—			(2,363	)


Balance – June 30, 2007	$	159	$	17,422		$	113	$	24,631		$	152,900		$	(8,701	)	$	(3,758	)	$	182,766

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)


	Six Months Ended
	June 30,
(Dollars in thousands)	2007			2006
Cash flows from operating activities:
Net income	$	7,058		$	9,113
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,962			2,114
Net (accretion) amortization of premiums and discounts on securities		(155	)		380
Credit for loan loses		(153	)		(1,351	)
Amortization of unvested stock options		371			442
Amortization of unvested restricted stock awards		50			—
Deferred income tax expense (benefit)		332			(1,114	)
Proceeds from sale of loans held for sale		20,170			43,516
Originations of loans held for sale		(20,334	)		(43,033	)
Net gain on sale of securities		(51	)		—
Net gain on sale of loans held for sale		(276	)		(330	)
Net gain on sale of commercial-related loans held for sale		—			(82	)
Net gain on sale of other assets		(88	)		(121	)
Net gain on sale of trust relationships		(13	)		—
Decrease in other assets		1,586			7,948
Increase in accrued expenses and other liabilities		357			23

Net cash provided by operating activities		10,816			17,505

Cash flows from investing activities:
Purchase of securities:
Available for sale		(182,924	)		(19,501	)
Held to maturity		(31,063	)		(17,501	)
Proceeds from maturity, call and principal pay-down of securities:
Available for sale		144,372			59,692
Held to maturity		19,984			17,665
Proceeds from the sale of securities available for sale		14,275			—
Net loan (increase) decrease		(15,843	)		37,594
Net proceeds from sale of commercial-related loans		—			659
Proceeds from sales of other assets		675			1,313
Proceeds from sale of trust relationships		13			—
Purchase of premises and equipment		(1,988	)		(531	)

Net cash (used in) provided by investing activities		(52,499	)		79,390

Cash flows from financing activities:
Net decrease in deposits		(647	)		(100,204	)
Net (decrease) increase in short-term borrowings		(9,789	)		5,722
Repayment of long-term borrowings		(1,028	)		(5,033	)
Purchase of preferred and common shares		(3,986	)		(218	)
Issuance of common shares		105			114
Stock options exercised		174			—
Excess tax benefit from stock options exercised		8			—
Dividends paid		(2,897	)		(2,556	)

Net cash used in financing activities		(18,060	)		(102,175	)


Net decrease in cash and cash equivalents		(59,743	)		(5,280	)

Cash and cash equivalents at the beginning of the period		109,772			91,940


Cash and cash equivalents at the end of the period	$	50,029		$	86,660


Supplemental disclosure of cash flow information:
Cash paid during period for:
Interest	$	22,124		$	20,283
Income taxes paid		2,321			1,642
Income taxes received		—			(5,852	)

Noncash investing and financing activities:
Real estate and other assets acquired in settlement of loans	$	1,081		$	948
Net increase in security purchases pending settlement		1,060			—
Net increase in unrealized loss on available for sale securities (net of tax of $137, and $3,963, respectively)		295			5,976

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation

Financial Institutions, Inc. (“FII”), a bank holding company organized under the laws of New York State, and its subsidiaries (collectively the “Company”) provide deposit, lending and other financial services to individuals and businesses in Central and Western New York State. The Company is subject to regulation by certain federal and state agencies.

FII’s primary subsidiary is its New York State-chartered Five Star Bank (100% owned) (“FSB” or the “Bank”). In addition, FII formerly qualified as a financial holding company under the Gramm-Leach-Bliley Act, which allowed the expansion of business operations to include a broker-dealer subsidiary, namely, Five Star Investment Services, Inc. (100% owned) (“FSIS”). During 2003, FII terminated its financial holding company status and now operates as a bank holding company. Future acquisition or expansion of non-financial activities may require prior Federal Reserve Bank (“FRB”) approval and will be limited to those that are permissible for bank holding companies.

In February 2001, the Company formed FISI Statutory Trust I (100% owned) (“FISI” or the “Trust”) and capitalized the entity with a $502,000 investment in the Trust’s common securities. The Trust was formed to facilitate the private placement of $16.2 million in capital securities (“trust preferred securities”). Effective December 31, 2003, the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities,” resulted in the deconsolidation of the Trust. The deconsolidation resulted in the derecognition of the $16.2 million in trust preferred securities and the recognition of $16.7 million in junior subordinated debentures and a $502,000 investment in the Trust recorded in other assets in the Company’s consolidated statements of financial condition.

In management’s opinion, the interim consolidated financial statements reflect all adjustments necessary for a fair presentation. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year ended December 31, 2007. The interim consolidated financial statements should be read in conjunction with the Company’s 2006 Annual Report on Form 10-K. The consolidated financial information included herein combines the results of operations, assets, liabilities and shareholders’ equity of FII and its subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation. Certain amounts in the prior periods’ consolidated financial statements are reclassified when necessary to conform to the current period’s presentation.

The interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and prevailing practices in the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, and the reported revenues and expenses for the period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to near-term change is the allowance for loan losses.

For purposes of the consolidated statements of cash flows, cash and due from banks, federal funds sold, interest-bearing deposits in other banks and commercial paper due in less than 90 days are considered cash and cash equivalents.

(2) Recent Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 155, “Accounting for Certain Hybrid Financial Instruments.” SFAS No. 155 amends SFAS No. 133 and SFAS No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides a means to simplify the accounting for these instruments. Specifically, SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The Company adopted this statement effective January 1, 2007 and adoption did not have an effect on its consolidated financial position, consolidated results of operations, or liquidity.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets,” an amendment of SFAS No. 140, which requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable and permits the entities to elect either fair value measurement with changes in

fair value reflected in earnings or the amortization and impairment requirements of SFAS No. 140 for subsequent measurement. SFAS No. 156 is effective for fiscal years beginning after September 15, 2006. The Company adopted this statement effective January 1, 2007 and elected to continue using the amortization and impairment requirements of SFAS No. 140 for subsequent measurement of servicing assets, therefore adoption did not have an effect on its consolidated financial position, consolidated results of operations, or liquidity.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted this statement effective January 1, 2007 and the required disclosures are included in Note 9. The adoption of FIN 48 did not have a material effect on the Company’s consolidated financial position, consolidated results of operations, or liquidity.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and states that a fair value measurement should be determined based on assumptions that market participants would use in pricing the asset or liability. The Company is required to adopt SFAS No. 157 for its fiscal year beginning after November 15, 2007. The Company plans to adopt this statement on January 1, 2008 and is currently assessing the impact that the adoption will have on its consolidated financial position, consolidated results of operations, or liquidity.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R).” SFAS No. 158 requires companies to recognize the over-funded or under-funded status of a defined benefit postretirement plan (other than a multi-employer plan) as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The Company adopted this provision of SFAS No. 158 for the year ended December 31, 2006 and the required disclosures were included in Note 13 of the annual report on Form 10-K as filed on March 13, 2007. SFAS No. 158 also requires companies to measure the funded status of a plan as of the date of the company’s fiscal year-end, with limited exceptions. The Company is required and plans to adopt this provision for the fiscal year ending December 31, 2008 and does not expect adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.

In September 2006, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue No. 06-04, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements” (“EITF 06-04”). In accordance with EITF 06-04, an agreement by an employer to share a portion of the proceeds of a life insurance policy with an employee during the postretirement period is a postretirement benefit arrangement required to be accounted for in accordance with SFAS No. 106 or Accounting Principles Board Opinion (“APB”) No. 12, “Omnibus Opinion — 1967.” Furthermore, the purchase of a split dollar life insurance policy does not constitute a settlement under SFAS No. 106 and, therefore, a liability for the postretirement obligation must be recognized under SFAS No. 106 if the benefit is offered under an arrangement that constitutes a plan or under APB No. 12 if it is not part of a plan. The provisions of EITF 06-04 are to be applied through either a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption or retrospective application. The Company is required to adopt this statement in its fiscal year beginning after December 15, 2007, with early adoption permitted. The Company plans to adopt this statement on January 1, 2008 and is currently assessing the impact that the adoption will have on its consolidated financial position, consolidated results of operations, or liquidity.

In September 2006, the EITF reached a final consensus on Issue No. 06-05, “Accounting for Purchases of Life Insurance — Determining the Amount That Could Be Realized in Accordance with FASB Technical Bulletin No. 85-4, “Accounting for Purchases of Life Insurance” (“EITF 06-05”). EITF 06-05 provides clarifying guidance on determining the amount that could be realized from a life insurance contract The provisions of EITF 06-05 are to be applied through either a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption or retrospective application. EITF 06-05 is effective for fiscal years beginning after December 15, 2006. The Company adopted this statement effective January 1, 2007 and adoption did not have an effect on its consolidated financial position, consolidated results of operations, or liquidity.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.” SFAS No. 159 allows entities to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities that are not otherwise required to be measured at fair value, with changes in fair value recognized in earnings as they occur. SFAS No. 159 also requires entities to report those financial assets and financial liabilities measured at fair value in a manner that separates those reported fair values from the carrying amounts of similar assets and liabilities measured using another measurement attribute on the face of the statement of financial condition. Lastly, SFAS No. 159 establishes presentation and disclosure requirements designed to improve comparability between entities that elect different measurement attributes for similar assets and liabilities. The Company is required to adopt SFAS No. 159 for its fiscal year beginning after November 15, 2007, with early adoption permitted if an entity also early adopts the provisions of SFAS No. 157. The Company plans to adopt this statement on January 1, 2008 and is currently assessing the impact the adoption will have on its consolidated financial position, consolidated results of operations, or liquidity.

(3) Earnings Per Common Share

Basic earnings per common share, after giving effect to preferred stock dividends, has been computed using weighted average common shares outstanding. Diluted earnings per share reflect the effects, if any, of incremental common shares issuable upon exercise of dilutive stock options.

