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 September 30, 2008

Commission File Number 0-26481

(Exact Name of Registrant as specified in its charter)

NEW YORK		16-0816610
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification Number)
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 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days.

YES þ NO o

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

Large Accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company 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 AS OF OCTOBER 31, 2008
Common Stock, $0.01 par value		10,798,019 shares

 

 

FINANCIAL INSTITUTIONS, INC.
Form 10-Q
For the Quarterly Period Ended September 30, 2008

TABLE OF CONTENTS

		PAGE
PART I. FINANCIAL INFORMATION
ITEM 1. Financial Statements
Consolidated Statements of Financial Condition (Unaudited) — at September 30, 2008 and December 31, 2007			3
Consolidated Statements of Operations (Unaudited) — Three and nine months ended September 30, 2008 and 2007			4
Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Income (Unaudited) — Nine months ended September 30, 2008			5
Consolidated Statements of Cash Flows (Unaudited) — Nine months ended September 30, 2008 and 2007			6
Notes to Consolidated Financial Statements (Unaudited)			7
ITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations			16
ITEM 3. Quantitative and Qualitative Disclosures About Market Risk			35
ITEM 4. Controls and Procedures			35
PART II. OTHER INFORMATION
ITEM 1. Legal Proceedings			36
ITEM 1A. Risk Factors			36
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds			36
ITEM 6. Exhibits			37
Signatures			39
Exhibit 31.1
Exhibit 31.2
Exhibit 32.1
Exhibit 32.2

PART I. FINANCIAL INFORMATION

ITEM 1. Financial Statements

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

		September 30,				December 31,
(Dollars in thousands, except share and per share data)		2008				2007
ASSETS
Cash and cash equivalents:
Cash and due from banks		$	54,105			$	45,165
Federal funds sold and interest-bearing deposits in other banks			22,599				1,508
Total cash and cash equivalents			76,704				46,673
Securities available for sale, at fair value			607,357				695,241
Securities held to maturity, at amortized cost (fair value of $64,346 and $59,902, respectively)			64,434				59,479
Loans held for sale			1,008				906
Loans			1,078,123				964,173
Less: Allowance for loan losses			17,420				15,521
Loans, net			1,060,703				948,652
Premises and equipment, net			35,411				34,157
Goodwill			37,369				37,369
Company owned life insurance			23,352				3,017
Other assets			39,481				32,382
Total assets		$	1,945,819			$	1,857,876
LIABILITIES AND SHAREHOLDERS’ EQUITY
Deposits:
Noninterest-bearing demand		$	293,027			$	286,362
Interest-bearing demand			376,098				335,314
Savings and money market			383,456				346,639
Certificates of deposit			607,833				607,656
Total deposits			1,660,414				1,575,971
Short-term borrowings			47,209				25,643
Long-term borrowings			50,773				25,865
Junior subordinated debentures issued to unconsolidated subsidiary trust			16,702				16,702
Other liabilities			17,951				18,373
Total liabilities			1,793,049				1,662,554
Shareholders’ equity:
3% cumulative preferred stock, $100 par value, 10,000 authorized shares, 1,533 and 1,586 shares issued and outstanding			153				159
8.48% cumulative preferred stock, $100 par value, 200,000 authorized shares, 174,223 shares issued and outstanding			17,422				17,422
Common stock, $0.01 par value, 50,000,000 authorized shares, 11,348,122 shares issued			113				113
Additional paid-in capital			24,298				24,778
Retained earnings			129,534				158,744
Accumulated other comprehensive (loss) income			(8,650	)			667
Treasury stock, at cost - 541,659 and 336,971 shares, respectively			(10,100	)			(6,561	)
Total shareholders’ equity			152,770				195,322
Total liabilities and shareholders’ equity		$	1,945,819			$	1,857,876

See accompanying notes to the consolidated financial statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

		Three months ended								Nine months ended
		September 30,								September 30,
(Dollars in thousands, except per share amounts)		2008				2007				2008				2007
Interest income:
Interest and fees on loans		$	17,018			$	17,571			$	50,146			$	51,130
Interest and dividends on investment securities			7,472				8,814				23,648				26,192
Other interest income			68				168				572				1,494
Total interest income			24,558				26,553				74,366				78,816
Interest expense:
Deposits			6,538				10,428				23,193				32,528
Short-term borrowings			287				360				571				682
Long-term borrowings			555				472				1,288				1,441
Junior subordinated debentures			432				432				1,296				1,296
Total interest expense			7,812				11,692				26,348				35,947
Net interest income			16,746				14,861				48,018				42,869
Provision (credit) for loan losses			1,891				(82	)			3,965				(235	)
Net interest income after provision (credit) for loan losses			14,855				14,943				44,053				43,104
Noninterest (loss) income:
Service charges on deposits			2,794				2,778				7,812				8,114
ATM and debit card			852				735				2,460				2,079
Broker-dealer fees and commissions			363				323				1,223				1,053
Loan servicing			112				259				530				707
Company owned life insurance			223				1,090				269				1,139
Net gain on sale of loans held for sale			48				313				304				589
Net gain on sale of other assets			102				59				254				160
Net gain on investment securities			12				67				232				118
Impairment charges on investment securities			(34,554	)			—				(38,345	)			—
Other			700				710				1,589				1,719
Total noninterest (loss) income			(29,348	)			6,334				(23,672	)			15,678
Noninterest expense:
Salaries and employee benefits			7,021				8,574				23,626				24,935
Occupancy and equipment			2,642				2,422				7,789				7,321
Computer and data processing			603				547				1,764				1,593
Professional services			467				476				1,504				1,548
Supplies and postage			475				443				1,353				1,283
Advertising and promotions			472				322				905				1,006
Other			1,729				1,825				5,126				5,200
Total noninterest expense			13,409				14,609				42,067				42,886
(Loss) income before income taxes			(27,902	)			6,668				(21,686	)			15,896
Income tax expense			524				1,414				1,330				3,585
Net (loss) income		$	(28,426	)		$	5,254			$	(23,016	)		$	12,311
(Loss) earnings per common share (Note 3):
Basic		$	(2.68	)		$	0.44			$	(2.22	)		$	1.00
Diluted		$	(2.68	)		$	0.44			$	(2.22	)		$	1.00

