SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-K

[X]		ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
		SECURITIES EXCHANGE ACT OF 1934
		For the fiscal year ended December 31, 2011

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

For the fiscal year ended December 31, 2012

[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
		SECURITIES EXCHANGE ACT OF 1934
		For the transition period from to

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

For the transition period from to

Commission file number 0-15366

ALLIANCE FINANCIAL CORPORATION

(Exact name of Registrant as specified in its charter)

New York

16-1276885

(State or Other Jurisdiction of

Incorporation or Organization)

(I.R.S. Employer

Identification No.)

120 Madison Street, 18^th Floor, Syracuse, NY 13202

(Address of principal executive offices, including zip code)

Registrant’s telephone number including area code: (315) 475-2100

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class: Common Stock, $1.00 par value per share

Name of each exchange on which registered: The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No X x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. Yes ¨ No x

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 ¨ No X x

Indicate by check mark whether the ~~Registrant~~registrant ~~(1)~~ has ~~filed~~submitted ~~all~~electronically ~~reports~~and ~~required~~posted toon beits corporate ~~filed~~Web bysite, ~~Section 13~~if orany, ~~15(d)~~every ofInteractive ~~the~~Data ~~Securities~~File ~~Exchange~~required ~~Act~~to be submitted and posted pursuant to Rule 405 of ~~1934~~Regulation S-T during the preceding 12 months (or for such shorter period that the ~~Registrant~~registrant was required to ~~file~~submit ~~such reports),~~ and ~~(2) has~~post ~~been subject to~~ such ~~filing requirements for the past 90~~ ~~days~~files). Yes X x No ¨

Indicate by check mark ~~whether~~if ~~the~~disclosure ~~registrant~~of ~~has~~delinquent ~~submitted~~filers ~~electronically~~pursuant ~~and~~to ~~posted~~Item 405 onof ~~its~~Regulation ~~corporate~~S-K ~~Web~~is ~~site,~~not ifcontained ~~any~~herein, ~~every~~and ~~Interactive~~will ~~Data~~not ~~File~~be ~~required~~contained, to bethe ~~submitted~~best ~~and~~of ~~posted~~registrant’s ~~pursuant~~knowledge, ~~to Rule~~in ~~405~~definitive ofproxy ~~Regulation~~or ~~S-T~~information ~~during~~statements ~~the~~incorporated ~~preceding~~by 12reference ~~months~~in ~~(or~~Part ~~for~~III ~~such~~of ~~shorter~~this ~~period~~Form ~~that~~10-K ~~the~~or ~~registrant~~any ~~was~~amendment ~~required~~ to ~~submit~~this ~~and~~Form ~~post such files)~~10-K. ~~Yes X No~~ ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]

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 definition of “accelerated filer, large accelerated filer and smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer ~~[ ]~~ ¨ Accelerated Filer ~~[X]~~ x Non-accelerated filer ~~[ ]~~ ¨ 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 ¨ No X x

As of June 3029, ~~2011~~2012, the aggregate market value of the voting stock held by non-affiliates of the registrant was $~~130~~148.38 million based on the closing sale price as reported on the NASDAQ Global Market.

The number of outstanding shares of our common stock, $1.00 par value per share, on March 9 1, ~~2012~~2013 was 4,~~784~~776,~~648~~398 shares.

DOCUMENTS INCORPORATED BY REFERENCE:

~~Portions of the proxy statement for the 2012 annual meeting of shareholders (the “Proxy Statement”) are incorporated by reference in Part III of this Annual Report on Form 10-K~~None.

TABLE OF CONTENTS

FORM 10-K ANNUAL REPORT

FOR THE YEAR ENDED

DECEMBER 31, ~~2011~~2012

ALLIANCE FINANCIAL CORPORATION

			Page
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS			i	i
PART I
	Item 1.	Business	1	1
	Item 1A.	Risk Factors	6	7
	Item 1B.	Unresolved Staff Comments	12	13
	Item 2.	Properties	12	13
	Item 3.	Legal Proceedings	12	13
	Item 4.	Mine Safety Disclosures	12	13
PART II
	Item 5.	Market for the Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities	13	14
	Item 6.	Selected Financial Data	15	16
	Item 7.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19	20
	Item 7A.	Quantitative and Qualitative Disclosures about Market Risk	38	38
	Item 8.	Financial Statements and Supplementary Data	40	39
	Item 9.	Changes in and Disagreements with Accountants on Accounting and Financial Disclosure	40	39
	Item 9A.	Controls and Procedures	40	39
	Item 9B.	Other Information	40	40
PART III
	Item 10.	Directors, Executive Officers and Corporate Governance	41	41
	Item 11.	Executive Compensation	41	44
	Item 12.	Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters	41	60
	Item 13.	Certain Relationships and Related Transactions and Director Independence	41	63
	Item 14.	Principal Accountant Fees and Services	41	64
PART IV
	Item 15.	Exhibits and Financial Statement Schedules	42	65

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

We may, from time to time, make written or oral “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, including statements contained in our filings with the Securities and Exchange Commission (the “SEC”), our reports to shareholders and in other communications by us. This Annual Report on Form 10-K contains “forward-looking statements” which may be identified by the use of such words as “believe,” “expect,” “anticipate,” “should,” “planned,” “estimated,” and “potential.” Examples of forward-looking statements include, but are not limited to, statements of our goals, intentions and expectations, statements regarding our business plans and prospects and growth and operating strategies, estimates of our risks, and future costs and benefits that are subject to various factors which could cause actual results to differ materially from these estimates. These factors include, but are not limited to:

¡• anchanges ~~increase~~ in ~~competitive~~the ~~pressure~~interest inrate ~~the~~environment ~~banking~~that ~~industry~~reduce margins;

¡• changes in ~~interest~~the ~~rates~~regulatory environment;

¡• ~~changes~~the highly competitive industry and market area in ~~the~~which ~~regulatory~~we ~~environment~~operate;

¡• general economic conditions, ~~both~~either nationally ~~and~~or regionally, resulting in, among other things, in a deterioration in credit quality;

¡• changes in business conditions and inflation;

¡• changes in ~~the~~credit ~~securities~~market ~~markets~~conditions;

¡• changes in ~~technology~~the ~~used~~securities inmarkets ~~the~~which ~~banking~~affect ~~business~~investment management revenues;

¡• ~~changes~~increases in ~~laws~~Federal Deposit Insurance Corporation (“FDIC”) deposit insurance premiums and ~~regulations~~assessments tocould ~~which~~adversely weaffect ~~are~~our ~~subject~~financial condition;

¡• ~~our~~changes ~~ability~~in totechnology ~~maintain~~used ~~and~~in ~~increase~~the ~~market~~banking ~~share and control expenses~~business; ~~and~~

¡• the soundness of other ~~factors~~financial ~~detailed~~services ~~from~~institutions ~~time~~which tomay ~~time~~adversely inaffect our ~~SEC~~credit ~~filings.~~risk;

~~Any~~• orcertain ~~all~~ of our ~~forward-looking~~intangible ~~statements~~assets inmay ~~this~~become ~~Annual~~impaired ~~Report on Form 10-K, and~~ in any other public statements we make may turn out to be wrong. They can be affected by inaccurate assumptions we might make or by known or unknown risks and uncertainties. Consequently, no forward-looking statements can be guaranteed. We disclaim any obligation to subsequently revise any forward-looking statements to reflect events or circumstances after the ~~date of such statements, or to reflect the occurrence of anticipated or unanticipated events.~~ future;

•

our controls and procedures may fail or be circumvented;

•

new line of business or new products and services which may subject us to additional risks;

•

changes in key management personnel which may adversely impact our operations;

•

the effect on our operations of recent legislative and regulatory initiatives that were or may be enacted in response to the ongoing financial crisis;

•

severe weather, natural disasters, acts of war or terrorism and other external events which could significantly impact our business;

•

risks related to the merger with NBT Bancorp Inc. as described in Item 1A “Risk Factors” in this Annual Report on Form 10-K; and

•

other factors detailed from time to time in our Securities and Exchange Commission (“SEC”) filings.