Earnings per common share have been computed based on the following:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
(Dollars and shares in thousands, except per share amounts)	2007		2006		2007		2006
Net income	$	3,443	$	5,374	$	7,058	$	9,113

Less: Preferred stock dividends		371		372		742		744


Net income available to common shareholders	$	3,072	$	5,002	$	6,316	$	8,369


Weighted average number of common shares outstanding used to calculate basic earnings per common share		11,189		11,324		11,252		11,326

Add: Effect of common stock equivalents		34		42		39		43


Weighted average number of common shares used to calculate diluted earnings per common share	$	11,223	$	11,366	$	11,291	$	11,369


Earnings per common share:
Basic	$	0.27	$	0.44	$	0.56	$	0.74
Diluted	$	0.27	$	0.44	$	0.56	$	0.74

There were approximately 296,000 and 283,000 weighted average common stock equivalents from outstanding stock options for the three and six months ended June 30, 2007, respectively, that were not considered in the calculation of diluted earnings per share since their effect would have been anti-dilutive. There were approximately 289,000 and 286,000 weighted average stock options for the three and six months ended June 30, 2006, respectively, that were not considered in the calculation of diluted earnings per share since their effect would have been anti-dilutive.

(4) Stock Compensation Plans

The Company has a Management Stock Incentive Plan and a Director’s Stock Incentive Plan (the “Plans”). Under the Plans, the Company may grant stock options to purchase shares of common stock, shares of restricted stock or stock appreciation rights to its directors and key employees. Grants under the Plans may be made up to 10% of the number of shares of common stock issued, including treasury shares. The exercise price of each option equals the market price of the Company’s stock on the date of the grant. The maximum term of each option is ten years and the vesting period generally ranges between three and five years. During the six months ended June 30, 2007, 22,000 stock option awards were granted under the Plans, all of which were granted to directors. During the six months ended June 30, 2007, there were no restricted stock awards granted under the Plans.

Effective January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payments”, requiring the Company to recognize expense related to the fair value of the stock-based compensation awards. The following table presents the expense associated with the amortization of unvested stock compensation included in the consolidated statements of income for the periods indicated;


	Three Months Ended				Six Months Ended
	June 30,				June 30,
(Dollars and shares in thousands, except per share amounts)	2007		2006		2007		2006
Stock options:
Management Stock Incentive Plan (1)	$	78	$	55	$	171	$	198
Director Stock Incentive Plan (2)		179		206		200		244

Total amortization of unvested stock options		257		261		371		442

Restricted stock awards:
Management Stock Incentive Plan (1)		26		—		50		—

Total amortization of unvested stock options		26		—		50		—


Total amortization of unvested restricted stock compensation	$	283	$	261	$	421	$	442


(1)		Included in salaries and employee benefits in the consolidated statements of income.

(2)		Included in other noninterest expense in the consolidated statements of income.

(5) Loans

Loans outstanding, including net unearned income and net deferred fees and costs of $4.9 million and $4.5 million at June 30, 2007 and December 31, 2006, respectively, are summarized as follows:


	June 30,			December 31,
(Dollars in thousands)	2007			2006
Commercial	$	121,687		$	105,806
Commercial real estate		246,032			243,966
Agricultural		53,375			56,808
Residential real estate		165,516			163,243
Consumer indirect		117,403			106,391
Consumer direct and home equity		236,857			250,268


Total loans		940,870			926,482

Allowance for loan losses		(16,522	)		(17,048	)


Loans, net	$	924,348		$	909,434

The Company’s significant concentrations of credit risk in the loan portfolio relate to a geographic concentration in the communities that the Company serves.

(6) Retirement and Postretirement Benefit Plans

The Company adopted SFAS No. 158 effective December 31, 2006, which required the over-funded or under-funded status of its defined benefit pension and postretirement benefit plans to be recognized as an asset or liability in the consolidated statements of financial condition. Future changes in the funded status of the defined benefit and postretirement plans will be recognized in the year in which the changes occur on a net of tax basis through comprehensive income or loss.

Defined Benefit Pension Plan

The Company participates in The New York State Bankers Retirement System, which is a defined benefit pension plan covering substantially all employees. The benefits are based on years of service and the employee’s highest average compensation during five consecutive years of employment.

The defined benefit pension plan was closed to new participants effective December 31, 2006. Only employees hired on or before December 31, 2006 and who meet participation requirements on or before January 1, 2008 shall be eligible to receive benefits.

Net periodic pension cost consists of the following components:


	Three Months Ended						Six Months Ended
	June 30,						June 30,
(Dollars in thousands)	2007			2006			2007			2006
Service cost	$	374		$	432		$	749		$	863
Interest cost on projected benefit obligation		368			336			736			671
Expected return on plan assets		(477	)		(467	)		(954	)		(933	)
Amortization of net transition asset		—			(7	)		—			(14	)
Amortization of unrecognized loss		8			55			16			111
Amortization of unrecognized prior service cost		3			3			6			7


Net periodic pension cost	$	276		$	352		$	553		$	705

The Company’s funding policy is to contribute, at a minimum, an actuarially determined amount that will satisfy the minimum funding requirements determined under the appropriate sections of Internal Revenue Code. The minimum required contribution is zero for the year ended December 31, 2007, however, the Company is considering making a discretionary contribution to the defined benefit pension plan during 2007.

Postretirement Benefit Plan

Prior to December 31, 2001, an entity acquired by the Company provided health and dental care benefits to certain retired employees who met specified age and service requirements through a postretirement health and dental care plan in which both the acquired entity and the retiree shared the cost. The plan was amended in 2001 to curtail eligible benefit payments to only retired employees and active participants who were fully vested under the plan.

(7) Commitments and Contingencies

In the normal course of business there are outstanding commitments to extend credit not reflected in the accompanying consolidated financial statements. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company uses the same credit policy to make such commitments as it uses for on-balance-sheet items. Unused lines of credit and loan commitments totaling $266.2 million and $258.6 million were contractually available at June 30, 2007 and December 31, 2006, respectively, and are not reflected in the consolidated statements of financial condition. Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, the amount does not necessarily represent future cash commitments.

The Company guarantees the obligations or performance of customers by issuing stand-by letters of credit to third parties. The risk involved in issuing stand-by letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance-sheet products. Typically, these instruments have terms of five years or less and expire unused; therefore, the amount does not necessarily represent future cash requirements. Stand-by letters of credit totaled $6.7 million and $5.8 million at June 30, 2007 and December 31, 2006, respectively. As of June 30, 2007, the fair value of the stand-by letters of credit was not material to the Company’s consolidated financial statements.

From time to time, the Company is a party to or otherwise involved in legal proceedings arising in the normal course of business. Management does not believe that there is any pending or threatened proceeding against the Company, which, if determined adversely, would have a material adverse effect on the Company’s business, results of operations or financial condition.

(8) Supervision and Regulation

The supervision and regulation of financial and bank holding companies and their subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds regulated by the FDIC and the banking system as a whole, and not for the protection of shareholders or creditors of bank holding companies. The various bank regulatory agencies have broad enforcement power over bank holding companies and banks, including the power to impose substantial fines, operational restrictions and other penalties for violations of laws and regulations. In addition, payments of dividends by FSB to FII are limited or restricted in certain circumstances under banking regulations.

The Company is also subject to varying 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 impact on the Company’s consolidated financial statements.

For evaluating regulatory capital adequacy, companies are required to determine capital and assets under regulatory accounting practices. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios. The leverage ratio requirement is based on period-end capital to average adjusted total assets during the previous three months. Compliance with risk-based capital requirements is determined by dividing regulatory capital by the sum of a company’s weighted asset values. Risk weightings are established by the regulators for each asset category according to the perceived degree of risk. As of June 30, 2007 and December 31, 2006, the Company and FSB met all capital adequacy requirements to which they are subject.

(9) Income Taxes

The Company adopted the provisions FIN 48 effective January 1, 2007. There was no cumulative effect adjustment related to the adoption of FIN 48. As of January 1, 2007, the Company’s unrecognized tax benefits totaled $50,000, of which $32,000 would impact the Company’s effective tax rate, if recognized or reversed. The Company is currently under examination by New York State and expects to conclude the examination during 2007, at which point the uncertain tax position would be resolved.

The tax years that remain subject to examination by major tax jurisdictions are as follows:


Federal			2003 - 2005
New York			2002 - 2005

The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes. As of January 1, 2007, the Company had accrued $17,000 of interest related to uncertain tax positions. As of June 30, 2007, the total amount of accrued interest was $20,000.

(10) Subsequent Events

On July 25 2007, the Company’s Board of Directors approved a new one-year $5.0 million common stock repurchase program and canceled the remaining portion of the Company’s one-year $5.0 million stock repurchase program that was approved October 25, 2006. Under the previous program, the Company had purchased a total of 231,946 shares at an average price per share of $20.22 for a total purchase price of $4.691 million. Under the new program, stock repurchases may be made either in the open market or through privately negotiated transactions.

The Company is the owner and beneficiary of life insurance policies on a former officer of the Company who passed away in July 2007. The Company anticipates that proceeds from the policies will result in $1.1 million in net income, or approximately $0.10 per diluted common share, in the third quarter of 2007.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

FORWARD-LOOKING STATEMENTS

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words “anticipate”, “believe”, “estimate”, “expect”, “intend”, “may”, “project”, “plan”, “seek” and similar expressions identify such forward-looking statements. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein. There are a number of important factors that could affect the Company’s forward-looking statements which include the quality of collateral associated with nonperforming loans, the ability of customers to continue to make payments on criticized or substandard loans, the impact of rising interest rates on customer cash flows, the inability to re-price existing loans or to replace older, lower-rate loans with newer, higher-rate loans, the impact of the yield curve, the speed or cost of resolving bad loans, the ability to hire and train personnel, the economic conditions in the area in which the Company operates, customer preferences, competition and other factors discussed in the Company’s filings with the Securities and Exchange Commission. Many of these factors are beyond the Company’s control.