See accompanying notes to the consolidated financial statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

																						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				Income (Loss)				Stock				Equity
Balance at January 1, 2008		$	159			$	17,422			$	113			$	24,778			$	158,744			$	667			$	(6,561	)		$	195,322
Purchase 264,417 shares of common stock			—				—				—				—				—				—				(4,695	)			(4,695	)
Purchase 53 shares of 3% preferred stock			(6	)			—				—				3				—				—				—				(3	)
Issue 51,500 shares of common stock — restricted stock awards			—				—				—				(998	)			—				—				998				—
Issue 2,317 shares of common stock — exercised stock options, net of tax			—				—				—				(12	)			—				—				44				32
Issue 5,912 shares of common stock — directors retainer			—				—				—				(2	)			—				—				114				112
Amortization of unvested stock-based compensation			—				—				—				529				—				—				—				529
Cumulative effect of adoption of EITF 06-04			—				—				—				—				(284	)			—				—				(284	)
Comprehensive income:
Net loss			—				—				—				—				(23,016	)			—				—				(23,016	)
Net unrealized holding losses on securities available for sale, net of tax			—				—				—				—				—				(32,666	)			—				(32,666	)
Reclassification of impairment charges and realized gains on investment securities included in net loss, net of tax			—				—				—				—				—				23,369				—				23,369
Defined benefit pension plan, net of tax			—				—				—				—				—				6				—				6
Postretirement benefit plan, net of tax			—				—				—				—				—				(26	)			—				(26	)
Other comprehensive loss																															(9,317	)
Total comprehensive loss																															(32,333	)
Cash dividends declared:
3% Preferred — $2.25 per share			—				—				—				—				(4	)			—				—				(4	)
8.48% Preferred — $6.36 per share			—				—				—				—				(1,108	)			—				—				(1,108	)
Common — $0.44 per share			—				—				—				—				(4,798	)			—				—				(4,798	)
Balance at September 30, 2008		$	153			$	17,422			$	113			$	24,298			$	129,534			$	(8,650	)		$	(10,100	)		$	152,770

See accompanying notes to the consolidated financial statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

		Nine months ended September 30,
(Dollars in thousands)		2008				2007
Cash flows from operating activities:
Net (loss) income		$	(23,016	)		$	12,311
Adjustments to reconcile net (loss) income to net cash provided by operating activities:
Depreciation and amortization			2,922				2,958
Net amortization (accretion) of premiums and discounts on investment securities			374				(150	)
Provision (credit) for loan losses			3,965				(235	)
Amortization of unvested stock-based compensation			529				785
Deferred income tax (benefit) expense			(1,865	)			655
Proceeds from sale of loans held for sale			25,401				35,999
Originations of loans held for sale			(25,199	)			(34,525	)
Net gain on investment securities			(232	)			(118	)
Impairment charge on investment securities			38,345				—
Net gain on sale of loans held for sale			(304	)			(589	)
Net gain on sale and disposal of other assets			(254	)			(160	)
Increase in other assets			(206	)			(721	)
Decrease in other liabilities			(2,727	)			(4,145	)
Net cash provided by operating activities			17,733				12,065
Cash flows from investing activities:
Purchase of investment securities:
Available for sale			(287,678	)			(255,497	)
Held to maturity			(44,065	)			(40,206	)
Proceeds from principal payments, maturities and calls on investment securities:
Available for sale			270,367				222,096
Held to maturity			40,924				26,463
Proceeds from sale of securities available for sale			51,545				31,400
Net loan originations			(116,772	)			(26,317	)
Purchase of company owned life insurance			(20,000	)			—
Proceeds from sales of other assets			1,395				1,010
Purchase of premises and equipment			(4,058	)			(2,884	)
Net cash used in investing activities			(108,342	)			(43,935	)
Cash flows from financing activities:
Net increase (decrease) in deposits			84,443				(1,434	)
Net increase in short-term borrowings			21,566				1,063
Proceeds from long-term borrowings			30,000				—
Repayment of long-term borrowings			(5,092	)			(9,042	)
Purchase of preferred and common shares			(4,698	)			(5,888	)
Issuance of common shares			112				105
Stock options exercised			32				212
Dividends paid			(5,723	)			(4,497	)
Net cash provided by (used in) financing activities			120,640				(19,481	)
Net increase (decrease) in cash and cash equivalents			30,031				(51,351	)
Cash and cash equivalents, beginning of period			46,673				109,772
Cash and cash equivalents, end of period		$	76,704			$	58,421
Supplemental disclosure of cash flow information:
Cash paid for interest		$	28,306			$	38,491
Cash paid for income taxes			2,349				3,091
Supplemental disclosure of noncash investing and financing activities:
Real estate and other assets acquired in settlement of loans		$	756			$	1,930
Dividends declared and unpaid			1,992				1,702
Increase in unsettled security purchases			1,814				2,755

See accompanying notes to the consolidated financial statements.

(1.) BASIS OF PRESENTATION

Financial Institutions, Inc. (“FII”), a financial 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’s business operations include a broker-dealer subsidiary, Five Star Investment Services, Inc. (100% owned) (“FSIS”). During the second quarter of 2008, FII received Federal Reserve Bank (“FRB”) approval for an election to reinstate its status as a financial holding company under the Gramm-Leach-Bliley Act, which permits FII to engage in business activities that are financial in nature or incidental to financial activity.

FII formed the FISI Statutory Trust I (100% owned) (the “Trust”) in February 2001 to facilitate the private placement of $16.2 million in capital securities (“trust preferred securities”). FII capitalized the Trust with a $502 thousand investment in the Trust’s common securities. The Trust is a variable interest entity as defined by Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities,” and, as such, the Trust is accounted for as an unconsolidated subsidiary. Therefore, the Company’s consolidated statements of financial position reflect the $16.7 million in junior subordinated debentures as a liability and the $502 thousand investment in the Trust’s common securities is included in other assets.