Although we believe that the expectations reflected in such forward-looking statements are reasonable, actual results may differ materially from the results discussed in these forward-looking statements. You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. We do not undertake any obligation to republish revised forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

Unless the context indicates otherwise, all references in this Annual Report on Form 10-K to “Alliance” “we,” “us,” “our company,” “corporation” and “our” refer to Alliance Financial Corporation and its subsidiaries Alliance Bank, N.A., our wholly owned bank subsidiary (the “Bank”) and Alliance Agency Inc.

PART I

Item 1. Business

General

Alliance Financial Corporation is a New York corporation and a registered financial holding company formed on November 25, 1998 as a result of the merger of Cortland First Financial Corporation and Oneida Valley Bancshares, Inc. Alliance is the holding company of Alliance Bank, N.A. which was formed as the result of the merger of First National Bank of Cortland and Oneida Valley National Bank in 1999.

We provide financial services from 29 retail branches and customer service facilities in the New York counties of Cortland, Madison, Oneida, Onondaga, Oswego, and from a Trust Administration Center in Buffalo, NY. Our primary services include commercial, retail and municipal banking, consumer finance, mortgage financing and servicing, trust and investment management services. The Bank has a substantially wholly owned subsidiary, Alliance Preferred Funding Corp., which is engaged in residential real estate activity, and a wholly owned subsidiary, Alliance Leasing, Inc.

Our corporate and administrative offices are located on the 18^th Floor, AXA Tower II, 120 Madison St., Syracuse, New York. Banking services are provided at the administrative offices as well as at Alliance’s 29 customer service facilities.

We formed Alliance Financial Capital Trust I and Alliance Financial Capital Trust II (collectively “Capital Trusts”) for the purpose of issuing corporation-obligated mandatorily redeemable capital securities to third-party investors and investing the proceeds from the sale of such capital securities solely in junior subordinated debt securities of Alliance.

At December 31, ~~2011~~2012, we had ~~328~~331 full-time equivalent employees. Our employees are not represented by any collective bargaining group. We consider our employee relations to be good.

The Bank is a member of the Federal Reserve System and the Federal Home Loan Bank System, and its deposits are insured by the Federal Deposit Insurance Corporation up to applicable limits.

Pending Merger

On October 8, 2012, we reported that we entered into a definitive merger agreement (“Merger Agreement’) with NBT Bancorp Inc. (“NBT”). Under the terms of the Merger Agreement, NBT will acquire us for approximately $233.4 million based on the 5-day average closing price of NBT’s common stock for the period ended October 5, 2012, and we will merge with and into NBT, with NBT being the surviving corporation (the “Merger”). Immediately following the Merger, the Bank will be merged with and into NBT’s subsidiary bank, NBT Bank, N.A. (“NBT Bank”) and NBT Bank will continue as the surviving bank. Merger related expenses in non-interest expense totaled $3.4 million in 2012 and included $2.7 million for professional fees and $676,000 for personnel related accrual for estimated retention awards. The NBT stockholders voted to approve the Merger Agreement on March 5, 2013, and our shareholders voted to approve the Merger Agreement on March 7, 2013. The Merger is scheduled to be completed on March 8, 2013.

Services

We offer full-service banking with a broad range of financial products to meet the needs of our commercial, retail, government, and investment management customers. Depository account services include interest and non-interest-bearing checking accounts, money market accounts, savings accounts, time deposit accounts, and individual retirement accounts. Our lending activities include the making of residential and commercial mortgage loans, business lines of credit, working capital facilities and business term loans, as well as installment loans, home equity loans, and personal lines of credit to individuals. Investment management and trust services include personal trust, employee benefit trust, investment management, custodial, and financial planning. Through UVEST Financial Services, a subsidiary of LPL Financial Institution Services and member NASD/SIPC, we provide financial counseling and brokerage services. We also offer safe deposit boxes, wire transfers, collection services, drive-up banking facilities, 24-hour night depositories, automated teller machines, 24-hour telephone banking, and on-line internet banking.

Competition

Our business is extremely competitive. We compete not only with other commercial banks, but also with other financial institutions such as thrifts, credit unions, money market and mutual funds, insurance companies, brokerage firms, and a variety of other financial services companies.

Supervision and Regulation

The following discussion summarizes some of the laws and regulations applicable to bank holding companies and national banks and provides certain specific information relevant to Alliance. This regulatory framework is primarily intended for the protection of depositors, consumers, and the deposit insurance funds that insure bank deposits, and not for the protection of shareholders or creditors of bank holding companies and banks. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Moreover, Congress, regulatory agencies, and state legislatures frequently propose changes to the law and regulations affecting the banking industry. The likelihood and timing of any changes and the impact such changes might have on us are impossible to accurately predict. A change in the statutes, regulations, or regulatory policies applicable to us or our subsidiaries may have a material adverse effect on our business.

deposits, and not for the protection of shareholders or creditors of bank holding companies and banks. To the extent that the following information describes statutory and regulatory provisions, it is qualified in its entirety by reference to those provisions. Moreover, Congress, regulatory agencies, and state legislatures frequently propose changes to the law and regulations affecting the banking industry. The likelihood and timing of any changes and the impact such changes might have on us are impossible to accurately predict. A change in the statutes, regulations, or regulatory policies applicable to us or our subsidiaries may have a material adverse effect on our business.

Recent Legislative and Regulatory Changes

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act” or “Dodd-Frank”), passed into law on July 21, 2010, is a broad-ranging financial reform law that affects numerous aspects of the U.S. financial regulatory system. It calls for over 200 rulemakings by numerous federal agencies, some of which have begun to issue rules. However, numerous rules have yet to be proposed or finalized. The Dodd-Frank Act covers subject matter including, but not limited to, systemic risk, corporate governance, executive compensation, credit rating agencies, capital and derivatives. Many of Dodd-Frank’s effects will not be known for months or years to come, pending, for instance, the issuance of final regulations implementing all of its provisions.

The Dodd-Frank Act also created a Bureau of Consumer Financial Protection (“CFPB”) as an independent bureau of the Board of Governors of the Federal Reserve System (“Federal Reserve Board”). The CFPB has the authority to write regulations on consumer financial products and services that will apply to depository institutions and many other entities that provide consumer financial products and services. The CFPB began operations on July 21, 2011.

Bank Holding Company Regulation

General

Alliance is a bank holding company registered under the Bank Holding Company Act of 1956 and, as such, is subject to supervision, regulation and examination by the Federal Reserve Board. The Bank Holding Company Act and other federal laws and regulations subject bank holding companies to restrictions on the types of activities in which they may engage, as well as to a supervisory regime that provides for possible regulatory enforcement actions for violations of laws and regulations. Alliance elected to also become a financial holding company on June 21, 2006. A bank holding company that also qualifies as a financial holding company can expand into a wide variety of services that are deemed by the Federal Reserve Board to be financial in nature, including securities underwriting, dealing and market making; sponsoring mutual funds and investment companies; insurance underwriting; and merchant banking. In order for a bank holding company to qualify for, and retain, financial holding company status, the holding company must be deemed to be “well managed” and “well capitalized” and each one of the bank holding company’s subsidiary depository institutions must be deemed “well capitalized” and “well managed” by regulators and must have received at least a “Satisfactory” rating on its last Community Reinvestment Act (“CRA”) examination.

The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if after such acquisition it would own or control, directly or indirectly, more than 5% of ~~the~~any class of voting shares of such bank. In approving bank acquisitions by bank holding companies, the Federal Reserve Board is required to consider factors including, among others, the financial and managerial resources and future prospects of the bank holding company and the banks concerned; the convenience and needs of the communities to be served; and competitive factors. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank or bank holding company unless the Federal Reserve Board has been notified and has not objected to the transaction. In addition, any entity is required to obtain the approval of the Federal Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of our outstanding common stock, or otherwise obtaining control or a “controlling influence” over us.

The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their nonbanking subsidiaries that represent unsafe or unsound practices or which constitute violations of laws or regulations, and can bring enforcement actions, including the assessment of civil money penalties, for certain violations or practices.

communities to be served; and competitive factors. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank or bank holding company unless the Federal Reserve Board has been notified and has not objected to the transaction. In addition, any entity is required to obtain the approval of the Federal Reserve Board under the Bank Holding Company Act before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of our outstanding common stock, or otherwise obtaining control or a “controlling influence” over us.

Under Federal Reserve Board regulations, a bank holding company is expected to act as a source of financial and managerial strength to each of its banking subsidiaries and to commit resources to their support. The Federal Reserve Board may charge the holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank when required. Any capital loans by Alliance to its subsidiary bank would be subordinate in right of payment to depositors and to certain other indebtedness of the subsidiary bank.