GENERAL

The principal objective of this discussion is to provide an overview of the financial condition and results of operations of the Company for the periods covered in this quarterly report. This discussion and tabular presentations should be read in conjunction with the accompanying consolidated financial statements and accompanying notes.

The Company’s revenues are dependent primarily on net interest income, which is the difference between the income earned on loans and securities and the interest paid on deposits and borrowings. Revenues are also affected by service charges on deposits, ATM and debit card income, broker-dealer fees and commissions, mortgage banking income, gain or loss on the sale of securities, gain or loss on sale of loans held for sale, gain or loss on the sale and disposal of other assets and other miscellaneous noninterest income.

The Company’s expenses primarily consist of the provision (credit) for loan losses, salaries and employee benefits, occupancy and equipment, supplies and postage, amortization of other intangible assets, computer and data processing, professional fees and services, other miscellaneous noninterest expense and income tax expense (benefit).

Results of operations are also affected by the general economic and competitive conditions, particularly changes in interest rates, government policies and the actions of regulatory authorities.

OVERVIEW

Net income for the second quarter of 2007 was $3.4 million, or $0.27 per diluted share, compared with $5.4 million, or $0.44 per diluted share, for the same quarter last year. For the first six months of 2007 net income was $7.1 million, or $0.56 per diluted share, compared with $9.1 million, or $0.74 per diluted share, for the first six months of 2006.

The decline in net income was primarily the result of a decline in net interest income and a decline in the credit for loan losses in comparison to the prior year on both a quarter-to-date and year-to-date basis. Net interest income was $14.1 million for the second quarter of 2007, down $1.0 million versus the second quarter of 2006. Net interest income was $28.0 million for the six months ended June 30, 2007, down $2.5 million in comparison to the same period in the prior year. Net interest margin declined 22 basis points, to 3.35%, for the second quarter of 2007 compared with the same quarter last year. On a year-to-date basis, net interest margin was down 23 basis points to 3.37% versus the prior year. The flat-to-inverted interest rate yield curve that prevailed throughout much of 2006 and continued into the first half of 2007, coupled with soft loan demand that makes replacement of lower-rate loans with new, higher-rate loans difficult, has had a negative effect on net interest margin, as have changes in our deposit mix that resulted in an increased cost of funds.

The Company experienced an increase of $14.4 million in loans to $940.9 million at June 30, 2007 compared to $926.5 million at December 31, 2006. Commercial-related loans increased $14.5 million over December 31, 2006, as a result of an extensive commercial business development program over the past year.

Asset quality showed continued improvement. Nonperforming assets were $11.8 million at June 30, 2007, down $5.3 million from December 31, 2006. Net loan charge-offs were $239 thousand for the second quarter of 2007 or 10 basis points of average loans (annualized) and for the first six months of 2007 were $373 thousand or 8 basis points of average loans (annualized).

CRITICAL ACCOUNTING POLICIES

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and are consistent with predominant practices in the financial services industry. Application of critical accounting policies, which are those policies that management believes are the most important to the Company’s financial position and results, requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes and are based on information available as of the date of the consolidated financial statements. Future changes in information may affect these estimates, assumptions and judgments, which, in turn, may affect amounts reported in the consolidated financial statements.

The Company has numerous accounting policies, of which the most significant are presented in Note 1 of the notes to consolidated financial statements included in the Company’s Annual Report on Form 10-K as of December 31, 2006, dated March 13, 2007, as filed with the Securities and Exchange Commission. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how

significant assets, liabilities, revenues and expenses are reported in the consolidated financial statements and how those reported amounts are determined. Based on the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies with respect to the allowance for loan losses, goodwill and defined benefit pension plan require particularly subjective or complex judgments important to the Company’s consolidated financial statements, results of operations, and, as such, are considered to be critical accounting policies as discussed below.

Allowance for Loan Losses: The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of subjective measurements including management’s assessment of the internal risk classifications of loans, changes in the nature of the loan portfolio, industry concentrations and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts of principal and interest under the original terms of the agreement or the loan is restructured in a troubled debt restructuring. Accordingly, the Company evaluates impaired commercial and agricultural loans individually based on the present value of future cash flows discounted at the loan’s effective interest rate, or at the loan’s observable market price or the net realizable value of the collateral if the loan is collateral dependent. The majority of the Company’s loans are secured.

Loans, including impaired loans, are generally classified as nonaccruing if they are past due as to maturity or payment of principal or interest for a period of more than 90 days (120 days for consumer loans), unless such loans are well-collateralized and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccruing if repayment in full of principal and/or interest is uncertain.

For additional discussion related to the Company’s accounting policies for the allowance for loan losses, see the section titled “Analysis of the Allowance for Loan Losses.”

Goodwill: Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets are subject to at least an annual impairment review, and more frequently if certain impairment indicators are in evidence. Changes in the estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity. During the fourth quarter of 2006, the Company evaluated goodwill for impairment using a discounted cash flow analysis and determined no impairment existed. There were no material events or transactions that occurred subsequent to that evaluation that indicates any impairment at the current period end.

Defined Benefit Pension Plan: Management is required to make various assumptions in valuing its defined benefit pension plan assets and liabilities. These assumptions include, but are not limited to, the expected long-term rate of return on plan assets, the weighted average discount rate used to value certain liabilities and the rate of compensation increase. The Company uses a third-party specialist to assist in making these estimates and assumptions. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

SELECTED FINANCIAL DATA

The following tables present certain information and ratios that management of the Company considers important in evaluating performance:


	At or For the Three Months Ended June 30,
(Dollars in thousands, except per share amounts)	2007			2006
Per common share data:
Net income — basic	$	0.27		$	0.44
Net income — diluted	$	0.27		$	0.44
Cash dividends declared	$	0.11		$	0.08
Book value	$	14.80		$	13.69
Tangible book value	$	11.38		$	10.29
Common shares outstanding:
Weighted average shares – basic		11,188,840			11,323,691
Weighted average shares – diluted		11,222,994			11,366,183
Period end		11,161,835			11,325,693
Performance ratios (annualized) and data:
Return on average assets		0.71	%		1.11	%
Return on average common equity		7.40	%		13.03	%
Return on average tangible common equity		9.60	%		17.37	%
Common dividend payout ratio		40.74	%		18.18	%
Net interest margin (tax-equivalent)		3.35	%		3.57	%
Efficiency ratio (1)		72.04	%		67.28	%
Full-time equivalent employees		636			657
Asset quality data:
Loans past due 90 days or more	$	4		$	1
Nonaccruing loans		10,402			15,361

Total nonperforming loans		10,406			15,362
Other real estate owned (ORE) and repossessed assets (repos)		1,352			933

Total nonperforming assets	$	11,758		$	16,295
Gross loan charge-offs	$	970		$	886
Net loan charge-offs	$	239		$	100
Allowance for loan losses	$	16,522		$	18,590
Asset quality ratios:
Nonperforming loans to total loans		1.11	%		1.61	%
Nonperforming assets to total loans, ORE and repos		1.25	%		1.71	%
Nonperforming assets to total assets		0.62	%		0.85	%
Allowance for loan losses to total loans		1.76	%		1.95	%
Allowance for loan losses to nonperforming loans		159	%		121	%
Net loan charge-offs to average loans (annualized)		0.10	%		0.04	%
Capital ratios:
Period-end common equity to total assets		8.70	%		8.06	%
Period-end tangible common equity to total tangible assets		6.83	%		6.18	%
Leverage ratio		8.89	%		8.39	%
Tier 1 risk-based capital ratio		15.86	%		14.66	%
Total risk-based capital ratio		17.12	%		15.92	%

(1) The efficiency ratio represents noninterest expense less other real estate expense and amortization of intangibles divided by net interest income (tax-equivalent) plus other noninterest income less gain on sale of trust relationships and net gain on sale of commercial-related loans held for sale calculated using the following detail:

Noninterest expense	$	14,348		$	14,581
Less: Other real estate expense		(46	)		(59	)
Amortization of other intangible assets		(76	)		(107	)

Net expense (numerator)	$	14,226		$	14,415


Net interest income	$	14,052		$	15,012
Plus: Tax-equivalent adjustment		1,141			1,233

Net interest income (tax-equivalent)		15,193			16,245
Plus: Noninterest income		4,606			5,181
Less: Net gain on sale of securities		(51	)		—

Net revenue (denominator)	$	19,748		$	21,426


	At or For the Six Months Ended June 30,
(Dollars in thousands, except per share amounts)	2007			2006
Per common share data:
Net income — basic	$	0.56		$	0.74
Net income — diluted	$	0.56		$	0.74
Cash dividends declared	$	0.21		$	0.16
Book value	$	14.80		$	13.69
Tangible book value	$	11.38		$	10.29
Common shares outstanding:
Weighted average shares – basic		11,252,472			11,326,035
Weighted average shares – diluted		11,291,219			11,369,202
Period end		11,161,835			11,325,693
Performance ratios (annualized) and data:
Return on average assets		0.74	%		0.94	%
Return on average common equity		7.68	%		10.93	%
Return on average tangible common equity		9.97	%		14.56	%
Common dividend payout ratio		37.50	%		21.62	%
Net interest margin (tax-equivalent)		3.37	%		3.60	%
Efficiency ratio (1)		70.72	%		68.63	%
Full-time equivalent employees		636			657
Asset quality data:
Gross loan charge-offs	$	1,662		$	2,190
Net loan charge-offs	$	373		$	290
Asset quality ratio:
Net loan charge-offs to average loans (annualized)		0.08	%		0.06	%
Capital ratios:
Period-end common equity to total assets		8.70	%		8.06	%
Period-end tangible common equity to total tangible assets		6.83	%		6.18	%
Leverage ratio		8.89	%		8.39	%
Tier 1 risk-based capital ratio		15.86	%		14.66	%
Total risk-based capital ratio		17.12	%		15.92	%