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, 2008. The interim consolidated financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K as of December 31, 2007, dated March 11, 2008, as filed with the Securities and Exchange Commission. The consolidated financial information included herein combines the results of operations, the assets, liabilities and shareholders’ equity of FII and its subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation.

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. Current market conditions increase the risk and uncertainty associated with these estimates and assumptions and, although management uses its best judgment, actual results could differ from those estimates. Material estimates that are particularly susceptible to near-term change are the allowance for loan losses and the valuation of the investment securities portfolio.

Amounts in the prior periods’ consolidated financial statements are reclassified when necessary to conform to the current period’s presentation.

(2.) RECENT ACCOUNTING PRONOUNCEMENTS

In September 2006, the FASB issued Statement of Financial Accounting Standards (“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. In February 2008, the FASB issued FSP SFAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13,” which removes certain leasing transactions from the scope of SFAS No. 157, and FSP SFAS 157-2, “Effective Date of FASB Statement No. 157,” which defers the effective date of SFAS No. 157 for one year for certain nonfinancial assets and nonfinancial liabilities, except those that are recognized or disclosed at fair value in the financial statements on a recurring basis. In October 2008, the FASB also issued FSP SFAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” which clarifies the application of SFAS No. 157 in an inactive market and illustrates how an entity would determine fair value when the market for a financial asset is not active. On January 1, 2008, the Company adopted, without material impact on our consolidated financial statements, the provisions of SFAS No. 157 related to financial assets and liabilities and to nonfinancial assets and liabilities measured at fair value on a recurring basis.

Beginning January 1, 2009, the Company will adopt the provisions for nonfinancial assets and nonfinancial liabilities that are not required or permitted to be measured at fair value on a recurring basis, which include those measured at fair value in goodwill impairment testing, indefinite-lived intangible assets measured at fair value for impairment assessment, nonfinancial long-lived assets measured at fair value for impairment assessment, asset retirement obligations initially measured at fair value, and those initially measured at fair value in a business combination. The Company does not expect the provisions of SFAS No. 157 related to these items to have a material impact on its consolidated financial statements.

(2.) RECENT ACCOUNTING PRONOUNCEMENTS (Continued)

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. 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 of SFAS No. 158 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 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 adopted this statement on January 1, 2008 and recorded a liability (included in other liabilities in the consolidated statement of financial position) of $284 thousand and a corresponding cumulative-effect adjustment to retained earnings as disclosed in the consolidated statement of changes in shareholders’ equity and other comprehensive income.

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 adopted this statement on January 1, 2008 and did not elect the SFAS No. 159 fair value option for any of its financial assets or liabilities, therefore the adoption did not have an impact on its consolidated financial position, consolidated results of operations, or liquidity.

In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133.” The statement requires enhanced disclosures regarding the use of derivative instruments, the accounting for derivative instruments under SFAS No. 133 and related interpretations, and the impact of derivative instruments and related hedged items on financial position, financial performance, and cash flows, particularly from a risk perspective. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. The Company plans to adopt this statement on January 1, 2009 and does not expect adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.

In April 2008, the FASB Staff Position (“FSP”) No. 142-3, “Determination of the Useful Life of Intangible Assets” was issued, which amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB Statement No. 142, “Goodwill and Other Intangible Assets.” This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. The Company is required to adopt this statement for its fiscal year beginning after December 15, 2008. The Company plans to adopt this statement on January 1, 2009 and does not expect the adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.

In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles.” SFAS No. 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for selecting accounting principles to be used in preparing financial statements that are presented in conformity with generally accepted accounting principles in the United States for non-governmental entities. SFAS No. 162 is effective 60 days following approval by the SEC of the Public Company Accounting Oversight Board’s amendments to AU Section 411, “The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles.” The Company does not expect adoption of this statement to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.

(3.) (LOSS) EARNINGS PER COMMON SHARE

Basic (loss) earnings per common share, after giving effect to preferred stock dividends, has been computed using weighted average common shares outstanding excluding unvested restricted stock. 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								Nine months ended
		September 30,								September 30,
(Dollars and shares in thousands, except per share amounts)		2008				2007				2008				2007
Net (loss) income		$	(28,426	)		$	5,254			$	(23,016	)		$	12,311
Less: Preferred stock dividends			371				371				1,112				1,113
Net (loss) income available to common shareholders		$	(28,797	)		$	4,883			$	(24,128	)		$	11,198
Weighted average number of common shares used to calculate basic (loss) earnings per common share			10,738				11,091				10,852				11,198
Add: Effect of common stock equivalents			—				23				—				33
Weighted average number of common shares used to calculate diluted (loss) earnings per common share			10,738				11,114				10,852				11,231
(Loss) earnings per common share:
Basic		$	(2.68	)		$	0.44			$	(2.22	)		$	1.00
Diluted		$	(2.68	)		$	0.44			$	(2.22	)		$	1.00

There were approximately 483,000 and 447,000 weighted average common stock equivalents from outstanding stock options for the three and nine months ended September 30, 2008, respectively, that were not considered in the calculation of diluted earnings per share since their effect would have been anti-dilutive. There were approximately 410,000 and 326,000 weighted average stock options for the three and nine months ended September 30, 2007, respectively, that were not considered in the calculation of diluted earnings per share since their effect would have been anti-dilutive.

(4.) FAIR VALUE ACCOUNTING

Effective January 1, 2008, the Company adopted SFAS No. 157, which defines fair value, establishes a consistent framework for measuring fair value and expands the disclosure requirements related to fair value measurements. SFAS No. 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. In accordance with FASB Staff Position No. 157-2, “Effective Date of FASB Statement No. 157,” the Company delayed the application of SFAS No. 157 for nonfinancial assets, such as goodwill, and nonfinancial liabilities until January 1, 2009.