Our ability to pay dividends to our shareholders is primarily dependent on the ability of the Bank to pay dividends to usAlliance. The ability of both Alliance and the Bank to pay dividends is limited by federal statutes, regulations and policies. For example, it is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the holding company’s expected future needs and financial condition. The policy provides that holding companies should not maintain a level of cash dividends that undermines the holding company’s ability to serve as a source of strength to its banking subsidiaries.

Furthermore, the Bank must obtain the prior approval of the Office of the Comptroller of the Currency (“OCC”) for the payment of dividends if the total of all dividends declared in any calendar year would exceed the sum of the Bank’s net profits, as defined by applicable regulations, for that year, combined with its retained net profits for the preceding two calendar years, less any required transfers to surplus. Federal law also prohibits the Bank from paying a dividend in an amount greater than its undivided profits after deducting statutory bad debt in excess of the Bank’s allowance for loan losses, as defined by applicable regulations.

Capital Adequacy Guidelines for Bank Holding Companies

The Federal Reserve Board has established risk-based capital guidelines that are applicable to bank holding companies. The guidelines apply on a consolidated basis and require bank holding companies to maintain a minimum ratio of Tier 1 capital to total assets (“leverage ratio”) of 4%. For the most highly rated bank holding companies, the minimum ratio is 3%. The Federal ~~Reserve~~ Reserve Board capital adequacy guidelines also require bank holding companies to maintain a minimum ratio of Tier 1 capital to risk-weighted assets of 4% and a minimum ratio of qualifying total capital to risk-weighted assets of 8%. Any bank holding ~~company~~ company whose capital does not meet the minimum capital adequacy guidelines is considered to be undercapitalized, and is required to submit an acceptable plan to the Federal Reserve Board for achieving capital adequacy. In addition, an ~~undercapitalized~~ undercapitalized company'’s ability to pay dividends to its shareholders and expand its lines of business through the acquisition of new banking or non-banking subsidiaries also could be restricted by the Federal Reserve Board. The Federal Reserve Board may set higher minimum capital requirements for bank holding companies where circumstances warrant, such as companies anticipating significant growth or facing unusual risks. The sum of Tier 1 capital and Tier 2 capital is “total risk-based capital.” Alliance’s Tier 1 and total risk-based capital ratios as of December 31, ~~2011~~2012 were 14.7248% and 15.9743%, respectively. In addition, the Federal Reserve Board has established a minimum leverage ratio of Tier 1 capital to total assets (“Tier 1 leverage ratio”) of 3.00% for the bank holding companies with the highest supervisory ratings. All other bank holding companies are required to maintain a Tier 1 leverage ratio of at least 4.00%. Alliance’s Tier 1 leverage ratio as of December 31, ~~2011~~2012 was 9.0937%. The guidelines also provide that banking organizations with supervisory, financial, operational, or managerial weaknesses, as well as organizations that are anticipating or experiencing ~~internal~~ internal growth, are expected to maintain capital ratios well above the minimum supervisory levels.

On March 1, 2005 the Federal Reserve Board issued a final rule allowing the continued inclusion of trust preferred securities in the Tier 1 capital of bank holding companies within certain limits. At December 31, ~~2011~~2012, Alliance’s trust preferred securities comprised 20% of the sum of Alliance’s Tier 1 capital. However, pursuant to the Dodd-Frank Act, the ability of bank holding companies to continue to include trust preferred securities in Tier 1 capital will be limited in the future. Under Section 171 of the Dodd-Frank Act, the Federal Reserve must promulgate regulations implementing capital requirements for bank holding companies with assets greater than $500 million that are no less stringent than those applicable to insured depository institutions. Since depository institutions may not count trust preferred securities in Tier 1 capital (but may count them in Tier 2 capital), bank holding companies with over $500 million in assets will no longer be able to do so. Thus, trust preferred securities issued on or after May 19, 2010 may no longer be counted in Tier 1 capital of bank holding companies with over $500 million in assets. Trust preferred securities issued before May 19, 2010 by bank holding companies with assets of less than $15 billion as of year-end 2009 may continue to be included in Tier 1 capital until their original maturity. Alliance’s trust preferred securities are scheduled to mature in 2034 and 2036.

will be limited in the future. Under Section 171 of the Dodd-Frank Act, the Federal Reserve must promulgate regulations implementing capital requirements for bank holding companies with assets greater than $500 million that are no less stringent than those applicable to insured depository institutions. Since depository institutions may not count trust preferred securities in Tier 1 capital (but may count them in Tier 2 capital), bank holding companies with over $500 million in assets will no longer be able to do so. Thus, trust preferred securities issued on or after May 19, 2010 may no longer be counted in Tier 1 capital of bank holding companies with over $500 million in assets. Trust preferred securities issued before May 19, 2010 by bank holding companies with assets of less than $15 billion as of year-end 2009 may continue to be included in Tier 1 capital until their original maturity. However, in its proposed capital rules, the Federal Reserve Board included a provision requiring bank holding companies with assets of less than $15 billion to phase-out the inclusion of trust preferred securities over a 10-year period. This rule is still pending. Alliance’s trust preferred securities are scheduled to mature in 2034 and 2036.

Transactions with Affiliates

The Bank’s authority to engage in transactions with its affiliates is limited by Sections 23A and 23B of the Federal Reserve Act and the Federal Reserve Board’s Regulation W. In general, these transactions must be on terms that are at least as favorable to the Bank as comparable transactions with non-affiliates. In addition, certain types of these transactions are restricted to an aggregate percentage of the Bank’s capital. Collateral in specified amounts must usually be provided by affiliates in order to receive loans from the Bank.

Loans to Insiders

The Bank’s authority to extend credit to its directors, executive officers and principal shareholders, as well as to entities controlled by such persons (collectively, “insiders”), is governed by the requirements of Sections 22(g) and 22(h) of the Federal Reserve Act and Regulation O of the Federal Reserve Board. Among other things, these provisions require that extensions of credit to insiders: (i) be made on terms that are substantially the same as, and follow credit underwriting procedures that are not less stringent than, those prevailing for comparable transactions with unaffiliated persons and that do not involve more than the normal risk of repayment or present other unfavorable features; and (ii) not exceed certain limitations on the amount of credit extended to such persons, individually and in the aggregate, which limits are based, in part, on the amount of the Bank’s capital. In addition, extensions for credit in excess of established limits must be approved by the Bank’s Board of Directors.

Bank Regulation

As a national bank, the Bank is subject to primary supervision, regulation, and examination by the OCC. The Bank must file periodic reports with the OCC concerning its activities and financial condition, and must obtain regulatory approval to enter into certain transactions or conduct certain activities. Like other federal banking regulators, the OCC has broad authority to examine and supervise the Bank and to evaluate the Bank’s compliance with applicable laws, regulations and guidance. The OCC may initiate enforcement actions to sanction, remedy, or prevent unsafe or unsound banking practices, breaches of fiduciary duty, and/or violations of law.

The Bank is subject to a wide variety of statutes and regulations that significantly affect its business and activities. Such statutes and regulations include those relating to capital requirements, allowable investments, underwriting of loans, reserves against deposits, trust activities, mergers and consolidations, payment of dividends, establishment of branches and certain other facilities, limitations on loans to one borrower and loans to affiliated persons, and numerous other aspects of the business of banks. Additionally, bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other services offered by a holding company or its affiliates.

Consumer Compliance

The Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. These laws and regulations include, among others, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Fair Credit Reporting Act, provisions of the Gramm-Leach-Bliley Act of 1999 relating to privacy and safeguarding of consumer information, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act, and the Real Estate Settlement Procedures Act. These laws and regulations mandate certain disclosures and, in certain cases, restrict the terms on which the Bank may offer products and services to consumers.

Community Reinvestment

Additionally, the Bank is subject to the Community Reinvestment Act of 1977 (“CRA”) and the regulations issued thereunder, which are intended to encourage banks to help meet the credit needs of their service area, including low-to-moderate-income (“LMI”) neighborhoods, consistent with safe and sound operations. The CRA also provides for regulatory assessment of a bank’s record in meeting the needs of its service area when considering applications regarding establishing branches, mergers or other bank or branch acquisitions. In the case of a bank holding company, the CRA performance record of the banks involved in the transaction are reviewed in connection with the filing of an application to acquire ownership or control of shares or assets of a bank or to merge with any other bank holding company. An unsatisfactory record can substantially delay or block the transaction. The Bank received a rating of “Satisfactory” at its last CRA exam.

