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 March 31, 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:

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. (Check one):

Large accelerated filer o		Accelerated filer þ		Non-accelerated filer o		Smaller reporting company o
		(Do not check if a smaller reporting company)

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 APRIL 30, 2008
Common Stock, $0.01 par value		10,968,360 shares

 

 

FINANCIAL INSTITUTIONS, INC.

FORM 10-Q

INDEX

PART I — FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited)
		Consolidated Statements of Financial Condition (Unaudited) as of March 31, 2008 and December 31, 2007			3
		Consolidated Statements of Income (Unaudited) for the Three Months Ended March 31, 2008 and 2007			4
		Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Income (Unaudited) for the Three Months Ended March 31, 2008			5
		Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2008 and 2007			6
		Notes to Unaudited Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			14
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			30
Item 4.		Controls and Procedures			30
PART II — OTHER INFORMATION
Item 1.		Legal Proceedings			31
Item 1A.		Risk Factors			31
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			31
Item 6.		Exhibits			32
SIGNATURES
EXHIBITS
EX-31.1
EX-31.2
EX-32.1
EX-32.2

Item 1. Financial Statements (Unaudited)

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
(Unaudited)

		March 31,				December 31,
(Dollars in thousands, except per share amounts)		2008				2007
Assets
Cash and due from banks		$	49,460			$	45,165
Federal funds sold and interest-bearing deposits in other banks			53,539				1,508
Securities available for sale, at fair value			688,504				695,241
Securities held to maturity, at amortized cost (fair value of $58,238 and $59,902 as of March 31, 2008 and December 31, 2007, respectively)			57,631				59,479
Loans held for sale			1,099				906
Loans			972,444				964,173
Less: Allowance for loan losses			15,549				15,521
Loans, net			956,895				948,652
Premises and equipment, net			33,611				34,157
Goodwill			37,369				37,369
Other assets			34,544				35,399
Total assets		$	1,912,652			$	1,857,876
Liabilities And Shareholders’ Equity
Liabilities:
Deposits:
Noninterest-bearing demand		$	268,419			$	286,362
Interest-bearing demand, savings and money market			736,925				681,953
Certificates of deposit			622,628				607,656
Total deposits			1,627,972				1,575,971
Short-term borrowings			27,835				25,643
Long-term borrowings			25,799				25,865
Junior subordinated debentures issued to unconsolidated subsidiary trust (“Junior subordinated debentures”)			16,702				16,702
Other liabilities			16,980				18,373
Total liabilities			1,715,288				1,662,554
Shareholders’ equity:
3% cumulative preferred stock, $100 par value, authorized 10,000 shares, issued and outstanding — 1,586 shares as of March 31, 2008 and December 31, 2007			159				159
8.48% cumulative preferred stock, $100 par value, authorized 200,000 shares, issued and outstanding — 174,223 shares as of March 31, 2008 and December 31, 2007			17,422				17,422
Common stock, $0.01 par value, authorized 50,000,000 shares, issued 11,348,122 shares as of March 31, 2008 and December 31, 2007			113				113
Additional paid-in capital			24,105				24,778
Retained earnings			160,328				158,744
Accumulated other comprehensive income			2,104				667
Treasury stock, at cost — 355,673 and 336,971 shares as of March 31, 2008 and December 31, 2007, respectively			(6,867	)			(6,561	)
Total shareholders’ equity			197,364				195,322
Total liabilities and shareholders’ equity		$	1,912,652			$	1,857,876

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)

		Three Months Ended
		March 31,
(Dollars in thousands, except per share amounts)		2008				2007
Interest income:
Interest and fees on loans		$	16,728			$	16,627
Interest and dividends on securities			8,234				8,427
Other interest income			310				752
Total interest income			25,272				25,806
Interest expense:
Deposits			9,236				10,763
Short-term borrowings			152				169
Long-term borrowings			367				486
Junior subordinated debentures			432				432
Total interest expense			10,187				11,850
Net interest income			15,085				13,956
Provision for loan losses			716				—
Net interest income after provision for loan losses			14,369				13,956
Noninterest income:
Service charges on deposits			2,500				2,569
ATM and debit card income			752				620
Broker-dealer fees and commissions			459				383
Loan servicing			186				205
Corporate owned life insurance			19				20
Net gain on sale or call of securities			173				—
Net gain on sale of loans held for sale			164				161
Net gain on sale of other assets			37				57
Net gain on sale of trust relationships			—				13
Other			454				710
Total noninterest income			4,744				4,738
Noninterest expense:
Salaries and employee benefits			8,436				8,354
Occupancy and equipment			2,580				2,448
Supplies and postage			441				438
Amortization of other intangible assets			77				77
Computer and data processing			581				457
Professional fees and services			557				495
Advertising and promotions			150				220
Other			1,451				1,439
Total noninterest expense			14,273				13,928
Income before income taxes			4,840				4,766
Income tax expense			1,061				1,151
Net income		$	3,779			$	3,615
Earnings per common share (note 3):
Basic		$	0.31			$	0.29
Diluted		$	0.31			$	0.29