(1) The efficiency ratio represents noninterest expense less other real estate expense and amortization of intangibles divided by net interest income (tax-equivalent) plus other noninterest income less gain on sale of trust relationships and net gain on sale of commercial-related loans held for sale calculated using the following detail:

Noninterest expense	$	28,276		$	29,856
Less: Other real estate expense		(134	)		(130	)
Amortization of other intangible assets		(153	)		(215	)

Net expense (numerator)	$	27,989		$	29,511


Net interest income	$	28,008		$	30,491
Plus: Tax-equivalent adjustment		2,290			2,454

Net interest income (tax-equivalent)		30,298			32,945
Plus: Noninterest income		9,344			10,137
Less: Net gain on sale of securities		(51	)		—
Less: Net gain on sale of commercial-related loans held for sale		—			(82	)
Less: Net gain on sale of trust relationships		(13	)		—

Net revenue (denominator)	$	39,578		$	43,000

NET INCOME ANALYSIS

The following tables present, for the periods indicated, information regarding: (i) the average balance sheet; (ii) the amount of interest income from interest-earning assets and the resulting annualized yields (tax-exempt yields and tax-preferred yields on securities that qualify for the Federal dividend received deduction (“DRD”) have been adjusted to a tax-equivalent basis using the applicable Federal tax rate in each year); (iii) the amount of interest expense on interest-bearing liabilities and the resulting annualized rates; (iv) net interest income; (v) net interest rate spread; (vi) net interest income as a percentage of average interest-earning assets (“net interest margin”); and (vii) the ratio of average interest-earning assets to average interest-bearing liabilities. Average balances are calculated using daily balances. Investment securities are at amortized cost for both held to maturity and available for sale securities. Loans include net unearned income, net deferred loan fees and costs and nonaccruing loans.


	For the Three Months Ended June 30,
	2007								2006
	Average			Interest		Annualized			Average			Interest		Annualized
	Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
(Dollars in thousands)	Balance			Paid		Rate			Balance			Paid		Rate
Interest-earning assets:
Federal funds sold and interest-bearing deposits	$	43,320		$	574		5.31	%	$	24,404		$	300		4.93	%
Commercial paper due in less than 90 days		—			—		—	%		14,981			185		4.96	%
Investment securities:
Taxable		591,893			6,702		4.53	%		564,952			5,951		4.21	%
Tax-exempt		235,683			3,233		5.49	%		259,562			3,514		5.42	%
Tax-preferred		10,030			158		6.32	%		81			12		59.11	%

Total investment securities		837,606			10,093		4.82	%		824,595			9,477		4.60	%
Loans held for sale		530			11		8.46	%		376			8		8.78	%
Loans:
Commercial and agricultural		420,711			8,073		7.70	%		432,049			8,270		7.68	%
Residential real estate		163,656			2,672		6.53	%		164,779			2,649		6.43	%
Consumer indirect		111,518			1,898		6.83	%		91,040			1,418		6.25	%
Consumer direct and home equity		236,958			4,278		7.24	%		270,145			4,676		6.94	%

Total loans		932,843			16,921		7.27	%		958,013			17,013		7.12	%

Total interest-earning assets		1,814,299		$	27,599		6.09	%		1,822,369		$	26,983		5.93	%

Allowance for loans losses		(17,074	)							(20,535	)

Other noninterest-earning assets		141,460								148,804

Total assets	$	1,938,685							$	1,950,638


Interest-bearing liabilities:
Savings and money market	$	357,849		$	1,608		1.80	%	$	333,118		$	1,052		1.27	%
Interest-bearing demand		335,009			1,459		1.75	%		387,112			1,695		1.76	%
Certificates of deposit		706,540			8,271		4.70	%		670,181			6,374		3.82	%
Short-term borrowings		22,952			153		2.68	%		25,414			126		2.00	%
Long-term borrowings		37,482			483		5.16	%		74,661			1,059		5.69	%
Junior subordinated debentures		16,702			432		10.35	%		16,702			432		10.35	%

Total interest-bearing liabilities		1,476,534		$	12,406		3.37	%		1,507,188		$	10,738		2.86	%

Noninterest-bearing demand deposits		258,577								254,785
Other noninterest-bearing liabilities		19,466								17,008

Total liabilities		1,754,577								1,778,891
Shareholders’ equity		184,108								171,657


Total liabilities and shareholders’ equity	$	1,938,685							$	1,950,638

Net interest income (tax-equivalent)				$	15,193							$	16,245
Less: tax-exempt equivalent adjustment					1,099								1,230
Less: tax-preferred equivalent adjustment					42								3

Net interest income				$	14,052							$	15,012

Net interest rate spread							2.72	%							3.07	%

Net earning assets	$	337,765							$	315,181

Net interest margin (tax-equivalent)							3.35	%							3.57	%

Ratio of average interest-earning assets to average interest-bearing liabilities							122.88	%							120.91	%


	For the Six Months Ended June 30,
	2007								2006
	Average			Interest		Annualized			Average			Interest		Annualized
	Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
(Dollars in thousands)	Balance			Paid		Rate			Balance			Paid		Rate
Interest-earning assets:
Federal funds sold and interest-bearing deposits	$	50,324		$	1,326		5.31	%	$	20,424		$	486		4.79	%
Commercial paper due in less than 90 days		—			—		—	%		12,145			290		4.84	%
Investment securities:
Taxable		576,992			12,870		4.46	%		571,533			12,034		4.21	%
Tax-exempt		237,758			6,510		5.48	%		261,041			6,991		5.36	%
Tax-preferred		9,126			289		6.34	%		81			25		61.57	%

Total investment securities		823,876			19,669		4.77	%		832,655			19,050		4.58	%
Loans held for sale		465			20		8.46	%		465			20		8.81	%
Loans:
Commercial and agricultural		414,837			15,858		7.71	%		439,061			16,374		7.52	%
Residential real estate		163,352			5,315		6.51	%		165,529			5,324		6.43	%
Consumer indirect		108,873			3,653		6.77	%		88,381			2,674		6.10	%
Consumer direct and home equity		240,204			8,713		7.31	%		273,821			9,261		6.82	%

Total loans		927,266			33,539		7.28	%		966,792			33,633		7.01	%

Total interest-earning assets		1,801,931		$	54,554		6.08	%		1,832,481		$	53,479		5.86	%

Allowance for loans losses		(17,116	)							(20,532	)
Other noninterest-earning assets		141,890								152,214

Total assets	$	1,926,705							$	1,964,163

Interest-bearing liabilities:
Savings and money market	$	346,216		$	2,978		1.73	%	$	341,260		$	1,979		1.17	%
Interest-bearing demand		345,340			3,052		1.78	%		392,062			3,254		1.67	%
Certificates of deposit		695,014			16,071		4.66	%		668,734			12,109		3.65	%
Short-term borrowings		25,985			322		2.50	%		23,606			238		2.03	%
Long-term borrowings		37,828			969		5.17	%		75,633			2,090		5.57	%
Junior subordinated debentures		16,702			864		10.35	%		16,702			864		10.35	%

Total interest-bearing liabilities		1,467,085		$	24,256		3.33	%		1,517,997		$	20,534		2.73	%

Noninterest-bearing demand deposits		256,437								256,908
Other noninterest-bearing liabilities		19,649								17,170

Total liabilities		1,743,171								1,792,075
Shareholders’ equity		183,534								172,088

Total liabilities and shareholders’ equity	$	1,926,705							$	1,964,163

Net interest income (tax-equivalent)				$	30,298							$	32,945
Less: tax-exempt equivalent adjustment					2,213								2,447
Less: tax-preferred equivalent adjustment					77								7

Net interest income				$	28,008							$	30,491

Net interest rate spread							2.75	%							3.13	%

Net earning assets	$	334,846							$	314,484

Net interest margin (tax-equivalent)							3.37	%							3.60	%

Ratio of average interest-earning assets to average interest-bearing liabilities							122.82	%							120.72	%

Net Interest Income

For the three months ended June 30, 2007, net interest income was $14.1 million, down $1.0 million in comparison with the same quarter last year. Net interest margin was 3.35% for the second quarter of 2007, 22 basis points lower than 3.57% in the same period last year. The yield on interest-earning assets increased 16 basis points, to 6.09%, for the quarter ended June 30, 2007, compared to the same quarter a year ago. The Company’s cost of funds increased 38 basis points, to 2.74%, for the second quarter of 2007, versus the same quarter last year. The Company’s funding sources are more heavily influenced by the short-end of the interest rate yield curve, so the flat-to-inverted yield curve has led to a more rapid increase in the cost of funds versus the yield on interest-earning assets. In addition, the

cost of funds was adversely impacted by a change in the mix of funding sources as customers shifted deposits to higher cost certificates of deposit from lower cost interest-bearing demand, savings and money market accounts.

For the first six months of 2007 net interest income was $28.0 million, a decline of $2.5 million from the six months ending June 30, 2006. For the first six months of 2007 average interest-earning assets declined $30.6 million from the first six months of 2006 and, together with the 23 basis point decline in net interest margin, resulted in the $2.5 million drop in net interest income. The decline in average interest-earning assets for the first six months of 2007 resulted from a decline in average borrowings of $35.4 million due to the repayment and maturity of those borrowings. The drop in net interest margin resulted as the average cost of funds increased 45 basis points while average interest-earning asset yield increased only 22 basis points. For most of the first six months of 2007, a flat-to-inverted yield curve contributed to reduced spread on asset transactions and nonpublic deposits shifted into higher cost certificates of deposits from lower cost deposit products. In addition, soft loan demand made replacement of lower-rate loans with new, higher-rate loans difficult.

Rate/Volume Analysis

The following table presents the extent to which changes in interest rates and changes in the volume of average interest-earning assets and average interest-bearing liabilities have affected the Company’s interest income (on a tax-equivalent basis) and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by current year rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.