Community Reinvestment

Anti-money Laundering

Alliance and the Bank are also subject to the Bank Secrecy Act, as amended by the USA PATRIOT Act, which gives the federal government powers to address money laundering and terrorist threats through enhanced domestic security measures, expanded surveillance powers, and mandatory transaction reporting obligations. For example, the Bank Secrecy Act imposes an affirmative obligation on the Bank to report currency transactions that exceed certain thresholds and to report other transactions determined to be suspicious. Title III of the USA PATRIOT Act takes measures intended to encourage information sharing among financial institutions, bank regulatory agencies and law enforcement bodies. Further, certain provisions of Title III impose affirmative obligations on a broad range of financial institutions, including banks, thrifts, brokers, dealers, credit unions, money transfer agents and parties registered under the Commodity Exchange Act. Among other provisions, the USA PATRIOT Act and the related regulations require banks operating in the United States to supplement and enhance the anti-money laundering compliance programs, due diligence policies and controls required by the Bank Secrecy Act and Office of Foreign Assets Control regulations to ensure the detection and reporting of money laundering.

The Bank has in place a comprehensive program to ensure compliance with these requirements. In ~~2011~~2012, the Bank engaged in a very limited number of transactions of any kind with foreign financial institutions or foreign persons.

Capital and Prompt Corrective Action

Under the Prompt Corrective Action (“PCA”) provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”), federal banking regulators are required to take “prompt corrective action” regarding depository institutions that do not meet certain minimum capital requirements. The PCA provisions impose progressively more restrictive constraints on banks as their capital levels decline. The PCA provisions identify the following capital categories for financial institutions: “well capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized,” and “critically undercapitalized.” Rules adopted by the federal banking agencies implementing PCA provide that an institution is deemed to be “well capitalized” if it has a total risk-based capital ratio of 10.0% or greater, a Tier 1 risk-based ratio of 6.0% or greater, and a leverage ratio of 5.0% or greater, and the institution is not subject to an order, written agreement, capital directive, or PCA directive to meet and maintain a specific level for any capital measure. Additionally, under FDIC regulations, no FDIC-insured bank can accept brokered deposits unless it is well capitalized, or is adequately capitalized and receives a waiver from the FDIC. In addition, these regulations prohibit any bank that is not well capitalized from paying an interest rate on brokered deposits above certain levels.

At December 31, ~~2011~~2012, ~~Alliance and~~ the Bank ~~were~~was in the “well capitalized” category.

Insurance of Deposits

The deposits of the Bank are insured up to the applicable limits established by law and are subject to the deposit insurance premium assessments of the Deposit Insurance Fund (“DIF”). Under Dodd-Frank, the standard deposit insurance amount has been permanently increased to $250,000. The FDIC currently maintains a risk-based assessment system under which assessment rates vary based on the level of risk posed by the institution to the DIF.

In February 2011, the FDIC adopted a final rule making certain changes to the deposit insurance assessment system, many of which were made as a result of provisions of the Dodd-Frank Act. The final rule also revised the assessment rate schedule effective April 1, 2011, and adopted additional rate schedules that will go into effect when the DIF reserve ratio reaches various milestones. The final rule changed the deposit insurance assessment system from one that is based on domestic deposits to one that is based on average consolidated total assets minus average tangible equity. In addition, the rule will suspend FDIC dividend payments if the DIF reserve ratio exceeds 1.5 percent at the end of any year but provides for decreasing assessment rates when the DIF reserve ratio reaches certain thresholds.

In calculating assessment rates, the rule adopts a new “scorecard” assessment scheme for insured depository institutions with $10 billion or more in assets. It retains the risk category system for insured depository institutions with less than $10 billion in assets, assigning each institution to one of four risk categories based upon the institution’s capital evaluation and supervisory evaluation, as defined by the rule.

tangible equity. In addition, the rule will suspend FDIC dividend payments if the DIF reserve ratio exceeds 1.5 percent at the end of any year but provides for decreasing assessment rates when the DIF reserve ratio reaches certain thresholds.

Monetary and Fiscal Policies

The earnings of Alliance are significantly affected by the monetary and fiscal policies of governmental authorities, including the Federal Reserve Board. Among the instruments of monetary policy used by the Federal Reserve Board to implement these objectives are open-market operations in U.S. government securities and federal funds, changes in the discount rate on member bank borrowings, and changes in reserve requirements against member bank deposits. These instruments of monetary policy are used in varying combinations to influence the overall level of bank loans, investments and deposits, and the interest rates charged on loans and paid for deposits. The Federal Reserve Board frequently uses these instruments of monetary policy, especially its open-market operations and the discount rate, to influence the level of interest rates and to affect the strength of the economy, the level of inflation or the price of the dollar in foreign exchange markets. The monetary policies of the Federal Reserve Board have had a significant effect on the operating results of banking institutions in the past and are expected to continue to do so in the future. It is not possible to predict the nature of future changes in monetary and fiscal policies, or the effect that they may have on Alliance’s business and earnings.

The Sarbanes-Oxley Act of 2002

The Sarbanes-Oxley Act of 2002 (“Sarbanes-Oxley”) also imposes numerous requirements designed to address corporate and accounting fraud. Sarbanes-Oxley requires chief executive officers and chief financial officers, or their equivalent, to certify the accuracy of periodic reports filed with the SEC, subject to civil and criminal penalties if they knowingly or willfully violate this certification requirement. In addition, under Sarbanes-Oxley, legal counsel is required to report evidence of a material violation of the securities laws or a breach of fiduciary duty by a company to the chief executive officer or chief financial officer, and, if such officer does not appropriately respond, to report such evidence to the audit committee or other similar committee of the Board of Directors or the Board itself. Executives are also prohibited from insider trading during retirement plan “blackout” periods, and loans to company executives are restricted.

Available Information

We file annual reports, quarterly reports, proxy statements and other documents with the SEC under the Securities Exchange Act of 1934 (the “Exchange Act"”). The public may read and copy any materials that we file with the SEC at the SEC’s Public Reference Room at 100 F. Street, N.E., Room 1580, Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. Also, the SEC maintains a website that contains reports, proxy and information statements, and other information regarding issuers, including Alliance, that file electronically with the SEC. The public can obtain any documents that we file with the SEC at www.sec.gov.

We also make available, free of charge through our website (www.alliancebankna.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and, if applicable, amendments to those reports filed or furnished pursuant to the Exchange Act as soon as reasonably practicable after we electronically file such material with, or furnishes it to, the SEC.

Item 1A. Risk Factors

There are risks inherent to our business. The material risks and uncertainties that management believes affect us are described below. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair our business operations. This report is qualified in its entirety by these risk factors. If any of the following risks actually occur, our financial condition and results of operations could be materially and adversely affected.

Risks Related to Our Business

We Are Subject to Interest Rate Risk

Our earnings and cash flows are largely dependent upon our net interest income. Net interest income is the difference between interest income earned on interest-earning assets such as loans and securities and interest expense paid on interest-bearing liabilities such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond our control, including general economic and credit market conditions and policies of various governmental and regulatory agencies, particularly the Federal Reserve System. Changes in monetary policy, including changes in interest rates, could not only influence the interest we receive on loans and securities and the amount of interest we pay on deposits and borrowings, but could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates earned on loans and other investments, our net interest income, and therefore our earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates earned on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

and the amount of interest we pay on deposits and borrowings, but could also affect (i) our ability to originate loans and obtain deposits, (ii) the fair value of our financial assets and liabilities, and (iii) the average duration of our mortgage-backed securities portfolio. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates earned on loans and other investments, our net interest income, and therefore our earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates earned on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

Although management believes it has implemented effective asset and liability management strategies to reduce the potential effects of changes in interest rates on our results of operations, any substantial, unexpected, prolonged change in market interest rates could have a material adverse effect on our financial condition and results of operations.

See the section captioned “Net Interest Income” in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations and Item 7A, Quantitative and Qualitative Disclosure About Market Risk located elsewhere in this report for further discussion related to our management of interest rate risk.