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				Income				Stock				Equity
Balance — December 31, 2007		$	159			$	17,422			$	113			$	24,778			$	158,744			$	667			$	(6,561	)		$	195,322
Purchase 70,202 shares of common stock			—				—				—				—				—				—				(1,304	)			(1,304	)
Issue 51,500 shares of common stock — restricted stock awards			—				—				—				(998	)			—				—				998				—
Amortization of unvested stock options			—				—				—				106				—				—				—				106
Amortization of unvested restricted stock awards			—				—				—				219				—				—				—				219
Cumulative effect of adoption of EITF 06-04			—				—				—				—				(284	)			—				—				(284	)
Comprehensive income:
Net income			—				—				—				—				3,779				—				—				3,779
Net unrealized gain on securities available for sale (net of tax of $844)			—				—				—				—				—				1,338				—				1,338
Reclassification adjustment for net gains included in net income (net of tax of $67)			—				—				—				—				—				106				—				106
Defined benefit pension plan (net of tax of $1)			—				—				—				—				—				2				—				2
Postretirement benefit plan (net of tax of $(5))			—				—				—				—				—				(9	)			—				(9	)
Other comprehensive income																															1,437
Total comprehensive income																															5,216
Cash dividends declared:
3% Preferred — $0.75 per share			—				—				—				—				(1	)			—				—				(1	)
8.48% Preferred — $2.12 per share			—				—				—				—				(370	)			—				—				(370	)
Common — $0.14 per share			—				—				—				—				(1,540	)			—				—				(1,540	)
Balance — March 31, 2008		$	159			$	17,422			$	113			$	24,105			$	160,328			$	2,104			$	(6,867	)		$	197,364

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

		Three Months Ended
		March 31,
(Dollars in thousands)		2008				2007
Cash flows from operating activities:
Net income		$	3,779			$	3,615
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			988				971
Net amortization of premiums and discounts on securities			120				140
Provision for loan losses			716				—
Amortization of unvested stock-based compensation			325				138
Deferred income tax expense			89				137
Proceeds from sale of loans held for sale			11,644				11,720
Originations of loans held for sale			(11,673	)			(11,644	)
Net gain on sale or call of securities			(173	)			—
Net gain on sale of loans held for sale			(164	)			(161	)
Net gain on sale and disposal of other assets			(37	)			(57	)
Net gain on sale of trust relationships			—				(13	)
(Increase) decrease in other assets			(329	)			451
Decrease in other liabilities			(1,715	)			(1,383	)
Net cash provided by operating activities			3,570				3,914
Cash flows from investing activities:
Purchase of securities:
Available for sale			(121,256	)			(59,257	)
Held to maturity			(5,973	)			(6,241	)
Proceeds from maturity, call and principal pay-down of securities:
Available for sale			97,240				39,356
Held to maturity			7,485				5,413
Proceeds from sale or call of securities available for sale			33,436				—
Net loan originations			(9,075	)			(3,373	)
Proceeds from sales of other assets			250				428
Proceeds from sale of trust relationships			—				13
Purchase of premises and equipment			(368	)			(672	)
Net cash provided by (used in) investing activities			1,739				(24,333	)
Cash flows from financing activities:
Net increase in deposits			52,001				54,067
Net increase (decrease) in short-term borrowings			2,192				(7,450	)
Repayment of long-term borrowings			(67	)			(14	)
Purchase of preferred and common shares			(1,304	)			(1,625	)
Stock options exercised			—				137
Excess tax benefit from stock options exercised			—				3
Dividends paid			(1,805	)			(1,392	)
Net cash provided by financing activities			51,017				43,726
Net increase in cash and cash equivalents			56,326				23,307
Cash and cash equivalents as of the beginning of the period			46,673				109,772
Cash and cash equivalents as of the end of the period		$	102,999			$	133,079
Supplemental disclosure of cash flow information:
Cash paid during period for:
Interest		$	10,228			$	10,734
Income taxes			170				1
Noncash investing and financing activities:
Real estate and other assets acquired in settlement of loans		$	118			$	470
Dividends declared and unpaid			1,912				1,504
Net (decrease) increase in unsettled security purchases			(61	)			7,721

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. The change in status did not affect the broker-dealer subsidiary or activities being conducted by the Company, although 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.