Depending on the nature of the asset or liability, the Company uses various valuation techniques and assumptions when estimating fair value. SFAS No. 157 requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. Accordingly, the Company applied the following fair value hierarchy:

Level 1 Inputs — Level 1 inputs are unadjusted quoted prices in active markets for assets or liabilities identical to those to be reported at fair value. An active market is a market in which transactions occur for the item to be fair valued with sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 Inputs — Level 2 inputs are inputs other than quoted prices included within Level 1 inputs that are observable either directly or indirectly. These inputs include: (a) Quoted prices for similar assets or liabilities in active markets; (b) Quoted prices for identical or similar assets or liabilities in markets that are not active, such as when there are few transactions for the asset or liability, the prices are not current, price quotations vary substantially over time or in which little information is released publicly; (c) Inputs other than quoted prices that are observable for the asset or liability; and (d) Inputs that are derived principally from or corroborated by observable market data by correlation or other means.

Level 3 Inputs — Level 3 inputs are unobservable inputs for an asset or liability. These inputs should be used to determine fair value only when observable inputs are not available. Unobservable inputs should be developed based on the best information available in the circumstances, which might include internally generated data and assumptions being used to price the asset or liability.

(4.) FAIR VALUE ACCOUNTING (Continued)

When determining the fair value measurements for assets required or permitted to be recorded at and/or marked to fair value, the Company considers the principal or most advantageous market in which it would transact and considers assumptions that market participants would use when pricing the asset or liability. When possible, the Company looks to active and observable markets to price identical assets. When identical assets are not traded in active markets, the Company looks to market observable data for similar assets. Nevertheless, certain assets are not actively traded in observable markets and the Company must use alternative valuation techniques to derive a fair value measurement.

The Company measures or monitors certain of its assets on either a recurring or nonrecurring fair value basis. Fair value is used on a recurring basis for securities available for sale, as fair value is the primary basis of accounting for these securities. Additionally, fair value is used on a nonrecurring basis to evaluate certain assets for impairment. Examples of these nonrecurring uses of fair value include: loans held for sale, mortgage servicing assets and collateral dependent impaired loans.

The following is a description of the Company’s valuation methodologies used to measure and disclose the fair values of its financial assets and liabilities on a recurring or nonrecurring basis:

Securities available for sale. Level 1 fair value is based on quoted market prices or quoted market prices for similar assets and liabilities. If these market prices are not available, Level 2 fair values are estimated based on dealer quotes, pricing models, discounted cash flow methodologies, or similar techniques for which the determination of fair value may require significant judgment or estimation. The Level 3 fair values are determined using unobservable inputs and included auction-rate preferred equity securities transferred to Level 3 in the first quarter of 2008 and pooled trust preferred securities transferred to Level 3 in the third quarter of 2008. There is no secondary market for the auction-rate preferred equity securities, so third-party dealer quotes were obtained that were derived by obtaining price quotes for preferred equity securities not held in a trust and adjusting those prices to reflect the rate-capped and other components of the trust structure of the instruments owned by the Company. The market for pooled trust preferred securities has very low demand due to imbalances in liquidity that exist in the marketplace and the uncertainty in evaluating the credit risk in these securities. In determining fair value as of September 30, 2008 for pooled trust preferred securities, the Company considered and weighed all inputs. The Company considered fair values from a pricing service derived from inputs from an inactive market. The Company also considered fair value derived from the Company’s own assumptions with input from outside brokerage firms, as to expected cash flows and approximate risk-adjusted discount rates.

Impaired loans (collateral dependent). Level 2 fair value is determined based upon estimates of the value of the collateral underlying the impaired loans typically using appraisals of comparable property or valuation guides.

Assets measured and recorded at fair value on a recurring basis as of September 30, 2008 are summarized as follows:

		Assets Measured and Recorded at Fair Value
(Dollars in thousands)		Total				Level 1				Level 2				Level 3
Securities available for sale		$	607,357			$	591			$	589,474			$	17,292

The following table shows a reconciliation of the beginning and ending balances for assets measured at fair value on a recurring basis using significant unobservable inputs for the three and nine months ended September 30, 2008:

		Three months				Nine months
		ended				ended
		September 30,				September 30,
(Dollars in thousands)		2008				2008
Securities available for sale (Level 3), beginning of period		$	30,808			$	—
Transfers into Level 3			31,737				65,587
Sale, at par			—				(1,000	)
Impairment charges included in earnings			(34,554	)			(34,554	)
Principal paydowns and amortization of premiums			(17	)			(17	)
Unrealized losses included in other comprehensive income			(10,682	)			(12,724	)
Securities available for sale (Level 3), end of period		$	17,292			$	17,292

(4.) FAIR VALUE ACCOUNTING (Continued)

During the third quarter, the Company recorded an impairment charge in the Level 3 auction-rate preferred equity securities and pooled trust preferred securities totaling $31.0 million and $3.6 million, respectively. The $31.8 million of pooled trust preferred securities transferred into Level 3 in the quarter ended September 30, 2008, includes an impairment charge of $1.5 million recorded during the second quarter relating to two of those pooled trust preferred securities.

Assets measured and recorded at fair value on a nonrecurring basis during the nine months ended September 30, 2008 are summarized as follows:

		Assets Measured and Recorded at Fair Value
(Dollars in thousands)		Total				Level 1				Level 2				Level 3
Impaired loans (collateral dependent)		$	992			$	—			$	992			$	—

The amount of total income or losses included in earnings attributable to assets measured at fair value on a nonrecurring basis during the nine months ended September 30, 2008 was not significant.

(5.) INVESTMENT SECURITIES

The amortized cost and fair value of investment securities are summarized below:

		September 30, 2008
		Adjusted
		Amortized				Unrealized				Unrealized				Fair
(Dollars in thousands)		Cost				Gains				Losses				Value
Securities available for sale:
U.S. Government agency and government-sponsored enterprise securities		$	90,681			$	195			$	482			$	90,394
Mortgage-backed securities			365,523				1,539				6,442				360,620
Other asset-backed securities			28,497				—				12,724				15,773
State and municipal obligations			136,414				1,844				104				138,154
Equity securities			2,220				234				38				2,416
Total available for sale securities		$	623,335			$	3,812			$	19,790			$	607,357
Securities held to maturity:
State and municipal obligations		$	64,434			$	416			$	504			$	64,346