We Are Subject to Lending Risk

There are inherent risks associated with our lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic or credit market conditions in the markets where we operate as well as the State of New York and the ~~entire~~ United States. Increases in interest rates and/or weakening economic or credit market conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. We are also subject to various laws and regulations that affect our lending activities. Failure to comply with applicable laws and regulations could subject us to regulatory enforcement action that could result in the assessment of significant civil money penalties against us.

As of December 31, ~~2011~~2012, approximately 3533% of our loan and lease portfolio consisted of commercial loans and leases net of unearned income. These types of loans are generally viewed as having more risk of default than conventional residential real estate loans or most consumer loans. Commercial loans are also typically larger than residential real estate loans and consumer loans. Because our loan portfolio contains a significant number of commercial loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in nonperforming loans. An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for credit losses and an increase in loan charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

See the section captioned “Loans and Leases” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to commercial loans and leases.

Our Allowance for Credit Losses May Be Insufficient

We maintain an allowance for credit losses, which is a reserve established through a provision for credit losses charged to expense, that represents management’s best estimate of probable losses incurred within the existing portfolio of loans and leases. The allowance is necessary to provide for estimated credit losses and risks inherent in the loan and lease portfolio. The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan and lease portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan and lease portfolio. The determination of the appropriate level of the allowance for credit losses inherently involves a significant degree of subjectivity and requires us to make estimates of current credit risks, all of which may undergo material changes. Changes in economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside of our control, may require an increase in the allowance for credit losses. In addition, bank regulatory agencies periodically review our allowance for credit losses and may require an increase in the provision for credit losses or the recognition of further loan charge-offs, based on judgments different than those of management. In addition, if charge-offs in future periods exceed the allowance for credit losses, we will need additional provisions to increase the allowance for credit losses. These increases in the allowance for credit losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on our financial condition and results of operations.

Our Allowance for Credit Losses May Be Insufficient

See the section captioned “Asset Quality and the Allowance for Credit Losses” in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations located elsewhere in this report for further discussion related to our process for determining the appropriate level of the allowance for credit losses.

Our Profitability Depends Significantly on Economic Conditions in Upstate New York

Our profitability depends significantly on the general economic conditions of Upstate New York and the specific local markets in which we operate. Unlike larger national or other regional banks that are more geographically diversified, we provide banking and financial services to customers primarily in the Upstate New York counties of Cortland, Erie, Madison, Oneida, Onondaga, Oswego and nearby counties. The local economic conditions in these areas have a significant impact on the demand for our products and services as well as the ability of our customers to repay loans, the value of the collateral securing loans and the stability of our deposit funding sources. A significant decline in general economic conditions, caused by inflation, recession, acts of terrorism, outbreak of hostilities or other international or domestic occurrences, unemployment, changes in securities or credit markets or other factors could impact these local economic conditions and, in turn, have a material adverse effect on our financial condition and results of operations.

We Operate in a Highly Competitive Industry and Market Area

We face substantial competition in all areas of our operations from a variety of different competitors, many of which are larger and may have more financial resources. Such competitors primarily include national, regional, and community banks within the various markets where we operate. We also face competition from many other types of financial institutions, including, without limitation, savings and loans, credit unions, finance companies, brokerage firms, insurance companies, factoring companies and other financial intermediaries. The financial services industry could become even more competitive as a result of legislative, regulatory and technological changes and continued consolidation. Banks, securities firms and insurance companies can merge under the umbrella of a financial holding company, which can offer virtually any type of financial service, including banking, securities underwriting, insurance (both agency and underwriting) and merchant banking. Also, technology has lowered barriers to entry and made it possible for non-banks to offer products and services traditionally provided by banks, such as automatic transfer and automatic payment systems. Many of our competitors have fewer regulatory constraints and may have lower cost structures. Additionally, due to their size, many competitors may be able to achieve economies of scale and, as a result, may offer a broader range of products and services as well as better pricing for those products and services than we can. Our ability to compete successfully depends on a number of factors, including, among other things:

¡• The ability to develop, maintain and build upon long-term customer relationships based on top quality service, high ethical standards and safe and sound practices.

¡• The ability to maintain high asset quality.

¡• The ability to expand our market position.

¡• The scope, relevance and pricing of products and services offered to meet customer needs and demands.

¡ The rate at which we introduce new products and services relative to our competitors.

¡ Customer satisfaction with our level of service.

¡ Industry and general economic trends.

¡ Our ability to upgrade and acquire technology and information systems to support the sales and service of deposit and loan products.

Failure to perform in any of these areas could significantly weaken our competitive position, which could adversely affect our growth and profitability, which, in turn, could have a material adverse effect on our financial condition and results of operations.

We Are Subject to Extensive Government Regulation and Supervision

~~among~~• ~~other~~The ~~things.~~rate ~~Congress~~at ~~and~~which ~~federal~~we ~~regulatory~~introduce ~~agencies~~new continually review banking laws, regulations and policies for areas warranting changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products ~~we may offer~~ and~~/or~~ ~~increase the ability of non-banks to offer competing financial~~ services ~~and~~relative ~~products, among other things. Failure~~ to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties, private lawsuits, and/or reputation damage, which could have a material adverse effect on our ~~business, financial condition and results of operations~~competitors. ~~While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.~~

•

Customer satisfaction with our level of service.

•

Industry and general economic trends.

•

Our ability to upgrade and acquire technology and information systems to support the sales and service of deposit and loan products.

We Are Subject to Extensive Government Regulation and Supervision

We are subject to extensive federal regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for areas warranting changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties, private lawsuits, and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.

See the section captioned “Supervision and Regulation” in Item 1. Business, which is located elsewhere in this report, for further discussion.

Compliance with the Dodd-Frank Act Will Increase Our Regulatory Compliance Burdens, and May Increase Our Operating Costs and/or Adversely Impact Our Earnings and/or Capital Ratios

On July 21, 2010, President Obama signed the Dodd-Frank Act into law. The Dodd-Frank Act represents a significant overhaul of many aspects of the regulation of the financial-services industry. Among other things, the Dodd-Frank Act creates a new federal CFPB, tightens capital standards, imposes clearing and margining requirements on many derivatives activities, and generally increases oversight and regulation of financial institutions and financial activities.

The CFPB began operations on July 21, 2011. It has broad authority to write regulations regarding consumer financial products and services. These regulations will apply to numerous types of entities, including insured depository institutions such as the Bank, and mortgage servicing providers. It is impossible to predict at this time the content or number of such regulations.

The Dodd-Frank Act also requires depository institution holding companies with assets greater than $500 million to be subject to capital requirements at least as stringent as to those applicable to insured depository institutions, meaning, for instance, that such holding companies will no longer be able to count trust preferred securities issued on or after May 19, 2010 as Tier 1 capital. ~~Holding~~The Dodd-Frank Act permits holding companies with total consolidated assets of less than $15 billion ~~will be allowed~~ to continue to count securities, including trust preferred securities, issued before May 19, 2010 in Tier 1 capital if the securities qualified as Tier 1 capital on that date for the remaining life of the security. However, in its proposed capital rules, the Federal Reserve Board included a provision requiring bank holding companies with assets of less than $15 billion to phase-out the inclusion of trust preferred securities over a 10-year period. Holding companies with total consolidated assets of $15 billion or greater will be required to phase out existing trust preferred and other non-qualifying securities from Tier 1 capital over a 3-year period beginning on January 1, 2013. Moreover, agreements among bank regulators across the world (including the United States) known as the Basel III capital accord also call for the removal of trust preferred securities from Tier 1 capital, encourage more reliance on common equity as the main component of capital, and call for increased levels of capital. Rules implementing Basel III have ~~not be yet~~ been proposed in the United States and are still pending.

In addition to the self-implementing provisions of the statute, the Dodd-Frank Act calls for over 200 administrative rulemakings by various federal agencies to implement various parts of the legislation. While some rules have been finalized and/or issued in proposed form, many have yet to be proposed. It is impossible to predict when all such additional rules will be issued or finalized, and what the content of such rules will be. We will have to apply resources to ensure that we are in compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.

finalized and/or issued in proposed form, many have yet to be proposed. It is impossible to predict when all such additional rules will be issued or finalized, and what the content of such rules will be. We will have to apply resources to ensure that we are in compliance with all applicable provisions of the Dodd-Frank Act and any implementing rules, which may increase our costs of operations and adversely impact our earnings.