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 $502,000 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 $502,000 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 2007 Annual Report on Form 10-K. 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 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. The Company adopted this statement on January 1, 2008 and the required disclosures are included in Note 4.

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 $284,000 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 December 2007, the FASB issued SFAS No. 141(R), “Business Combinations (revised — 2007).” SFAS No. 141(R) is a revision to previously existing guidance on accounting for business combinations. The statement retains the fundamental concept of the purchase method of accounting and introduces new requirements for the recognition and measurement of assets acquired, liabilities assumed and noncontrolling interests. 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 adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements.” SFAS No. 160 requires that noncontrolling interests be reported as stockholders equity and establishes a single method of accounting for changes in a parent’s ownership interest in a subsidiary as long as that ownership change does not result in deconsolidation. 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 adoption to have a material effect 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.

(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
		March 31,
(Dollars and shares in thousands, except per share amounts)		2008				2007
Net income		$	3,779			$	3,615
Less: Preferred stock dividends			371				371
Net income available to common shareholders		$	3,408			$	3,244
Weighted average number of common shares used to calculate basic earnings per common share			10,938				11,317
Add: Effect of common stock equivalents			37				43
Weighted average number of common shares used to calculate diluted earnings per common share			10,975				11,360
Earnings per common share:
Basic		$	0.31			$	0.29
Diluted		$	0.31			$	0.29

There were approximately 380,327 and 270,132 weighted average common stock equivalents from outstanding stock options for the three months ended March 31, 2008 and 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.

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, impaired loans, other real estate owned (“ORE”) and repossessed assets.

Assets measured and recorded at fair value on a recurring basis as of March 31, 2008 are summarized as follows:

		Assets Measured and Recorded at Fair Value
		March 31, 2008
(Dollars in thousands)		Total				Level 1				Level 2				Level 3
Securities available for sale		$	688,504			$	976			$	655,092			$	32,436

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:

		Fair Value Measurements
		Using Significant
(Dollars in thousands)		Unobservable Inputs
Securities available for sale (level 3), beginning of period		$	—
Transfers into level 3			33,850
Sale			(1,000	)
Unrealized losses included in other comprehensive income			(414	)
Securities available for sale (level 3), end of period		$	32,436

Assets measured and recorded at fair value on a nonrecurring basis during the three months ended March 31, 2008 are summarized as follows:

		Assets Measured and Recorded at Fair Value
		Three Months Ended March 31, 2008
(Dollars in thousands)		Total				Level 1				Level 2				Level 3
Impaired loans (collateral dependent)		$	1,275			$	—			$	1,275			$	—
ORE and repossessed assets			451				—				451				—

The amount of totals gains or losses included in earnings attributable to assets measured at fair value on a nonrecurring basis during the three months ended March 31, 2008 was not significant.

The following summarizes the valuation technique for assets measured and recorded at fair value:

Securities available for sale. Fair value is generally based on quoted market prices or quoted market prices for similar assets and liabilities. If these market prices are not available, 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 securities valued using unobservable inputs were the auction-rate preferred equity securities as the financial and capital markets have experienced significant dislocation and illiquidity in regard to this type of instrument and there is currently no secondary market for this type of security. The Company obtained third-party dealer quotes that were derived by the dealer obtaining price quotes for identical preferred equity securities not held in a trust and adjusting those prices to reflect the rate-capped trust structure of the instruments owned by the Company.

Impaired loans (collateral dependent). Fair value is determined based upon estimates of the value of the collateral underlying the impaired loans.

ORE and repossessed assets. Fair value is determined based on third party appraisals of comparable property or valuation guides at the time title to the property is obtained.