	Three Months Ended June 30,									Six Months Ended June 30,
	2007 vs. 2006									2007 vs. 2006
	Increase/(Decrease)						Total			Increase/(Decrease)						Total
	Due To						Increase/			Due To						Increase/
(Dollars in thousands)	Volume			Rate			(Decrease)			Volume			Rate			(Decrease)
Interest-earning assets:
Federal funds sold and interest-bearing deposits	$	251		$	23		$	274		$	787		$	53		$	840
Commercial paper due in less than 90 days		(185	)		—			(185	)		(290	)		—			(290	)

Investment securities:
Taxable		303			448			751			122			714			836
Tax-exempt		(326	)		45			(281	)		(638	)		157			(481	)
Tax Preferred		157			(11	)		146			286			(22	)		264

Total investment securities		134			482			616			(230	)		849			619
Loans held for sale		3			—			3			—			—			—

Loans:
Commercial and agricultural		(219	)		22			(197	)		(933	)		417			(516	)
Residential real estate		(18	)		41			23			(104	)		95			(9	)
Consumer indirect		348			132			480			686			293			979
Consumer direct and home equity		(601	)		203			(398	)		(1,206	)		658			(548	)

Total loans		(490	)		398			(92	)		(1,557	)		1,463			(94	)


Total interest-earning assets	$	(287	)	$	903		$	616		$	(1,290	)	$	2,365		$	1,075


Interest-bearing liabilities:
Savings and money market	$	112		$	444		$	556		$	43		$	956		$	999
Interest-bearing demand		(226	)		(10	)		(236	)		(420	)		218			(202	)
Certificates of deposit		426			1,471			1,897			608			3,354			3,962
Short-term borrowings		(16	)		43			27			29			55			84
Long-term borrowings		(477	)		(99	)		(576	)		(971	)		(150	)		(1,121	)

Total interest-bearing liabilities	$	(181	)	$	1,849		$	1,668		$	(711	)	$	4,433		$	3,722


Net interest income	$	(106	)	$	(946	)	$	(1,052	)	$	(579	)	$	(2,068	)	$	(2,647	)

Credit for Loan Losses

The credit for loan losses represents management’s estimate of the adjustment necessary to maintain the allowance for loan losses at a level representative of probable credit losses inherent in the portfolio. The credit for loan losses recorded for the second quarter of 2007 was $153,000, compared with a credit for loan losses of $1.6 million for the second quarter of 2006. For the six months ended June 30, 2007, the credit for loan losses was $153,000, compared with $1.4 million for the same period last year.

Net loan charge-offs in the second quarter of 2007 were $239,000 compared to $100,000 for the prior year’s second quarter. Net loan charge-offs to average loans (annualized) for the second quarter 2007 was 0.10% compared with 0.04% in the same quarter last year. Net loan charge-offs for the six months ended June 30, 2007 were $373,000 compared to $290,000 from the same period last year. Net loan charge-offs to average loans (annualized) for the six months ended June 30, 2007 was 0.08% compared with 0.06% for the same period last year.

The credit for loans losses resulted from the continued improvement in the risk-rating profile of the loan portfolio, the low level of net loan charge-offs, a smaller loan portfolio in comparison to a year ago and a change in the mix of the loan portfolio to loan categories with reduced credit risk.

Noninterest Income

The following table details the major categories of noninterest income for the periods presented:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
(Dollars in thousands)	2007		2006		2007		2006
Noninterest income:
Service charges on deposits	$	2,767	$	2,833	$	5,336	$	5,505
ATM and debit card income		724		553		1,344		1,087
Broker-dealer fees and commissions		347		376		730		807
Trust fees		—		67		—		261
Mortgage banking income		301		306		555		614
Income from corporate owned life insurance		29		432		49		452
Net gain on sale of securities		51		—		51		—
Net gain on sale of student loans held for sale		58		30		170		177
Net gain on sale of commercial-related loans held for sale		—		—		—		82
Net gain (loss) on sale of premises and equipment		7		3		15		14
Net gain on sale of other real estate and repossessed assets		24		20		73		107
Net gain on sale of trust relationships		—		—		13		—
Other		298		561		1,008		1,031

Total noninterest income	$	4,606	$	5,181	$	9,344	$	10,137

Noninterest income for the three months ended June 30, 2007 and 2006 was $4.6 million and $5.2 million, respectively. Noninterest income for the six months ended June 30, 2007 and 2006 was $9.3 million and $10.1 million, respectively.

Service charges on deposits declined 2.3% on a quarter-to-date basis and 3.1% on a year-to-date basis in 2007 versus 2006. The decline is due in part to the decrease in average transaction-type deposit accounts compared to a year ago and fewer customer overdraft transactions and related fees.

Automated Teller Machine (“ATM”) and debit card income, which represents fees for foreign ATM usage and income associated with customer debit card purchases, totaled $724,000 and $1.3 million for the quarter and six months ended June 30, 2007, respectively, compared to $553,000 and $1.1 million for the same periods in the prior year. ATM and debit card income has increased as a result of higher ATM usage fees and an increase in customer utilization of debit card point-of-sale transactions.

Broker-dealer fees and commissions have declined on both a quarter-to-date and year-to-date basis as a result of lower sales volumes. There were no trust fees in 2007 as the Company sold its trust relationships at the end of the third quarter in 2006.

Mortgage banking income, which includes gains and losses from the sale of residential mortgage loans, mortgage servicing income and the amortization and impairment (if any) of mortgage servicing rights, have declined on a year-to-date basis in 2007 compared to 2006. The decline was a result of a higher level of originated residential

mortgages being retained in the loan portfolio, as well as overall slowing in residential real estate activity in the Company’s market area.

Included in noninterest income for the second quarter and first six months of 2006 was $432,000 in income from corporate owned life insurance, the bulk of which was life insurance policy proceeds.

Other noninterest income declined to $298,000 in the second quarter of 2007 versus $561,000 for the same period a year ago, primarily the result of equity method adjustments to our Small Business Investment Company (“SBIC”) limited partnership investments. On a year-to-date basis other noninterest income was basically flat in 2007 compared to 2006.

Noninterest Expense

The following table details the major categories of noninterest expense for the periods presented:


	Three Months Ended				Six Months Ended
	June 30,				June 30,
(Dollars in thousands)	2007		2006		2007		2006
Noninterest expense:
Salaries and employee benefits	$	8,008	$	8,064	$	16,362	$	16,784
Occupancy and equipment		2,450		2,428		4,898		4,790
Supplies and postage		402		451		840		1,010
Amortization of other intangible assets		76		107		153		215
Computer and data processing		589		438		1,046		843
Professional fees and services		577		876		1,072		1,549
Other		2,246		2,217		3,905		4,665

Total noninterest expense	$	14,348	$	14,581	$	28,276	$	29,856

Noninterest expense for the second quarter of 2007 decreased $233,000, or 1.6%, to $14.3 million from $14.6 million in the second quarter of 2006. For the first six months of 2007, noninterest expense was $28.3 million, down 5.3% from $29.9 million for the same period in 2006. The lower expense levels reflect operational efficiencies gained from the consolidation of administrative and operational functions, improved asset quality and lower advertising costs.

For the second quarter of 2007, salaries and benefits were relatively flat in comparison to the second quarter of 2006. For the six months ended June 30, 2007, salaries and benefits were $16.4 million, compared to $16.8 million for the first six months of 2006. Consolidation activities have resulted in a reduction of 21 full-time equivalent employees (“FTEs”) to 636 at June 30, 2007, down from 657 at June 30, 2006. The reduction in salaries expense was partially offset by an increase in benefits expense in 2007 in comparison to 2006, which was a result of a rise in health care costs and an increase in the Company’s 401(k) benefit plan match, offset by a decrease in unemployment insurance.

The Company experienced a slight increase in occupancy and equipment expense in the second quarter of 2007 compared to the same quarter a year ago. For the six months ended June 30, 2007, occupancy and equipment expense was up 2.3% compared to the first six months of 2006, primarily the result of an increase in service contracts expense.

Supplies and postage are down 10.9% and 16.8% on a quarter-to-date and year-to-date basis, respectively when comparing 2007 to 2006. The decline resulted from cost reduction efforts and an increase in expense in 2006 due to the purchase of branding-related stationery and supplies as a result of the reorganization.

Amortization of other intangibles declined in 2007 versus 2006 as a result of certain intangible assets being fully amortized during 2006.

Computer and data processing costs increased 34.5% and 24.1% on a quarter-to-date and year-to-date basis, respectively, when comparing 2007 to 2006. The increase is primarily a result of the timing of an annual software upgrade that occurred during the second quarter of 2007 versus the fourth quarter of 2006.

Professional fees have declined 34.1% and 30.8% for the three and six-month periods ended June 30, 2007, respectively as compared to the same periods a year ago. The decline in professional fees is primarily related to lower legal and external loan review costs associated with commercial-related loans.

Other expenses have increased slightly for the three-month period ended June 30, 2007 as compared to the same period a year ago, but decreased 16.3% on a year-to-date basis when 2007 is compared to 2006. A major branding campaign was initiated in the first quarter of the prior year due to the consolidation of our banks resulting in higher advertising and promotion costs in the first quarter of 2006.

The efficiency ratio for the second quarter of 2007 was 72.04%, compared with 67.28% for the second quarter of 2006, and 70.72% for the six months ended June 30, 2007, compared to 68.63% for the same period a year ago. The higher efficiency ratios in 2007 reflect the lower revenue levels in 2007 compared to 2006. The efficiency ratio represents noninterest expense less other real estate expense and amortization of intangibles divided by net interest income (tax-equivalent) plus other noninterest income less net gain on sale of securities, net gain on sale of commercial-related loans held for sale and net gain on sale of trust relationships.