The Dodd-Frank Act and any implementing rules that are ultimately issued could have adverse implications on the financial industry, the competitive environment, and/or our ability to conduct business.

We Cannot Predict the Effect On Our Operations of Any Future Legislative or Regulatory Initiatives

We cannot predict what, if any, additional legislative or regulatory initiatives any governmental entity may undertake in the future, and what, if any, effects such initiatives may have on our operations. The U.S. federal and state governments and many foreign governments have taken or are considering extraordinary actions in response to the worldwide financial crisis and the severe decline in the global economy.

There can be no assurance that the enactment or adoption of any such initiative will be effective at dealing with the ongoing economic crisis or will have the effect of improving economic conditions globally, nationally or in our markets, or that any such initiative will not have adverse consequences to us.

A Change to the Conservatorship of Fannie Mae and Freddie Mac and Related Actions, Along with Any Changes in Laws and Regulations Affecting the Relationship Between Fannie Mae and Freddie Mac and the U.S. Federal Government, Could Adversely Affect Our Business

There continues to be substantial uncertainty regarding the future of GSEs Fannie Mae and Freddie Mac, including whether they both will continue to exist in their current form. We sell the majority of our residential mortgages to Fannie Mae, Freddie Mac, and the Federal Home Loan Bank. Our ability to sell our residential mortgages into the secondary market is an important part of our overall interest rate risk, liquidity risk and capital management strategies.

Due to increased market concerns about the ability of Fannie Mae and Freddie Mac to withstand future credit losses associated with securities on which they provide guarantees and loans held in their investment portfolios without the direct support of the U.S. federal government, in September 2008, the Federal Housing Finance Agency (the “FHFA”) placed Fannie Mae and Freddie Mac into conservatorship and, together with the U.S. Treasury, established a program designed to boost investor confidence in Fannie Mae and Freddie Mac by supporting the availability of mortgage financing and protecting taxpayers. The U.S. government program includes contracts between the U.S. Treasury and each of Fannie Mae and Freddie Mac that seek to ensure that each GSE maintains a positive net worth by providing for the provision of cash by the U.S. Treasury to Fannie Mae and Freddie Mac if FHFA determines that its liabilities exceed its assets. Although the U.S. government has described some specific steps that it intends to take as part of the conservatorship process, efforts to stabilize these entities may not be successful and the outcome and impact of these events remain highly uncertain.

Future legislation could further change the relationship between Fannie Mae and Freddie Mac and the U.S. government, could change their business charters or structure, or could nationalize or eliminate such entities entirely. We cannot predict whether, or when, any such legislation may be enacted.

The Soundness of Other Financial Services Institutions May Adversely Affect Our Credit Risk

We rely on other financial services institutions through trading, clearing, counterparty, and other relationships. We maintain limits and monitor concentration levels of our counterparties as specified in our internal policies. Our reliance on other financial services institutions exposes us to credit risk in the event of default by these institutions or counterparties. These losses could adversely affect our results of operations and financial condition.

Certain of Our Intangible Assets May Become Impaired in the Future

Intangible assets are tested for impairment on a periodic basis. Impairment testing incorporates the current market price of our common stock, the estimated fair value of our assets and liabilities, and certain information of similar companies. It is possible that future impairment testing could result in a decline in value of our intangibles which may be less than the carrying value, which may adversely affect our financial condition. If we determine that an impairment exists at a given point in time, our earnings and the book value of the related intangibles will be reduced by the amount of the impairment. Notwithstanding the foregoing, the results of impairment testing on our intangible assets have no impact on our tangible book value or regulatory capital levels.

Our Controls and Procedures May Fail or Be Circumvented

Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.

New Lines of Business or New Products and Services May Subject Us to Additional Risks

From time to time, we may implement new lines of business or offer new products and services within existing lines of business. There are substantial risks and uncertainties associated with these efforts, particularly in instances where the markets are not fully developed. In developing and marketing new lines of business and/or new products and services, we may invest significant time and resources. Initial timetables for the introduction and development of new lines of business and/or new products or services may not be achieved and price and profitability targets may not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, results of operations and financial condition.

not prove feasible. External factors, such as compliance with regulations, competitive alternatives, and shifting market preferences, may also impact the successful implementation of a new line of business or a new product or service. Furthermore, any new line of business and/or new product or service could have a significant impact on the effectiveness of our system of internal controls. Failure to successfully manage these risks in the development and implementation of new lines of business or new products or services could have a material adverse effect on our business, results of operations and financial condition.

We Rely on Dividends from the Bank for Most of Our Revenue

We receive substantially all of our revenue from dividends from the Bank. These dividends are the principal source of funds to pay dividends on our common stock and interest and principal on our debt. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to us. Also, our right to participate in a distribution of assets upon a subsidiary’s liquidation or reorganization is subject to the prior claims of the subsidiary’s creditors. In the event the Bank is unable to pay dividends to us, we may not be able to service debt, pay obligations or pay dividends on our common stock.

The inability to receive dividends from the Bank could have a material adverse effect on our business, financial condition and results of operations. See the section captioned “Supervision and Regulation” in Item 1. Business and Note 16 – Dividends and Restrictions in the notes to consolidated financial statements included ~~in Item 8. Financial Statements and Supplementary Data, which are located~~ elsewhere in this report.

We May Not Be Able to Attract and Retain Skilled People

Our success depends, in large part, on our ability to attract and retain key human resource talent. Competition for the best employees in most activities and functions we are engaged in can be intense and we may not be able to hire employees or to retain them. The unexpected loss of services of one or more of our key personnel could have a material adverse impact on our business because of their skills, knowledge of our market, years of industry experience and the difficulty of promptly finding qualified replacement personnel.

Our Information Systems May Experience an Interruption or Breach in Security

We rely heavily on communications and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny and/or enforcement actions, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations.

We Continually Encounter Technological Changes

The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological enhancements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on our business and, in turn, our financial condition and results of operations.

Our Articles of Incorporation, By-Laws and Shareholder Rights Plan As Well As Certain Banking Laws May Have an Anti-Takeover Effect

Provisions of our articles of incorporation and by-laws, federal banking laws, including regulatory approval requirements, and our stock purchase rights plan could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

11Risks Related to the Merger with NBT Bancorp Inc.

After the merger is completed, our shareholders will become NBT stockholders and will have different rights that may be less advantageous than their current rights.

Upon completion of the merger, our shareholders will become NBT stockholders. Differences in our certificate of incorporation and bylaws and NBT’s certificate of incorporation and bylaws will result in changes to the rights of our shareholders who become NBT stockholders.

Our shareholders will have a reduced ownership and voting interest after the merger and will exercise less influence over management of the combined organization.

Our shareholders currently have the right to vote in the election of our board of directors and on various other matters affecting our company. After the merger, our shareholders will hold a percentage ownership of the combined organization that is much smaller than such shareholder’s current percentage ownership of Alliance. Accordingly, our shareholders will have less influence on the management and policies of the combined company than they now have on the management and policies of our company.

inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of our common stock.

Item 1B. Unresolved Staff Comments

Not applicable.

Item 2. Properties

We conduct business in Upstate New York through 29 banking offices and ~~two~~ 2 administrative centers. We lease our corporate headquarters located in Syracuse, NY. Eleven banking offices and one of the administrative centers are subject to leases and/or long-term land leases. The remaining banking offices and administrative center are owned.

Item 3. Legal Proceedings

We are subject to various claims, legal proceedings and matters that arise in the ordinary course of business. In management’s opinion, no pending action, if adversely decided, would materially affect our financial condition. See Note 15 to our consolidated financial statements ~~contained~~included elsewhere in this report for additional information.