(5) Loans

Loans outstanding, including net unearned income and net deferred fees and costs of $6.5 million and $5.9 million as of March 31, 2008 and December 31, 2007, respectively, are summarized as follows:

		March 31,				December 31,
(Dollars in thousands)		2008				2007
Commercial		$	144,976			$	136,780
Commercial real estate			245,148				245,797
Agricultural			44,162				47,367
Residential real estate			168,738				166,863
Consumer indirect			142,565				134,977
Consumer direct and home equity			226,855				232,389
Total loans			972,444				964,173
Allowance for loan losses			(15,549	)			(15,521	)
Loans, net		$	956,895			$	948,652

The Company’s significant concentrations of credit risk in the loan portfolio relates 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 our borrowers to make timely loan payments, which could have a negative impact on our earnings.

(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 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.

Net periodic pension cost consists of the following components:

		Three Months Ended
		March 31,
(Dollars in thousands)		2008				2007
Service cost		$	364			$	375
Interest cost on projected benefit obligation			390				368
Expected return on plan assets			(523	)			(477	)
Amortization of unrecognized loss			—				8
Amortization of unrecognized prior service cost			3				3
Net periodic pension cost		$	234			$	277

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.

(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 $299.8 million and $273.4 million were contractually available as of March 31, 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 $6.7 million and $7.3 million as of March 31, 2008 and December 31, 2007, respectively. As of March 31, 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.

(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 various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material 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 March 31,

2008 and December 31, 2007, the Company and FSB met all capital adequacy requirements to which they are subject.

(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 three months ended March 31, 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.

There were no stock options granted during the three months ended March 31, 2008.

Effective January 1, 2006, the Company adopted SFAS No. 123(R), “Share-Based Payment”, 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 (unaudited) for the periods indicated.

		Three Months Ended
		March 31,
(Dollars in thousands)		2008				2007
Stock options:
Management Stock Incentive Plan (1)		$	99			$	93
Director Stock Incentive Plan (2)			7				21
Total amortization of unvested stock options			106				114
Restricted stock awards:
Management Stock Incentive Plan (1)			219				24
Total amortization of unvested restricted stock awards			219				24
Total amortization of unvested restricted stock compensation		$	325			$	138

(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 $50,000, of which $32,000 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 March 31, 2008, there is no unrecognized tax benefit or corresponding accrued interest and penalties.

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

Federal			2006 — 2007
New York			2006 — 2007

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;
•		Changes in consumer spending, borrowing and savings habits;
•		Changes in accounting policies and practices, as generally accepted in the United States of America; and
•		Actions taken by regulators with jurisdiction over the Company or its subsidiaries.

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 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, corporate owned life insurance, gain or loss on the sale or call of 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 fees and 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

Net income for the first quarter of 2008 was $3.8 million, or $0.31 per diluted share, compared with $3.6 million, or $0.29 per diluted share, for the first quarter of 2007. The increase in net income was primarily the result of an increase in net interest income, which was $15.1 million for the first quarter of 2008, up $1.1 million from $14.0 million in the first quarter of 2007. Net interest margin increased 34 basis points, to 3.73%, for the first quarter of 2008 compared with 3.39% for 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 increase in net interest income was partially offset by increases in the provision for loan losses and noninterest expense. The Company’s provision for loan losses for the first quarter of 2008 was $716 thousand, compared to no provision for loan losses in the first quarter of 2007. Noninterest expense increased $345 thousand, or 2%, in the first quarter of 2008 to $14.3 million compared with $13.9 million for the first quarter of 2007. The principal expense items that contributed to the increase were: salaries and benefits increased $82 thousand primarily due to stock compensation related expenses, occupancy and equipment costs, which increased $132 thousand due to higher service contract costs on buildings, equipment and software, and computer and data processing expenses, which increased $124 thousand.

The Company experienced an increase of $8.2 million in loans to $972.4 million as of March 31, 2008 compared to $964.2 million as of December 31, 2007. The increase reflects execution of the Company’s business plan to rebuild its loan portfolio in a disciplined manner.

Nonperforming assets decreased $886 thousand from December 31, 2007 to $8.6 million at March 31, 2008. Since March 31, 2007, nonperforming assets have declined $8.4 million, or 49%. Net loan charge-offs of $688 thousand for the first quarter represented 29 basis points of average loans (annualized). Net charge-offs of $134 thousand for the first quarter of 2007 represented 6 basis points of average loans (annualized). The increase in net charge-offs in 2008 principally resulted from higher commercial mortgage and indirect loan charge-offs. The allowance for loan losses was $15.5 million as of March 31, 2008 and December 31, 2007. Nonperforming loans were $7.4 million at March 31, 2008, compared with $8.1 million at December 31, 2007. The ratio of allowance for loan losses to nonperforming loans improved to 211% at March 31, 2008 versus 192% at December 31, 2007 and 107% at March 31, 2007.