Income Tax Provision

The income tax provision provides for Federal and New York State income taxes and amounted to $1.0 million and $1.8 million for the three months ended June 30, 2007 and 2006, respectively. For the six months ended June 30, 2007 and 2006, the income tax provision amounted to $2.2 million and $3.0 million, respectively. The effective tax rates recorded for 2007 on a quarter-to-date and year-to-date basis were 22.9% and 23.5% of income before income taxes, respectively, in comparison to the June 30, 2006 quarter-to-date and year-to-date effective tax rates of 25.5% and 24.8%, respectively.

ANALYSIS OF FINANCIAL CONDITION

Lending Activities

Loans Held for Sale

Loans held for sale (not included in the table below) totaled $1.4 million and $992,000 at June 30, 2007 and December 31, 2006, respectively, all of which were residential real estate loans.

Loan Portfolio Composition

The following table sets forth selected information regarding the composition of the Company’s loan portfolio at the dates indicated:


	June 30,					December 31,
(Dollars in thousands)	2007					2006
Commercial	$	121,687		12.9	%	$	105,806		11.4	%
Commercial real estate		246,032		26.1			243,966		26.3
Agricultural		53,375		5.7			56,808		6.2
Residential real estate		165,516		17.6			163,243		17.6
Consumer indirect		117,403		12.5			106,391		11.5
Consumer direct and home equity		236,857		25.2			250,268		27.0

Total loans		940,870		100.0			926,482		100.0

Allowance for loan losses		(16,522	)				(17,048	)


Total loans, net	$	924,348				$	909,434

Total loans increased $14.4 million to $940.9 million at June 30, 2007 from $926.5 million at December 31, 2006. Commercial loans and commercial real estate loans increased $17.9 million to $367.7 million or 39.1% of the portfolio at June 30, 2007 from $349.8 million or 37.8% of the portfolio at December 31, 2006. Commercial loans increased $15.9 million over December 31, 2006, as our extensive commercial business development program over the past year delivered results. Agricultural loans decreased $3.4 million, to $53.4 million at June 30, 2007 from $56.8 million at December 31, 2006.

Residential real estate loans increased $2.3 million to $165.5 million at June 30, 2007 in comparison to $163.2 million at December 31, 2006. This category of loans increased as we added certain residential mortgages to our portfolio rather than selling the mortgages to the secondary market. The consumer indirect portfolio increased $11.0 million to $117.4 million at June 30, 2007 from $106.4 million at December 31, 2006. The Company has expanded its relationships with franchised new car dealers and is selectively originating a mix of approximately 35% new

automobile loans and 65% used automobile loans from those dealers. The consumer direct and home equity portfolio decreased $13.4 million to $236.9 million at June 30, 2007 in comparison to $250.3 million at December 31, 2006. The decline in direct consumer and home equity products is reflective of our maintaining a firm pricing and underwriting discipline on these products, which has led to slower loan originations in this category.

Nonaccruing Loans and Nonperforming Assets

Information regarding nonaccruing loans and other nonperforming assets is as follows:


	June 30,			December 31,
(Dollars in thousands)	2007			2006
Nonaccruing loans (1)
Commercial	$	1,227		$	2,205
Commercial real estate		3,444			4,661
Agricultural		1,258			4,836
Residential real estate		3,638			3,127
Consumer indirect		47			166
Consumer direct and home equity		788			842

Total nonaccruing loans		10,402			15,837

Loans past due 90 days or more		4			3


Total nonperforming loans		10,406			15,840

Other real estate owned (ORE) and repossessed assets (repos)		1,352			1,203


Total nonperforming assets	$	11,758		$	17,043


Total nonperforming loans to total loans (2)		1.11	%		1.71	%

Total nonperforming assets to total loans, ORE and repos (2)		1.25	%		1.84	%

Total nonperforming assets to total assets		0.62	%		0.89	%


(1)		Although loans are generally placed on nonaccruing status when they become 90 days or more past due, they may be placed on nonaccruing status earlier if they have been identified by the Company as presenting uncertainty with respect to the collectibility of interest or principal. Loans past due 90 days or more may remain on accruing status if they are both well secured and in the process of collection.

(2)		Ratios exclude loans held for sale from total loans.

The Company experienced a $5.2 million decline in total nonperforming assets to $11.8 million at June 30, 2007 compared to $17.0 million on December 31, 2006. Total nonaccruing loans declined $5.4 million at June 30, 2007 compared to December 31, 2006 as nonaccruing loans totaling $4.3 million were returned to accruing status in the second quarter of 2007, which included a single $3.1 million agricultural relationship that was returned to accruing status as a result of improved cash flow from the increase in the price of milk. The Company experienced a slight increase in ORE to $1.4 million at June 30, 2007 compared to $1.2 million on December 31, 2006.

Information regarding the activity in nonaccruing loans is as follows:


	Three Months			Six Months
	Ended			Ended
(Dollars in thousands)	June 30, 2007			June 30, 2007
Nonaccruing loans, beginning of period	$	15,778		$	15,837
Additions		1,915			4,749
Payments		(1,575	)		(3,177	)
Charge-offs		(830	)		(1,332	)
Returned to accruing status		(4,277	)		(4,596	)
Transferred to other real estate or repossessed assets		(609	)		(1,079	)


Nonaccruing loans, end of period	$	10,402		$	10,402

Potential problem loans are loans that are currently performing, but information known about possible credit problems of the borrowers causes management to have concern as to the ability of such borrowers to comply with the present loan payment terms and may result in disclosure of such loans as nonperforming at some point in the future. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and/or personal or government guarantees. Management considers loans classified as substandard, which continue to accrue interest, to be potential problem loans. The Company identified $16.3

million and $16.2 million in loans that continued to accrue interest which were classified as substandard as of June 30, 2007 and December 31, 2006, respectively.

Analysis of the Allowance for Loan Losses

The allowance for loan losses represents the estimated amount of probable credit losses inherent in the Company’s loan portfolio. The Company performs periodic, systematic reviews of the Bank’s loan portfolio to estimate probable losses in the respective loan portfolios. In addition, the Company regularly evaluates prevailing economic and business conditions, industry concentrations, changes in the size and characteristics of the portfolio and other environmental factors. The process used by the Company to determine the overall allowance for loan losses is based on this analysis. Based on this analysis the Company believes the allowance for loan losses is adequate at June 30, 2007.

Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon management’s evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing various factors. The adequacy of the allowance for loan losses is subject to ongoing management review. While management evaluates currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution’s allowance for loan losses. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

The following table sets forth an analysis of the activity in the allowance for loan losses for the periods indicated:


	Three Months Ended						Six Months Ended
	June 30,						June 30,
(Dollars in thousands)	2007			2006			2007			2006
Balance at beginning of period	$	16,914		$	20,291		$	17,048		$	20,231

Charge-offs:
Commercial		214			211			298			538
Commercial real estate		157			123			187			397
Agricultural		16			30			16			253
Residential real estate		—			142			61			184
Consumer indirect		246			111			421			237
Consumer direct and home equity		336			269			679			581

Total charge-offs		969			886			1,662			2,190

Recoveries:
Commercial		443			395			557			1,112
Commercial real estate		46			44			148			112
Agricultural		49			122			125			157
Residential real estate		1			1			47			2
Consumer indirect		46			64			88			122
Consumer direct and home equity		145			160			324			395

Total recoveries		730			786			1,289			1,900


Net charge-offs		239			100			373			290

Provision for loan losses		(153	)		(1,601	)		(153	)		(1,351	)


Balance at end of period	$	16,522		$	18,590		$	16,522		$	18,590	)


Ratio of net loan charge-offs to average loans (annualized)		0.10	%		0.04	%		0.08	%		0.06	%

Ratio of allowance for loan losses to total loans (1)		1.76	%		1.95	%		1.76	%		1.95	%

Ratio of allowance for loan losses to nonperforming loans (1)		159	%		121	%		159	%		121	%


(1)		Ratios exclude loans held for sale from total loans.

Net loan charge-offs were $239,000 and $373,000 for the second quarter and year-to-date 2007, respectively compared to $100,000 and $296,000 for the same 2006 periods. The ratio of net loan charge-offs to average loans (annualized) was 0.10% and 0.08% for the second quarter and year-to-date 2007, respectively, compared to 0.04% and 0.06% for the same 2006 periods. The Company’s net charge-off experience has improved for the periods presented as a result of the Company’s focus and efforts to improve the credit quality of its loan portfolio and underwriting process over the past few years. The ratio of the allowance for loan losses to nonperforming loans was 159% at June 30, 2007, improved from 108% at December 31, 2006 and 121% at June 30, 2006, as a result of the

reduction in nonperforming loans. The ratio of the allowance for loan losses to total loans was 1.76% at June 30, 2007, down from 1.84% at December 31, 2006 and 1.95% at June 30, 2006, as a result of the improvement in the risk profile of the loan portfolio.

Investing Activities

The Company’s total investment security portfolio totaled $811.7 million as of June 30, 2007 compared to $775.5 million as of December 31, 2006. The net unrealized losses on securities available for sale amounted to $11.6 million and $11.1 million as of June 30, 2007 and December 31, 2006, respectively. The unrealized losses present do not reflect deterioration in the credit worthiness of the issuing securities and resulted primarily from fluctuations in market interest rates. The Company has the intent and ability to hold these securities until their fair value recovers to their amortized cost; therefore, management has determined that the securities that were in an unrealized loss position at June 30, 2007 and December 31, 2006 represent only temporary declines in fair value. Further detail regarding the Company’s investment portfolio follows.

U.S. Government-Sponsored Enterprise (“GSE”) Securities

The GSE securities portfolio, all of which is classified as available for sale, is comprised of debt obligations issued directly by the GSEs and totaled $231.2 million at June 30, 2007. The portfolio consisted of approximately $116.4 million, or 50%, callable securities at June 30, 2007. At June 30, 2007, this category of securities also includes $85.9 million of structured notes, the majority of which were step callable agency debt issues. The step callable bonds step-up in rate at specified intervals and are periodically callable by the issuer. At June 30, 2007, the structured notes had a current average coupon of 4.18% that adjust on average to 6.53% within five years. However, under current market conditions these notes are likely to be called. At December 31, 2006, the available for sale GSE securities portfolio totaled $231.8 million.