In connection with the proposed merger with NBT, three plaintiffs filed purported class action lawsuits against Alliance, Alliance’s directors and NBT. All three purported class actions were brought in the Supreme Court of the State of New York, in the County of Onondaga, or the Court, and are captioned Oughterson v. Alliance Financial Corporation, et al. (No. 2012EF73, filed October 11, 2012), Stanard v. Alliance Financial Corporation, et al. (No. 2012EF75, filed October 22, 2012) and The Wire Family Trust of 1997 v. Alliance Financial Corporation et al. (No. 2012-5950, filed November 1, 2012). By Order dated December 10, 2012, the three cases were consolidated by the Court into a single action. The lawsuits allege that the Alliance directors breached their fiduciary duties to Alliance’s shareholders by seeking to sell Alliance through an allegedly unfair process and for an unfair price and on unfair terms, by soliciting shareholder approval of the proposed transaction through a Form S-4 that was alleged to be materially misleading, and that Alliance and NBT aided and abetted that breach. The lawsuits seek, among other things, equitable relief that would enjoin the merger, damages, and attorneys’ fees and costs. The plaintiffs also seek rescission of the merger (to the extent it has already been completed at the time that the court grants any relief). The parties have reached an agreement in principle to settle these cases and entered into a memorandum of understanding on January 15, 2013. As part of this memorandum of understanding, NBT and Alliance have agreed to disclose additional information in this joint proxy statement/prospectus, including information about matters discussed between the parties during the process of negotiating the merger, as well as information about the data that was analyzed and presented to the Alliance board of directors by its financial advisor. No substantive terms of the merger agreement will be modified as part of this settlement. The settlement is subject to review and approval by the Court.

Item 4. Mine Safety Disclosures

None.

1213

PART II

Item 5. Market for the Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities

Common Stock Data

Our common stock is listed on the NASDAQ Global Market under the symbol “ALNC.” There were ~~834~~842 shareholders of record as of December 31, ~~2011~~2012. The following table presents the high and low sales price during the periods indicated, as well as dividends declared.

	2011					2010
	2012									2011
	High		~~Low~~	~~Dividend Declared~~Low		~~High~~	~~Low~~DividendDeclared		~~Dividend Declared~~	High		Low		DividendDeclared
1st Quarter	$~~33.89~~	32.85	~~$29.50~~	$~~0.30~~	28.55	~~$29.50~~	$~~26.25~~	0.31	~~$0.28~~	$	33.89	$	29.50	$	0.30
2nd Quarter	$~~33.44~~	34.46	~~$27.34~~	$~~0.30~~	29.26	~~$31.00~~	$~~26.78~~	0.31	~~$0.28~~	$	33.44	$	27.34	$	0.30
3rd Quarter	$~~32.83~~	41.85	~~$26.37~~	$~~0.31~~	33.06	~~$31.55~~	$~~27.57~~	0.32	~~$0.30~~	$	32.83	$	26.37	$	0.31
4th Quarter	$~~32.93~~	46.39	~~$27.62~~	$~~0.31~~	38.95	~~$33.40~~	$~~29.11~~	0.32	~~$0.30~~	$	32.93	$	27.62	$	0.31

Dividends

We have historically paid regular quarterly cash dividends on our common stock, and the Board of Directors presently intends to continue the payment of regular quarterly cash dividends, subject to the need for those funds for debt service and other purposes. However, because substantially all of the funds available for the payment of dividends are derived from the Bank, future dividends will depend upon the earnings of the Bank, its financial condition and its need for funds. Furthermore, there are a number of federal banking policies and regulations that restrict our ability to pay dividends. In particular, because the Bank is a depository institution whose deposits are insured by the FDIC, it may not pay dividends or distribute capital assets if it is in default on any assessment due the FDIC. Also, as a national bank, the Bank is subject to OCC regulations which impose certain minimum capital requirements that would affect the amount of cash available for distribution to us. In addition, under Federal Reserve policy, we are required to maintain adequate regulatory capital, are expected to serve as a source of financial strength to the Bank and to commit resources to support the Bank. These policies and regulations may have the effect of reducing the amount of dividends that we can declare to our shareholders.

~~Automatic~~Under ~~Dividend~~the ~~Reinvestment~~Merger ~~Plan~~Agreement, Alliance has agreed that, until the effective time of the merger or the termination of the merger agreement, Alliance and its subsidiaries will not, except as expressly permitted by the merger agreement or with the prior written consent of NBT (which consent NBT will not unreasonably withhold) declare or pay any dividend or other distribution on its capital stock other than: (a) dividends paid by wholly owned subsidiaries to Alliance or any other wholly owned subsidiary of Alliance; or (b) regular quarterly cash dividends not to exceed the rate paid during the fiscal quarter immediately preceding the date of the merger agreement.

We have an automatic dividend reinvestment plan which is administered by our transfer agent, American Stock Transfer & Trust Company. The plan offers a convenient way for shareholders to increase their investment in us by enabling them to reinvest cash dividends on all or part of their common stock in additional shares of our common stock without paying brokerage commissions or service charges. Shareholders who are interested in this program may visit the Shareholder Services section of American Stock Transfer & Trust Company’s website for more information (www.amstock.com). Shareholders may also receive a Plan Prospectus and enrollment card by calling ASTC Dividend Reinvestment at 1-800-278-4353, or writing to the following address:

Dividend Reinvestment

American Stock Transfer & Trust Company

59 Maiden Lane

New York, NY 10038

Sales of Unregistered Securities and Purchases of Equity Securities

There were no sales by us of unregistered securities during the year ended December 31, ~~2011~~2012. There were no purchases made by or on behalf of us of our common stock during the fourth quarter of ~~2011~~2012.

1314

Stock Performance Graph

The graph below matches our cumulative 5-year total shareholder return on common stock with the cumulative total returns of the Russell 3000 index and the SNL Bank NASDAQ index. The graph tracks the performance of a $100 investment in our common stock and in each of the indexes (with the reinvestment of all dividends) from 12/31/~~2006~~2007 to 12/31/~~2011~~2012.

LOGO

Alliance Financial Corporation


	*Period Ending*
*Index*	12/31/07		12/31/08		12/31/09		12/31/10		12/31/11		12/31/12
Alliance Financial Corporation		100.00		95.31		113.82		141.00		140.09		204.45
SNL Bank NASDAQ		100.00		72.62		58.91		69.51		61.67		73.51
Russell 3000		100.00		62.69		80.46		94.08		95.05		110.65

	Period Ending
Index	12/31/06		12/31/07		12/31/08		12/31/09		12/31/10		12/31/11
Alliance Financial Corporation		100.00		84.42		80.46		96.08		119.03		118.25
SNL Bank NASDAQ		100.00		78.51		57.02		46.25		54.57		48.42
Russell 3000		100.00		105.14		65.92		84.60		98.92		99.93

Item 6. Selected Financial Data

The summary information presented below at or for each of the years presented is derived in part from our consolidated financial statements. The following information is only a summary, and you should read it in conjunction with our consolidated financial statements and notes beginning on page F-1.

		(In thousands)		(In thousands)		(In thousands)		(In thousands)		(In thousands)
	Year ended December 31,
	2011		2010		2009		2008		2007
	2012		2011		2010		2009		2008
Selected Financial Condition Data		(In thousands)
	(In thousands)
Total assets		$1,409,090		$1,454,622		$1,417,244		$1,367,358		$1,307,014
Selected Financial Condition Data
Loans & leases, net of unearned income		872,721		898,537		914,162		910,755		895,533
Total assets	$	1,406,357	$	1,409,090	$	1,454,622	$	1,417,244	$	1,367,358
Allowance for credit losses		10,769		10,683		9,414		9,161		8,426
Loans & leases, net of unearned income		928,094		872,721		898,537		914,162		910,755
Securities available-for-sale		374,306		414,410		362,158		310,993		282,220
Allowance for credit losses		8,571		10,769		10,683		9,414		9,161
Goodwill		30,844		30,844		32,073		32,073		32,187
Securities available-for-sale		336,493		374,306		414,410		362,158		310,993
Intangible assets, net		7,694		8,638		10,075		11,528		13,183
Goodwill		30,844		30,844		30,844		32,073		32,073
Deposits		1,083,065		1,134,598		1,075,671		937,882		945,230
Intangible assets, net		6,827		7,694		8,638		10,075		11,528
Borrowings		136,310		142,792		172,707		238,972		200,757
Deposits		1,094,993		1,083,065		1,134,598		1,075,671		937,882
Junior subordinated obligations		25,774		25,774		25,774		25,774		25,774
Borrowings		121,169		136,310		142,792		172,707		238,972
Shareholders’ equity		143,997		133,131		123,935		144,481		115,560
Junior subordinated obligations		28,774		25,774		25,774		25,774		25,774
Common shareholders’ equity		143,997		133,131		123,935		117,563		115,560
Shareholders’ equity		146,945		143,997		133,131		123,935		144,481
Investment assets under management (Market value, not included in total assets)		$ 827,504		$ 829,426		$ 786,302		$ 726,019		$ 971,078
Common shareholders’ equity		146,945		143,997		133,131		123,935		117,563
Investment assets under management (Market value, not included in total assets)	$	881,326	$	827,504	$	829,426	$	786,302	$	726,019