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 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 impaired loans are collateral dependent.

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, 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 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.

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 March 31,
(Dollars in thousands, except per share amounts)		2008				2007
Per common share data:
Net income — basic		$	0.31			$	0.29
Net income — diluted		$	0.31			$	0.29
Cash dividends declared		$	0.14			$	0.10
Book value		$	16.36			$	14.81
Tangible book value		$	12.91			$	11.42
Common shares outstanding:
Weighted average shares — basic			10,938,275				11,316,811
Weighted average shares — diluted			10,974,674				11,360,202
Period end			10,992,449				11,271,676
Performance ratios (annualized) and data:
Return on average assets			0.80	%			0.77	%
Return on average common equity			7.61	%			7.96	%
Return on average tangible common equity			9.65	%			10.35	%
Common dividend payout ratio			45.16	%			34.48	%
Net interest margin (tax-equivalent)			3.73	%			3.39	%
Efficiency ratio (1)			67.63	%			69.40	%
Full-time equivalent employees			620				634
Asset quality data:
Loans past due 90 days or more		$	2			$	7
Nonaccruing loans			7,353				15,778
Total nonperforming loans			7,355				15,785
Other real estate owned (“ORE”) and repossessed assets (“repos”)			1,257				1,216
Total nonperforming assets		$	8,612			$	17,001
Gross loan charge-offs		$	1,458			$	692
Net loan charge-offs		$	688			$	134
Allowance for loan losses		$	15,549			$	16,914
Asset quality ratios:
Nonperforming loans to total loans			0.76	%			1.70	%
Nonperforming assets to total loans, ORE and repos			0.88	%			1.83	%
Nonperforming assets to total assets			0.45	%			0.87	%
Allowance for loan losses to total loans			1.60	%			1.82	%
Allowance for loan losses to nonperforming loans			211	%			107	%
Net loan charge-offs to average loans (annualized)			0.29	%			0.06	%
Capital ratios:
Period-end common equity to total assets			9.40	%			8.50	%
Period-end tangible common equity to total tangible assets			7.57	%			6.69	%
Leverage ratio			9.38	%			8.99	%
Tier 1 risk-based capital ratio			15.34	%			15.58	%
Total risk-based capital ratio			16.59	%			16.83	%
(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 net gain on sale or call of securities, and net gain on sale of trust relationships:
Noninterest expense		$	14,273			$	13,928
Less: Other real estate expense			39				88
Amortization of other intangible assets			77				77
Net expense (numerator)		$	14,157			$	13,763
Net interest income		$	15,085			$	13,956
Plus: Tax-equivalent adjustment			1,276				1,149
Net interest income (tax-equivalent)			16,361				15,105
Plus: Noninterest income			4,744				4,738
Less: Net gain on sale or call of securities			(173	)			—
Less: Net gain on sale of trust relationships			—				(13	)
Net revenue (denominator)		$	20,932			$	19,830