		December 31, 2007
		Amortized				Unrealized				Unrealized				Fair
(Dollars in thousands)		Cost				Gains				Losses				Value
Securities available for sale:
U.S. Government agency and government-sponsored enterprise securities		$	158,920			$	344			$	324			$	158,940
Mortgage-backed securities			297,798				832				2,758				295,872
Other asset-backed securities			34,115				55				972				33,198
State and municipal obligations			171,294				1,568				261				172,601
Equity securities			33,930				700				—				34,630
Total available for sale securities		$	696,057			$	3,499			$	4,315			$	695,241
Securities held to maturity:
State and municipal obligations		$	59,479			$	431			$	8			$	59,902

(5.) INVESTMENT SECURITIES (Continued)

Included in mortgage-backed securities are collateralized mortgage obligations with an adjusted amortized cost and fair value of $119.5 million and $114.7 million, respectively, at September 30, 2008, and an amortized cost and fair value of $137.1 million and $135.9 million, respectively, at December 31, 2007. The remaining mortgage-backed securities include securities issued by government-sponsored enterprises. Other asset-backed securities include pooled trust preferred securities collateralized by preferred debt issued primarily by financial institutions and, to a lesser extent, insurance companies located throughout the United States. Equity securities include auction rate preferred equity securities collateralized by Federal National Mortgage Association (“FNMA”) and Federal Home Loan Mortgage Corporation (“FHLMC”) preferred stock with an adjusted amortized cost and fair value of $1.8 million at September 30, 2008.

For the nine months ended September 30, 2008, proceeds from sales of securities available for sale were $51.5 million, gross realized gains were $235 thousand and gross realized losses were $3 thousand. For the nine months ended September 30, 2007, proceeds from sales of securities available for sale were $31.4 million, gross realized gains were $118 thousand with no gross losses.

The following tables show the investments’ gross unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position at September 30, 2008 and December 31, 2007.

		September 30, 2008
		Less than 12 months								12 months or longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(Dollars in thousands)		Value				Losses				Value				Losses				Value				Losses
Securities available for sale:
U.S. Government agency and government-sponsored enterprise securities		$	42,813			$	482			$	—			$	—			$	42,813			$	482
Mortgage-backed securities			171,204				4,448				34,273				1,994				205,477				6,442
Other asset-backed securities			6,052				4,341				7,804				8,383				13,856				12,724
State and municipal obligations			9,756				103				85				1				9,841				104
Equity securities			214				38				—				—				214				38
Total available for sale securities			230,039				9,412				42,162				10,378				272,201				19,790
Securities held to maturity:
State and municipal obligations			33,295				504				—				—				33,295				504
Total temporarily impaired securities		$	263,334			$	9,916			$	42,162			$	10,378			$	305,496			$	20,294

		December 31, 2007
		Less than 12 months								12 months or longer								Total
		Fair				Unrealized				Fair				Unrealized				Fair				Unrealized
(Dollars in thousands)		Value				Losses				Value				Losses				Value				Losses
Securities available for sale:
U.S. Government agency and government-sponsored enterprise securities		$	18,287			$	45			$	64,937			$	279			$	83,224			$	324
Mortgage-backed securities			38,479				398				170,532				2,360				209,011				2,758
Other asset-backed securities			26,418				971				808				1				27,226				972
State and municipal obligations			701				17				45,657				244				46,358				261
Total available for sale securities			83,885				1,431				281,934				2,884				365,819				4,315
Securities held to maturity:
State and municipal obligations			7,153				4				875				4				8,028				8
Total temporarily impaired securities		$	91,038			$	1,435			$	282,809			$	2,888			$	373,847			$	4,323

Securities are evaluated periodically to determine whether a decline in their fair value is other than temporary. Management utilizes criteria such as, the magnitude and duration of the decline and, when appropriate, consideration of negative changes in cash flows from a market participant’s viewpoint, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable. Once a decline in fair value is determined to be other than temporary the cost basis of the security is reduced through a charge to earnings.

(5.) INVESTMENT SECURITIES (Continued)

Based upon an evaluation performed as of September 30, 2008, the Company recorded an impairment charge of $34.6 million ($33.2 million, net of tax) related to certain debt and equity securities in the investment portfolio considered to be other-than-temporarily impaired (“OTTI”) at September 30, 2008.

The Company has both the ability and intent to hold debt securities in an unrealized loss position until such time as the value recovers or the securities mature and management believes that the unrealized losses on debt securities at September 30, 2008 represent temporary impairments. Also, at September 30, 2008, the Company’s equity securities were in an unrealized loss position for a short duration and the Company has the ability and intent to hold these securities until market recovery. Therefore, management has determined that the unrealized losses on equity securities at September 30, 2008 are temporary.

Further deterioration in credit quality and/or a continuation of the current imbalances in liquidity that exist in the marketplace might adversely effect the fair values of the Company’s investment portfolio and may increase the potential that certain unrealized losses will be designated as other than temporary in future periods and that the Company will incur additional write-downs in the future.

(6.) LOANS

Loans outstanding, including net unearned income and net deferred fees and costs of $11.1 million and $5.9 million as of September 30, 2008 and December 31, 2007, respectively, are summarized as follows:

		September 30,				December 31,
(Dollars in thousands)		2008				2007
Commercial		$	156,809			$	136,780
Commercial real estate			248,267				245,797
Agricultural			46,490				47,367
Residential real estate			173,893				166,863
Consumer indirect			227,971				134,977
Consumer direct and home equity			224,693				232,389
Total loans			1,078,123				964,173
Allowance for loan losses			(17,420	)			(15,521	)
Total loans, net		$	1,060,703			$	948,652

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

Parts of the country have experienced a significant decline in real estate values that has led, in some cases, to the debt on the real estate exceeding the value of the real estate. Generally, the Western and Central New York State markets the Company serves have not experienced, to this point, such conditions. Should deterioration in real estate values in the markets we serve occur, the value and liquidity of real estate securing the Company’s loans could become impaired. While the Company is not engaged in the business of sub-prime lending, a decline in the value of residential or commercial real estate could have a material adverse effect on the value of property used as collateral for our loans.

Adverse changes in the economy may have a negative effect on the ability of borrowers to make timely loan payments, which could have a negative impact on earnings.