State and Municipal Obligations

At June 30, 2007, the portfolio of state and municipal obligations totaled $226.8 million, of which $174.9 million was classified as available for sale. At that date, $51.9 million was classified as held to maturity, with a fair value of $52.0 million. At December 31, 2006, the portfolio of state and municipal obligations totaled $238.7 million, of which $198.3 million was classified as available for sale. At that date, $40.4 million was classified as held to maturity, with a fair value of $40.4 million.

Mortgage-Backed Pass-through Securities (“MBS”), Collateralized Mortgage Obligations (“CMO”) and Other Asset-Backed Securities (“ABS”)

MBS, CMO and ABS securities, all of which were classified as available for sale, totaled $332.8 million and $300.0 million at June 30, 2007 and December 31, 2006, respectively. The portfolio was comprised of $172.7 million of MBSs, $144.6 million of CMOs and $15.5 million of other ABSs at June 30, 2007. The MBSs were issued by U.S. government agencies or GSEs (GNMA, FNMA or FHLMC). Approximately 85.7% of the MBSs were in fixed rate securities that were most frequently formed with mortgages having an original balloon payment of five or seven years. The adjustable rate agency mortgage-backed securities portfolio is principally indexed to the one-year Treasury bill. The CMO portfolio consisted primarily of fixed and variable rate government issues and fixed rate privately issued AAA rated securities. The ABSs were primarily Student Loan Marketing Association (“SLMA”) floaters, which are variable rate securities backed by student loans. At December 31, 2006, the portfolio consisted of $189.4 million of MBSs, $107.4 million of CMOs and $3.2 million of other ABSs.

Corporate Bonds and Other

The Company held $9.9 million and $3.9 million in corporate bonds and other securities at June 30, 2007 and December 31, 2006, respectively. The Company’s investment policy limits investments in corporate bonds to no more than 10% of total investments and to bonds rated as Baa or better by Moody’s Investors Service, Inc. or BBB or better by Standard & Poor’s Ratings Services at the time of purchase.

Equity Securities

Available for sale equity securities totaled $11.0 million and $1.1 million at June 30, 2007 and December 31, 2006, respectively. During 2007 the Company purchased $10.0 million of U.S. government agency (FNMA and FHLMC) preferred stock at par, which reprices every 90 days during 2007.

Funding Activities

The Company manages funding from the following principal components: nonpublic deposits, public deposits, brokered deposits, borrowings and junior subordinated debentures.

Nonpublic Deposits

Nonpublic deposits represent the largest component of the Company’s funding sources. The Company offers a broad array of nonpublic deposit products including noninterest-bearing demand, interest-bearing demand, savings and money market accounts and certificates of deposit. At June 30, 2007, total nonpublic deposits were $1.255 billion in comparison to $1.248 billion at December 31, 2006. The Company has managed this segment of funding through a strategy of competitive pricing that minimizes the number of customer relationships that have only a single service high cost deposit account. In addition, the Company has recently managed overall pricing of its nonpublic deposits in a manner that recognizes sufficient liquidity is already in place to expand the loan portfolio and the flat-to-inverted interest yield curve provides marginal opportunity to deploy new funding at a profitable spread.

Public Deposits

The Company offers a variety of deposit products to the many towns, villages, counties and school districts within our market. Public deposits generally range from 20 to 25% of the Company’s total deposits. At June 30, 2007, total public deposits were $345.0 million in comparison to $352.9 million at December 31, 2006. There is a high degree of seasonality in this component of funding, as the level of deposits varies with the seasonal cash flows for these public customers. The Company maintains the necessary levels of short-term liquid assets to accommodate the seasonality associated with public deposits. In general, the number of public relationships remained stable during the first six months of 2007.

Brokered Deposits

The Company has also utilized brokered certificates of deposit as a funding source as outstanding deposits totaled $16.7 million at June 30, 2007 and December 31, 2006. The Company intends to utilize its favorable position of liquidity to repay the brokered deposits as they mature throughout the remainder of 2007 and 2008.

Borrowings

The Company’s most significant source of borrowing funding are FHLB advances, which amounted to $37.2 million and $38.2 million as of June 30, 2007 and December 31, 2006. The FHLB borrowings mature on various dates through 2009. The Company had approximately $15.4 million and $31.5 million of immediate credit capacity with FHLB at June 30, 2007 and December 31, 2006, respectively. The FHLB credit capacity is collateralized by GSE securities. The Company also had $118.4 million and $102.1 million of credit available under unsecured lines of credit with various banks at June 30, 2007 and December 31, 2006, respectively. There were no advances outstanding on these lines of credit at June 30, 2007 and December 31, 2006. The Company also utilizes securities sold under agreements to repurchase as a source of funds. These short-term repurchase agreements amounted to $22.5 million and $32.3 million as of June 30, 2007 and December 31, 2006, respectively.

The Company also had a credit agreement with another commercial bank. The credit agreement included a $25.0 million term loan facility and a $5.0 million revolving loan facility. During October 2006, FII repaid the $25.0 million term loan. There were no advances on the $5.0 million revolving loan, which matured April 30, 2007.

Junior Subordinated Debentures

In February 2001, the Company issued $16.7 million of junior subordinated debentures to a statutory trust subsidiary. The junior subordinated debentures have a fixed interest rate equal to 10.20% and mature in 30 years. The Company incurred $487,000 in costs related to the issuance that are being amortized over 20 years using the straight-line method. The statutory trust subsidiary then participated in the issuance of trust preferred securities of similar terms and maturity. As of December 31, 2003, the Company deconsolidated the subsidiary trust, which had issued trust preferred securities, and replaced the presentation of such instruments with the Company’s junior subordinated debentures issued to the subsidiary trust. Such presentation reflects the adoption of FASB Interpretation No. 46 (“FIN 46 R”), “Consolidation of Variable Interest Entities.”

Equity Activities

Total shareholders’ equity amounted to $182.8 million at June 30, 2007, an increase of $0.4 million from $182.4 million at December 31, 2006. The increase in shareholders’ equity during the six months ended June 30, 2007

primarily resulted from $6.8 million of comprehensive income, offset by $3.1 million in dividends declared and $3.9 million in treasury stock acquisitions under the common stock repurchase program.

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

The objective of maintaining adequate liquidity is to assure the ability of the Company to meet its financial obligations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of borrowings as they mature, the ability to fund new and existing loan commitments and the ability to take advantage of new business opportunities. The Company achieves liquidity by maintaining a strong base of customer funds, maturing short-term assets, and the ability to sell securities, lines of credit, and access to capital markets.

Liquidity at the Bank is managed through the monitoring of anticipated changes in loans, the investment portfolio, deposits and wholesale funds. The strength of the Bank’s liquidity position is a result of its base of customer deposits. Deposits are supplemented by wholesale funding sources that include credit lines with other banking institutions, the FHLB and the Federal Reserve Bank.

The primary sources of liquidity for FII are dividends from the Bank and access to capital markets. Dividends from the Bank are limited by various regulatory requirements related to capital adequacy and earnings trends. The Bank relies on cash flows from operations, deposits, borrowings and short-term liquid assets. FSIS relies on cash flows from operations and funds from FII when necessary.

The Company’s cash and cash equivalents were $50.0 million at June 30, 2007, a decrease of $59.8 million from $109.8 million at December 31, 2006. The Company’s net cash provided by operating activities totaled $11.9 million and the principal source of operating activity cash flow was net income adjusted for noncash income and expense items and changes in other assets and other liabilities. Net cash used in investing activities totaled $53.6 million, which included net purchases of $36.4 million in securities, $15.8 million of loan originations in excess of loan payments, and a purchase of premises and equipment for $2.0 million dollars. Net cash used in financing activities of $18.1 million was primarily attributed to the $10.8 million reduction in short and long-term borrowings, $4.0 million of preferred and common share repurchases and $2.9 million in dividends paid. The Company’s cash and cash equivalents were $86.7 million at June 30, 2006 a decrease of $5.2 million from $91.9 million at December 31, 2005.

Capital Resources

The Federal Reserve Board has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies on a consolidated basis. The leverage ratio is utilized in assessing capital adequacy with a minimum requirement that can range from 4.0% to 5.0%. The guidelines also require a minimum total risk-based capital ratio of 8.0%.

The Company’s Tier 1 leverage ratio was 8.89% at June 30, 2007, comparable to 8.91% at December 31, 2006. Total Tier 1 capital of $169.6 million at June 30, 2007 was up from $168.7 million at December 31, 2006. The Company’s Tier 1 risk-based capital ratio was 15.86% at June 30, 2007, comparable to 15.85% at December 31, 2006. The Company’s total risk-weighted capital ratio was 17.12% at June 30, 2007 compared to 17.10% at December 31, 2006.

The following is a summary of the risk-based capital ratios for the Company and FSB:


	June 30,			December 31,
	2007			2006
Tier 1 leverage ratio
Company		8.89	%		8.91	%
FSB		8.25	%		8.06	%

Tier 1 risk-based capital ratio
Company		15.86	%		15.85	%
FSB		14.79	%		14.35	%

Total risk-based capital ratio
Company		17.12	%		17.10	%
FSB		16.04	%		15.61	%

Item 3. Quantitative and Qualitative Disclosures About Market Risk

The principal objective of the Company’s interest rate risk management is to evaluate the interest rate risk inherent in certain assets and liabilities, determine the appropriate level of risk to the Company given its business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with the guidelines approved by FII’s Board of Directors. The Company’s management is responsible for reviewing with the Board its activities and strategies, the effect of those strategies on the net interest margin, the fair value of the portfolio and the effect that changes in interest rates will have on the portfolio and exposure limits. Management develops an Asset-Liability Policy that meets strategic objectives and regularly reviews the activities of the Bank.