NET INCOME ANALYSIS

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 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 March 31,
		2008												2007
		Average								Annualized				Average								Annualized
		Outstanding				Interest Earned/				Yield/				Outstanding				Interest Earned/				Yield/
(Dollars in thousands)		Balance				Paid				Rate				Balance				Paid				Rate
Interest-earning assets:
Federal funds sold and interest-bearing deposits		$	40,807			$	310				3.06	%		$	57,405			$	752				5.32	%
Investment securities:
Taxable			492,312				5,582				4.54	%			561,927				6,168				4.39	%
Tax-exempt			228,319				3,129				5.48	%			239,855				3,277				5.46	%
Tax-preferred			33,192				799				9.63	%			8,212				131				6.37	%
Total investment securities			753,823				9,510				5.05	%			809,994				9,576				4.73	%
Loans held for sale			587				9				6.42	%			545				8				6.21	%
Loans:
Commercial and agricultural			430,945				7,683				7.17	%			408,752				7,785				7.72	%
Residential real estate			166,682				2,668				6.40	%			163,046				2,643				6.48	%
Consumer indirect			137,756				2,389				6.98	%			106,249				1,755				6.70	%
Consumer direct and home equity			229,035				3,979				6.99	%			243,435				4,436				7.39	%
Total loans			964,418				16,719				6.97	%			921,482				16,619				7.30	%
Total interest-earning assets			1,759,635			$	26,548				6.05	%			1,789,426			$	26,955				6.07	%
Allowance for loans losses			(15,530	)											(17,159	)
Other noninterest-earning assets			146,769												142,326
Total assets		$	1,890,874											$	1,914,593
Interest-bearing liabilities:
Savings and money market		$	361,425			$	1,324				1.47	%		$	334,455			$	1,370				1.66	%
Interest-bearing demand			345,102				1,117				1.30	%			355,785				1,593				1.82	%
Certificates of deposit			633,599				6,795				4.31	%			683,361				7,800				4.63	%
Short-term borrowings			26,814				152				2.28	%			29,052				169				2.36	%
Long-term borrowings			25,819				367				5.72	%			38,177				486				5.17	%
Junior subordinated debentures			16,702				432				10.35	%			16,702				432				10.35	%
Total interest-bearing liabilities			1,409,461				10,187				2.91	%			1,457,532				11,850				3.30	%
Noninterest-bearing demand deposits			267,322												254,274
Other noninterest-bearing liabilities			16,517												19,834
Total liabilities			1,693,300												1,731,640
Shareholders’ equity			197,574												182,953
Total liabilities and shareholders’ equity		$	1,890,874											$	1,914,593
Net interest income — tax-equivalent							16,361												15,105
Less: tax-exempt TE adjustment							1,064												1,114
Less: tax-preferred TE adjustment							212												35
Net interest income						$	15,085											$	13,956
Net interest rate spread											3.14	%											2.77	%
Net earning assets		$	350,174											$	331,894
Net interest income as a percentage of average interest-earning assets (“net interest margin”) — TE											3.73	%											3.39	%
Ratio of average interest-earning assets to average interest-bearing liabilities											124.84	%											122.77	%

Net Interest Income

For the three months ended March 31, 2008, net interest income was $15.1 million, up $1.1 million in comparison with $14.0 million for the same period last year. For the first quarter of 2008, average interest-earning assets totaled $1.760 billion, down $29.8 million from the same quarter a year ago. This decrease resulted principally from a decrease in average total investment assets, including Federal funds sold, of $72.8, partially offset by a $43.0 million increase in average total loans. The overall decline in average interest-earning assets was more than offset by a reduction in average interest-bearing liabilities of $48.1 million. Net interest margin was 3.73% for the three months ended March 31, 2008, a 34 basis point increase from 3.39% for the same period last year. The yield on interest-earning assets decreased by 2 basis points to 6.05%, for the quarter ended March 31, 2008, compared to 6.07% for the same quarter a year ago. The Company’s cost of funds decreased 36 basis points, to 2.32%, for the first quarter of 2008, versus the same quarter last year, primarily related to a reduction in market interest rates that has occurred over the past several months.

Rate/Volume Analysis

The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income 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 March 31,
		2008 vs. 2007
		Increase/(Decrease)								Total
		Due To								Increase/
(Dollars in thousands)		Volume				Rate				(Decrease)
Interest-earning assets:
Federal funds sold and interest-bearing deposits		$	(122	)		$	(320	)		$	(442	)
Investment securities:
Taxable			(799	)			213				(586	)
Tax-exempt			(160	)			12				(148	)
Tax-preferred			601				67				668
Total investment securities			(358	)			292				(66	)
Loans held for sale			1				—				1
Loans:
Commercial and agricultural			452				(554	)			(102	)
Residential real estate			58				(33	)			25
Consumer indirect			560				74				634
Consumer direct and home equity			(215	)			(242	)			(457	)
Total loans			855				(755	)			100
Total interest-earning assets			376				(783	)			(407	)
Interest-bearing liabilities:
Savings and money market			102				(148	)			(46	)
Interest-bearing demand			(25	)			(451	)			(476	)
Certificates of deposit			(468	)			(537	)			(1,005	)
Short-term borrowings			(11	)			(6	)			(17	)
Long-term borrowings			(171	)			52				(119	)
Total interest-bearing liabilities			(573	)			(1,090	)			(1,663	)
Net interest income — TE		$	949			$	307			$	1,256