(7.) 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 accumulated other 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 plan was closed to new participants effective December 31, 2006. Only employees hired on or before December 31, 2006 and who met the participation requirements on or before January 1, 2008 are eligible to receive benefits.

(7.) RETIREMENT AND POSTRETIREMENT BENEFIT PLANS (Continued)

Net periodic pension cost consists of the following components:

		Three months ended								Nine months ended
		September 30,								September 30,
(Dollars in thousands)		2008				2007				2008				2007
Service cost		$	364			$	374			$	1,092			$	1,123
Interest cost on projected benefit obligation			391				369				1,171				1,105
Expected return on plan assets			(524	)			(476	)			(1,570	)			(1,430	)
Amortization of unrecognized loss			—				7				—				23
Amortization of unrecognized prior service cost			3				3				9				9
Net periodic pension cost		$	234			$	277			$	702			$	830

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, 2008; however the Company is considering making a discretionary contribution to the pension plan during 2008.

Postretirement Benefit Plan

Prior to December 31, 2001, an entity acquired by the Company provided health and dental care benefits to 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’s eligibility requirements were amended in 2001 to curtail eligible benefit payments to only retired employees and active participants who were fully vested under the Plan.

(8.) 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 $317.4 million and $273.4 million were contractually available as of September 30, 2008 and December 31, 2007, respectively, and are not reflected in the consolidated statements of financial condition (unaudited). 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 $8.2 million and $7.3 million as of September 30, 2008 and December 31, 2007, respectively. As of September 30, 2008, 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.

(9.) 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.

The Company awarded grants of 51,500 restricted shares to eleven key officers during the nine months ended September 30, 2008. The market price of the restricted shares on the date of grant was $19.22. Both a performance requirement and a service requirement must be satisfied before the participant becomes vested in the shares. The performance period for the awards is the Company’s fiscal year ending on December 31, 2008. During the third quarter of 2008, the forfeiture rate assumption for certain restricted stock awards was increased as it became probable that certain performance and service requirements would not be achieved. The increase in the forfeiture rate assumption resulted in the reversal of restricted stock award expense recorded in previous periods. The Company granted 61,100 stock options to directors and officers during the nine months ended September 30, 2008, with a weighted average grant date fair value of $5.09.

(9.) STOCK COMPENSATION PLANS (Continued)

The following table presents the expense associated with the amortization of unvested stock compensation included in the consolidated statements of operations (unaudited) for the periods indicated.

		Three months ended								Nine months ended
		September 30,								September 30,
(Dollars in thousands)		2008				2007				2008				2007
Stock options:
Management Stock Incentive Plan (1)		$	125			$	286			$	304			$	457
Director Stock Incentive Plan (2)			12				10				28				210
Total amortization of unvested stock options			137				296				332				667
Restricted stock awards:
Management Stock Incentive Plan (1)			(160	)			68				197				118
Total amortization/adjustment of unvested restricted stock awards			(160	)			68				197				118
Total amortization/adjustment of unvested restricted stock compensation		$	(23	)		$	364			$	529			$	785

(10.) INCOME TAXES

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) effective January 1, 2007. There was no cumulative effect adjustment related to the adoption of FIN 48. As of December 31, 2007, the Company’s unrecognized tax benefits totaled $50 thousand, of which $32 thousand would impact the Company’s effective tax rate, if recognized or reversed. The unrecognized tax benefit was associated with a New York State (“NYS”) examination of the Company’s 2002 through 2005 tax years that remained in process as of December 31, 2007. During February 2008, the NYS examination was concluded and the taxes and related accrued interest were paid consistent with the amounts accrued as discussed above. As of September 30, 2008, there is no unrecognized tax benefit or corresponding accrued interest and penalties. The 2006 and 2007 tax years remain subject to examination for both the Federal and New York State tax jurisdictions.

Realization of deferred tax assets is dependent upon, among other things, the generation of future taxable income. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, management considers taxable income generated in prior years that is available for carry-back and projected future taxable income over the periods in which temporary differences comprising the deferred tax assets will be deductible. Management also considers the tax attributes of taxable income/expenses (i.e. ordinary items versus capital items).

As of September 30, 2008, the Company recognized a valuation allowance of $12.0 million against its deferred tax assets as a result of a substantial portion of the OTTI charge incurred in the third quarter of 2008 being classified as a capital loss for tax purposes, which significantly limited the tax benefit. Subsequently, on October 3, 2008, the Emergency Economic Stabilization Act (the “Act”) was enacted, which included a provision permitting banks, under certain circumstances, to recognize losses relating to FNMA and FHLMC preferred stock as an ordinary loss, increasing the tax benefit to the Company in the fourth quarter. The Company expects that it will eliminate the valuation allowance and recognize an additional tax benefit of $12.0 million in the fourth quarter of 2008.

With respect to the remainder of the deferred tax assets, management has concluded that these assets should be recognized without reserve. This conclusion is based on our past levels of taxable income and projections of future taxable income, using what management believes to be conservative asset growth and asset return assumptions. If met, the income projections would allow the full utilization of the deferred tax assets well before their expiration dates.

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

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, especially in Management’s Discussion and Analysis of Financial Condition and Results of Operation, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In general, the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions are intended to identify “forward-looking statements” and may include:

	•		Statements regarding our business plans, and prospects;
	•		Statements of our goals, intentions and expectations;
	•		Statements regarding our growth and operating strategies;
	•		Statements regarding the quality of our loan and investment portfolios; and
	•		Estimates of our risks and future costs and benefits.

The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. Some of the risks and uncertainties that may affect the operations, performance, development and results of the Company’s business, the interest rate sensitivity of its assets and liabilities, and the adequacy of its allowance for loan losses, include but are not limited to those described in Item 1A of the Company’s 2007 Annual Report on Form 10-K and the following:

	•		Significantly increased competition between depository and other financial institutions;
	•		Changes in the interest rate environment or yield curve that reduces our margins or the fair value of financial instruments;
	•		General economic conditions, either nationally or in our market areas, that are worse than expected;
	•		Declines in the value of real estate, equipment, livestock and other assets serving as collateral for our loans outstanding, which could affect our allowance for loan losses;
	•		Legislative or regulatory changes that adversely affect our business;
	•		Adverse conditions in the securities markets, including those related to the financial condition of significant issuers in our investment portfolio;
	•		Changes in consumer spending, borrowing and savings habits;
	•		Changes in accounting policies and practices, as generally accepted in the United States of America;
	•		Actions taken by regulators with jurisdiction over the Company or its subsidiaries; and
	•		Availability of capital under the Troubled Asset Relief Program Capital Purchase Program (the “TARP Capital Purchase Program”) of the U.S. Department of the Treasury (“Treasury”) .
	•		Further declines in the fair value of certain securities may increase the potential that certain unrealized losses be designated as other than temporary and that the Company may incur additional write-downs in the future.