The primary tool the Company uses to manage interest rate risk is a “rate shock” simulation to measure the rate sensitivity of the balance sheet. Rate shock simulation is a modeling technique used to estimate the impact of changes in rates on net interest income and economic value of equity. The Company measures net interest income at risk by estimating the changes in net interest income resulting from instantaneous and sustained parallel shifts in interest rates of different magnitudes over a period of twelve months. This simulation is based on management’s assumption as to the effect of interest rate changes on assets and liabilities and assumes a parallel shift of the yield curve. It also includes certain assumptions about the future pricing of loans and deposits in response to changes in interest rates. Further, it assumes that delinquency rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case. While this simulation is a useful measure as to net interest income at risk due to a change in interest rates, it is not a forecast of the future results and is based on many assumptions that, if changed, could cause a different outcome.

In addition to the changes in interest rate scenarios listed above, the Company typically runs other scenarios to measure interest rate risk, which vary depending on the economic and interest rate environments.

The Company has experienced no significant changes in market risk due to changes in interest rates since the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, dated March 13, 2007, as filed with the Securities and Exchange Commission.

Item 4. Controls and Procedures

a) As of June 30, 2007, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (“Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this report.

Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

b) Changes to Internal Control Over Financial Reporting

There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended June 30, 2007 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

The Company has experienced no significant changes in its legal proceedings from the disclosure included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, dated March 13, 2007, as filed with the Securities and Exchange Commission.

Item 1A. Risk Factors

The Company has experienced no material changes in its risk factors from the disclosure included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2006, dated March 13, 2007, as filed with the Securities and Exchange Commission.

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

The table below sets forth the information with respect to purchases made by the Company (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the three months ended June 30, 2007:


					Total Number of Shares		Approximate Dollar
	Total Number				Purchased as Part of		Value of Shares that May
	of Shares		Average Price		Publicly Announced Plans		Yet Be Purchased Under
Period	Purchased		Paid per Share		or Programs		the Plans or Programs (1)

04/01/07 – 04/30/07		68,850	$	19.26		68,850	$	1,951,000
05/01/07 – 05/31/07		25,250		20.20		25,250		1,440,000
06/01/07 – 06/30/07		23,700		20.37		23,700		958,000


Total		117,800	$	19.69		117,800	$	958,000


(1)		On October 25, 2006, the Company’s Board of Directors approved a one-year, $5.0 million common stock repurchase program. Under the program, stock repurchases may be made either in the open market or through privately negotiated transactions. On July 25, 2007, the Company’s Board of Directors approved a new one-year $5.0 million common stock repurchase program and canceled the remaining portion of the Company’s one-year $5.0 million stock repurchase program that was approved October 25, 2006.

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

At the Company’s Annual Meeting of Shareholders held May 2, 2007, shareholders elected the directors listed below. The voting results were as follows:


			Number of Votes
									Broker
Nominee	Term (years)		For		Withheld		Abstain		Non-Votes
Thomas P. Connolly		3		9,218,222		647,055		—		—
Samuel M. Gullo		3		9,217,968		646,056		—		—
James L. Robinson		3		9,566,503		299,283		—		—
James H. Wyckoff		3		9,218,456		645,568		—		—

In addition, the terms of office of the following directors continued after the meeting:

Karl V. Anderson, Jr.
John E. Benjamin
Barton P. Dambra
Susan R. Holliday
Peter G. Humphrey
Erland E. Kailbourne
Robert N. Latella
John R. Tyler, Jr.

Item 6. Exhibits

The following is a list of all exhibits filed or incorporated by reference as part of this Report.


Exhibit No.		Description	Location

	3.1	Amended and Restated Certificate of Incorporation	Incorporated by reference to Exhibit 3.1 of the Registrant’s Registration Statement on Form S-1 dated June 25, 1999 (File No. 333-76865) (The “S-1 Registration Statement”)

	3.2	Amended and Restated Bylaws dated May 23, 2001	Incorporated by reference to Exhibit 3.2 of the Form 10-K for the year ended December 31, 2001, dated March 11, 2002

	3.3	Amended and Restated Bylaws dated February 18, 2004	Incorporated by reference to Exhibit 3.3 of the Form 10-K for the year ended December 31, 2003, dated March 12, 2004

	3.4	Amended and Restated Bylaws dated February 22, 2006	Incorporated by reference to Exhibit 3.4 of the Form 10-K for the year ended December 31, 2005, dated March 15, 2006

	10.1	1999 Management Stock Incentive Plan	Incorporated by reference to Exhibit 10.1 of the S-1 Registration Statement

	10.2	Amendment Number One to the FII 1999 Management Stock Incentive Plan	Incorporated by reference to Exhibit 10.1 of the Form 8-K, dated July 28, 2006

	10.3	Form of Non-Qualified Stock Option Agreement Pursuant to the FII 1999 Management Stock Incentive Plan	Incorporated by reference to Exhibit 10.2 of the Form 8-K, dated July 28, 2006

	10.4	Form of Restricted Stock Award Agreement Pursuant to the FII 1999 Management Stock Incentive Plan	Incorporated by reference to Exhibit 10.3 of the Form 8-K, dated July 28, 2006

	10.5	1999 Directors Stock Incentive Plan	Incorporated by reference to Exhibit 10.2 of the S-1 Registration Statement

	10.6	Executive Agreement with Peter G. Humphrey	Incorporated by reference to Exhibit 10.1 of the Form 8-K, dated June 30, 2005

	10.7	Executive Agreement with James T. Rudgers	Incorporated by reference to Exhibit 10.2 of the Form 8-K, dated June 30, 2005

	10.8	Executive Agreement with Ronald A. Miller	Incorporated by reference to Exhibit 10.3 of the Form 8-K, dated June 30, 2005

	10.9	Executive Agreement with Martin K. Birmingham	Incorporated by reference to Exhibit 10.4 of the Form 8-K, dated June 30, 2005

	10.10	Agreement with Peter G. Humphrey	Incorporated by reference to Exhibit 10.6 of the Form 8-K, dated June 30, 2005

	10.11	Executive Agreement with John J. Witkowski	Incorporated by reference to Exhibit 10.7 of the Form 8-K, dated September 14, 2005

	10.12	Executive Agreement with George D. Hagi	Incorporated by reference to Exhibit 10.7 of the Form 8-K, dated February 2, 2006

	10.13	Term and Revolving Credit Loan Agreements between FII and M&T Bank, dated December 15, 2003	Incorporated by reference to Exhibit 1.1 of the Form 10-K for the year ended December 31, 2003, dated March 12, 2004

	10.14	Second Amendment to Term Loan Credit Agreement between FII and M&T Bank, dated September 30, 2005	Incorporated by reference to Exhibit 10.17 of the Form 10-Q for the quarterly period ended September 30, 2005, dated November 4, 2005


Exhibit No.		Description	Location

	10.15	Fourth Amendment to Revolving Credit Agreement between FII and M&T Bank, dated September 30, 2005	Incorporated by reference to Exhibit 10.17 of the Form 10-Q for the quarterly period ended September 30, 2005, dated November 4, 2005

	10.16	Amended Stock Ownership Requirements, dated December 14, 2005	Incorporated by reference to Exhibit 10.19 of the Form 10-K for the year ended December 31, 2005, dated March 15, 2006

	10.17	2006 Annual Incentive Plan, dated March 13, 2006	Incorporated by reference to Exhibit 10.20 of the Form 10-K for the year ended December 31, 2005, dated March 15, 2006

	10.18	Executive Enhanced Incentive Plan dated January 25, 2006	Incorporated by reference to Exhibit 10.21 of the Form 10-K for the year ended December 31, 2005, dated March 15, 2006

	10.19	Trust Company Agreement and Plan of Merger	Incorporated by reference to Exhibit 10.1 of the Form 8-K, dated April 3, 2006

	10.20	2007 Annual Incentive Plan, dated March 13, 2007	Incorporated by reference to Exhibit 10.21 of the Form 10-K for the year ended December 31, 2006, dated March 13, 2007

	10.21	2007 Director (Non-Management) Compensation	Incorporated by reference to Exhibit 10.22 of the Form 10-K for the year ended December 31, 2006, dated March 13, 2007

	11.1	Statement of Computation of Per Share Earnings	Incorporated by reference to Note 3 of the Registrant’s unaudited consolidated financial statements under Item 1 filed herewith.

	31.1	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 — CEO	Filed Herewith

	31.2	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 — CFO	Filed Herewith

	32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 — CEO	Filed Herewith

	32.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 — CFO	Filed Herewith


	FINANCIAL INSTITUTIONS, INC.

Date		Signatures

August 7, 2007	By:	/s/ Peter G. Humphrey

		Peter G. Humphrey
		President and Chief Executive Officer
		(Principal Executive Officer)

August 7, 2007	By:	/s/ Ronald A. Miller

		Ronald A. Miller
		Executive Vice President
		and Chief Financial Officer
		(Principal Accounting Officer)

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PART I — FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)

	Consolidated Statements of Financial Condition (Unaudited) as of June 30, 2007 and December 31, 2006	3

	Consolidated Statements of Income (Unaudited) for the Three and Six Months Ended June 30, 2007 and 2006	4

	Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Income (Unaudited) for the Six Months Ended June 30, 2007	5

	Consolidated Statements of Cash Flows (Unaudited) for the Six Months Ended June 30, 2007 and 2006	6

	Notes to Unaudited Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	12

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	28

Item 4.	Controls and Procedures	28

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	28

Item 1A.	Risk Factors	29

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29

Item 4.	Submission of Matters to a Vote of Security Holders	29

Item 6.	Exhibits	30

SIGNATURES

EXHIBITS
EX-31.1
EX-31.2
EX-32.1
EX-32.2