The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advises readers that various factors, including those described above, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected.

Except as required by law, the Company does not undertake, and specifically disclaims any obligation, to publicly release any revisions to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

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 investment 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, loan servicing income, company owned life insurance, gain or loss on the sale or call of investment securities, gain or loss on sale of loans held for sale, gain or loss on the sale of other assets and other miscellaneous noninterest income.

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

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

The Company incurred a net loss of $28.4 million, or $2.68 per diluted share, for the third quarter of 2008, compared with net income of $5.3 million, or $0.44 per diluted share, for the same quarter last year. The net loss for the first nine months of 2008 was $23.0 million, or $2.22 per diluted share, compared with net income of $12.3 million, or $1.00 per diluted share, for the first nine months of 2007.

Included in the third quarter 2008 results is an other-than-temporary impairment (“OTTI”) non-cash charge on certain investment securities of $34.6 million pre-tax and $33.2 million after-tax (or $3.09 per diluted share) related to auction rate preferred equity securities collateralized by preferred stock of FNMA and FHLMC and pooled trust preferred securities issued principally by financial institutions. For the first nine months of 2008, OTTI non-cash charges were $38.3 million pre-tax and $35.5 million after-tax (or $3.27 per diluted share). The tax benefit recognized on the OTTI charge for the period ended September 30, 2008 was based on the treatment of a substantial portion of the OTTI charge incurred in the third quarter being classified as a capital loss for tax purposes, which significantly limited the tax benefit. Subsequently, on October 3, 2008, the Emergency Economic Stabilization Act (the “Act”) was enacted, which included a provision permitting banks, under certain circumstances, to recognize losses relating to FNMA and FHLMC preferred stock as an ordinary loss, increasing the tax benefit to the Company in the fourth quarter. The Company expects that it will recognize an additional tax benefit of $12.0 million (or $1.12 per diluted share) in the fourth quarter of 2008. Prior to this OTTI charge, impairment was considered temporary and was recorded as an unrealized loss on securities available-for-sale, which resulted in an equity reduction recognized in other comprehensive income (loss).

Net interest income was $16.7 million for the third quarter, up $1.9 million, or 13%, from the third quarter of 2007, reflecting continued improvement in net interest margin and improved earning asset mix from growth of the loan portfolio. Net interest income was $48.0 million for the nine months ended September 30, 2008, up $5.1 million in comparison to the same period last year.

The net interest margin increased 35 basis points, to 3.98%, compared with 3.63% for the third quarter of 2007. The nine month period ended September 30, 2008 saw a similar increase of 43 basis points in net interest margin to 3.88% compared to the same period last year. The improved net interest margin resulted principally from lower funding costs, an improved yield from investment securities and the benefits associated with a higher percentage of earning assets being deployed in higher yielding loan assets.

The Company’s provision for loan losses for the three and nine months ended September 30, 2008 were $1.9 million and $4.0 million, respectively, compared to a credit to provision for loan losses of $82 thousand and $235 thousand for the comparable periods in 2007.

Noninterest income (loss) for the third quarter of 2008 was $(29.3) million, versus $6.3 million in the third quarter of 2007. For the nine months ended September 30, 2008 noninterest income (loss) was $(23.7) million compared with $15.7 million for the same period in 2007. The 2008 periods reflect OTTI non-cash charges on investment securities totaling $34.6 million and $3.8 million in the third and second quarters, respectively. Absent the OTTI charges in 2008, noninterest income would have been $5.2 million for the third quarter and $14.7 million for the first nine months. The higher level of noninterest income in 2007, compared to the same periods in 2008, results primarily from the $1.1 million in proceeds from company owned life insurance recorded in the third quarter of 2007.

Noninterest expense for the third quarter of 2008 was $13.4 million, versus $14.6 million in the third quarter of 2007. The third quarter of 2008 includes a $1.0 million reversal of accrued compensation expense that recognizes financial results for 2008 will not meet certain annual senior management incentive targets. Absent this reversal, noninterest expense for the third quarter would have been $14.4 million, down slightly from the same quarter last year. For the nine months ended September 30, 2008, noninterest expense was $42.1 million compared with $42.9 million for the same period in 2007. The decreases in both the three and nine-month periods of 2008 compared to those in 2007 are primarily due to lower salaries and benefits expense as previously discussed, partially offset by an increase in occupancy and equipment costs.

The Company experienced an increase of $114.0 million in loans to $1.078 billion at September 30, 2008 compared to $964.2 million at December 31, 2007. The increase reflects execution of the Company’s business plan to rebuild its loan portfolio in a disciplined manner and includes a $93.0 million increase in indirect auto loans, coupled with a $21.6 million increase in the commercial-related loan portfolio. Nonperforming assets decreased $848 thousand from December 31, 2007 to $8.7 million at September 30, 2008. Since September 30, 2007, nonperforming assets have declined $1.3 million, or 13%.

On November 5, 2008, the Board of Directors of the Company approved filing an application to issue $25.0 million of its preferred stock through the Treasury’s recently announced TARP Capital Purchase Program. See “Capital Resources” included herein for additional information.

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 financial statements. Future changes in information may affect these estimates, assumptions and judgments, which, in turn, may affect amounts reported in the 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, 2007, dated March 11, 2008, 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, defined benefit pension plan and impairment of investment securities 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.

The Company performs periodic, systematic reviews of the 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 pertinent factors. The process used by the Company to determine the overall allowance for loan losses is based on this analysis. 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.

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 discontinued 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 2007, 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 as of 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.

Impairment of Investment Securities

Securities are evaluated periodically to determine whether a decline in their fair value is other than temporary. Management utilizes criteria such as, the magnitude and duration of the decline and, when appropriate, consideration of negative changes in cash flows from a market participant’s viewpoint, in addition to the reasons underlying the decline, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable. Once a decline in fair value is determined to be other than temporary the cost basis of the security is reduced through a charge to earnings.

NET INCOME ANALYSIS

Net Interest Income

Net interest income was $16.7 million for the third quarter of 2008, up $1.9 million versus the third quarter of 2007. Net interest margin improved 35 basis points to 3.98% in the third quarter of 2008 versus 3.63% in the third quarter of 2007. The yield on interest-earning assets decreased 52 basis points, to 5.73%, for the quarter ended September 30, 2008, compared to the same quarter a year ago. The decline in interest-earning asset yield was a result of lower market interest rates, however the benefits associated with a higher percentage of earnings assets being deployed in higher yielding loan assets partially offset the lower interest rates. For the quarter ended September 30, 2008, investment securities and loans comprised 40.7% and 58.6%, respectively of total average interest-earnings assets. For the quarter ended September 30, 2007, investment securities and loans comprised 45.9% and 53.3%, respectively of total average interest-earnings assets. This shift in the mix of interest-earning assets reflects execution of the Company’s business plan to rebuild, in a disciplined manner, the commercial loan portfolio and grow consumer indirect auto loans. The Company’s cost of funds decreased 87 basis points, to 1.75%, for the third quarter of 2008, versus the same quarter last year, again primarily the result of a reduction in market interest rates, coupled with management’s efforts to lower its deposit costs.

For the first nine months of 2008 net interest income was $48.0 million compared with $42.9 million for the same period in 2007. Net interest margin improved 43 basis points to 3.88% for the first nine months of 2008 versus 3.45% for the same period last year. The yield on interest-earning assets decreased 27 basis points, 5.87%, for the nine months ended September 30, 2008, compared to the same period a year ago. The decline in interest-earning asset yield was a result of lower market interest rates, however the benefits associated with a higher percentage of earnings assets being deployed in higher yielding loan assets partially offset the lower interest rates. For the nine months ended September 30, 2008, investment securities and loans comprised 41.8% and 56.4%, respectively of total average interest-earnings assets. For the nine months ended September 30, 2007, investment securities and loans comprised 45.8% and 52.1%, respectively of total average interest-earnings assets. The Company’s cost of funds decreased 70 basis points, to 1.99%, for the first nine months of 2008, versus the same period last year, again primarily the result of a reduction in market interest rates, coupled with management’s efforts to lower its deposit costs.

The following table provides a reconciliation between tax equivalent net interest income as presented in the average balance sheets that follow and net interest income in the consolidated financial statements filed herewith in Part I, Item 1, “Financial Statements”.

		For the three months								For the nine months
		ended September 30,								ended September 30,
(Dollars in thousands)		2008				2007				2008				2007
Net interest income (tax equivalent)		$	17,686			$	16,051			$	51,448			$	46,349
Less: tax-exempt TE adjustment			859				1,071				2,926				3,284
Less: tax-preferred TE adjustment			81				119				504				196
Net interest income		$	16,746			$	14,861			$	48,018			$	42,869

Average Balance Sheets

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 investment 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.

		Three Months Ended September 30,
		2008												2007
		Average								Average				Average								Average
(Dollars in thousands)		Balance				Interest				Rate				Balance				Interest				Rate
Interest-earning assets:
Federal funds sold and interest-earning deposits		$	12,897			$	68				2.10	%		$	12,552			$	168				5.32	%
Investment securities:
Taxable			493,438				5,577				4.52				555,330				6,404				4.61
Tax-exempt			195,074				2,527				5.18				227,684				3,149				5.53
Tax-preferred			32,907				308				3.66				27,778				451				6.35
Total investment securities			721,419				8,412				4.66				810,792				10,004				4.93
Loans held for sale			799				14				6.81				773				14				7.31
Loans:
Commercial			150,373				2,244				5.94				121,258				2,519				8.24
Commercial real estate			246,746				4,234				6.83				243,230				4,601				7.50
Agricultural			45,965				732				6.34				54,017				1,231				9.04
Residential real estate			173,175				2,669				6.17				166,589				2,731				6.56
Consumer indirect			200,586				3,626				7.19				122,095				2,130				6.92
Consumer direct and home equity			222,241				3,499				6.26				235,205				4,345				7.33
Total loans			1,039,086				17,004				6.52				942,394				17,557				7.40
Total interest-earning assets			1,774,201				25,498				5.73				1,766,511				27,743				6.25
Allowance for loan losses			(16,385	)											(16,450	)
Other noninterest-earning assets			150,761												140,608
Total assets		$	1,908,577											$	1,890,669
Interest-bearing liabilities:
Deposits:
Interest-bearing demand		$	342,188			$	738				0.86	%		$	325,675			$	1,339				1.63	%
Savings and money market			366,449				853				0.93				333,895				1,349				1.60
Certificates of deposit			591,025				4,947				3.33				663,845				7,740				4.63
Total interest-bearing deposits			1,299,662				6,538				2.00				1,323,415				10,428				3.13
Short-term borrowings			52,608				287				2.17				37,699				360				3.79
Long-term borrowings			48,713				555				4.53				35,911				472				5.21
Junior subordinated debentures			16,702				432				10.35				16,702				432				10.35
Total interest-bearing liabilities			1,417,685				7,812				2.19				1,413,727				11,692				3.28
Noninterest-bearing demand deposits			294,136												275,228
Other noninterest-bearing liabilities			15,652												17,156
Shareholders’ equity			181,104												184,558
Total liabilities and shareholders’ equity		$	1,908,577											$	1,890,669
Net interest income (tax-equivalent)						$	17,686											$	16,051
Interest rate spread											3.54	%											2.97	%
Net earning assets		$	356,516											$	352,784
Net interest margin (tax-equivalent)											3.98	%											3.63	%
Ratio of average interest-earning assets to average interest-bearing liabilities											125.15	%											124.95	%