		(In thousands)			(In thousands)			(In thousands)			(In thousands)			(In thousands)
	Year ended December 31,
	2011			2010			2009			2008			2007
	2012			2011			2010			2009			2008
	(In thousands, except share and per share data)
Selected Operating Data
Interest income	$	~~$55~~48,~~759~~251		$	~~$60~~55,~~342~~759		$	~~$63~~60,~~962~~342		$	~~$67~~63,~~964~~962		$	~~$71~~67,~~032~~964
Interest expense		128,~~459~~805			1612,~~053~~459			2016,~~581~~053			3020,~~267~~581			3830,~~550~~267
Net interest income		4339,~~300~~446			4443,~~289~~300			4344,~~381~~289			3743,~~697~~381			3237,~~482~~697
Provision for credit losses		~~1,910~~(300	)		41,~~085~~910			64,~~100~~085			56,~~502~~100			35,~~790~~502
Net interest income after provision for credit losses		4139,~~390~~746			4041,~~204~~390			3740,~~281~~204			3237,~~195~~281			2832,~~692~~195
Non-interest income		2018,~~002~~851			20,~~505~~002			20,~~811~~505			20,~~360~~811			2120,~~292~~360
Total operating income		6158,~~392~~597			6061,~~709~~392			5860,~~092~~709			5258,~~555~~092			4952,~~984~~555
Non-interest expense		4346,~~581~~442			4443,~~480~~581			4344,~~208~~480			3943,~~378~~208			3739,~~638~~378
Income before taxes		1712,~~811~~155			1617,~~229~~811			1416,~~884~~229			1314,~~177~~884			1213,~~346~~177
Income tax expense		42,~~514~~967			4,~~605~~514			34,~~436~~605			23,~~820~~436			2,~~869~~820
Net income	$	~~$13~~9,~~297~~188		$	~~$11~~13,~~624~~297		$	$11,~~448~~624		$	~~$10~~11,~~357~~448		$	~~$ 9~~10,~~477~~357
Dividends and accretion of discount on preferred stock		—			—			~~1,084~~—			471,084			—47
Net income available to common shareholders	$	~~$13~~9,~~297~~188		$	~~$11~~13,~~624~~297		$	~~$10~~11,~~364~~624		$	$10,~~310~~364		$	$910,~~477~~310
Stock and Per Share Data
Basic earnings per common share	$	~~$ 2~~1.8092		$	$ 2.4980		$	$ 2.2549		$	$ 2.2325		$	~~$ 1~~2.9823
Diluted earnings per common share	$	~~$ 2~~1.8092		$	$ 2.4880		$	$ 2.2448		$	$ 2.2124		$	~~$ 1~~2.9621
Basic weighted average common shares outstanding		4,~~670~~701,~~052~~687			4,~~619~~670,~~718~~052			4,~~514~~619,~~268~~718			4,~~542~~514,~~957~~268			4,~~710~~542,~~530~~957
Diluted weighted average common shares outstanding		4,~~675~~701,~~212~~687			4,~~640~~675,~~096~~212			4,~~543~~640,~~069~~096			4,~~565~~543,~~709~~069			4,~~754~~565,~~045~~709
Cash dividends declared	$	$ 1.2226		$	$ 1.1622		$	$ 1.0816		$	$ 1.0008		$	~~$ 0~~1.9000
Dividend payout ratio(1)		4365.6%	%		4643.8%6	%		4846.2%8	%		4448.6%2	%		4544.5%6	%
Common book value	$	$ 30.1973		$	~~$ 28~~30.1519		$	~~$ 26~~28.8615		$	~~$ 25~~26.6786		$	~~$ 24~~25.5367
Tangible common book value(2)	$	$ 22.1185		$	~~$ 19~~22.8011		$	~~$ 17~~19.7280		$	~~$ 16~~17.1572		$	~~$ 14~~16.9015

1516

	Year ended December 31,
Selected Financial and Other Data(3)	2011			2010			2009			2008			2007
	2012			2011			2010			2009			2008
Selected Financial and Other Data(3)
Performance Ratios
Return on average assets		0.~~92%~~65	%		0.~~81%~~92	%		0.81%	%		0.~~78%~~81	%		0.~~74%~~78	%
Return on average equity		96.~~88%~~40	%		9.~~17%~~88	%		89.~~68%~~17	%		8.~~77%~~68	%		8.~~48%~~77	%
Return on average common equity		96.~~88%~~40	%		9.~~17%~~88	%		89.~~46%~~17	%		8.~~80%~~46	%		8.~~48%~~80	%
Return on average tangible common equity		138.~~91%~~71	%		13.~~64%~~91	%		13.~~02%~~64	%		1413.~~19%~~02	%		14.~~77%~~19	%
Non-interest income to total income(4)		3032.~~14%~~34	%		30.~~44%~~10	%		30.~~06%~~44	%		3430.~~86%~~06	%		3934.~~29%~~86	%
Efficiency ratio(5)		7079.~~32%~~66	%		6970.~~86%~~35	%		69.~~66%~~86	%		6869.~~04%~~66	%		7068.~~35%~~04	%
Rate/Yield Information
Yield on interest-earning assets (tax equivalent)		43.~~37%~~89	%		4.~~78%~~37	%		54.~~15%~~78	%		5.~~88%~~15	%		65.~~36%~~88	%
Cost of interest-bearing liabilities		10.~~11%~~83	%		1.~~42%~~11	%		1.~~85%~~42	%		21.~~87%~~85	%		32.~~78%~~87	%
Net interest rate spread		3.~~26%~~06	%		3.~~36%~~26	%		3.~~30%~~36	%		3.~~01%~~30	%		23.~~58%~~01	%
Net interest margin (tax equivalent)(6)		3.~~43%~~21	%		3.~~55%~~43	%		3.55%	%		3.~~35%~~55	%		3.~~02%~~35	%

	At or for the Year Ended December 31,
	At or for the Year ended December 31,
	2011			2010			2009			2008			2007
	2012			2011			2010			2009			2008
Asset Quality Ratios
Nonperforming loans and leases to total loans and leases		10.~~30%~~52	%		01.~~95%~~30	%		0.~~94%~~95	%		0.~~49%~~94	%		0.~~75%~~49	%
Nonperforming assets to total assets		0.~~84%~~39	%		0.~~63%~~84	%		0.~~64%~~63	%		0.~~38%~~64	%		0.~~53%~~38	%
Allowance for credit losses to nonperforming loans and leases		95178.4%	%		~~125~~95.8%4	%		~~109~~125.7%8	%		~~204~~109.6%7	%		~~125~~204.7%6	%
Allowance for credit losses to total loans and leases		10.~~24%~~93	%		1.~~19%~~24	%		1.~~03%~~19	%		1.~~01%~~03	%		01.~~94%~~01	%
Net charge-offs to average loans and leases		0.21%	%		0.~~31%~~21	%		0.~~63%~~31	%		0.~~53%~~63	%		0.~~27%~~53	%
Equity Ratios
Total common shareholders’ equity to total assets		10.~~22%~~45	%		910.~~15%~~22	%		89.~~74%~~15	%		8.~~60%~~74	%		8.~~84%~~60	%
Tangible common equity to tangible assets(8)		7.69%			6.62%			5.95%			5.59%			5.56%
Tangible common equity to tangible assets(7)		7.98	%		7.69	%		6.62	%		5.95	%		5.59	%
Regulatory Ratios
Consolidated:
Tier 1 (core) capital		9.~~09%~~37	%		89.~~28%~~09	%		78.~~55%~~28	%		97.~~59%~~55	%		79.~~53%~~59	%
Tier 1 risk-based capital		14.~~72%~~32	%		1314.~~43%~~72	%		1213.~~07%~~43	%		1412.~~05%~~07	%		1014.~~64%~~05	%
Tier 1 risk based common capital(7)		11.81%			10.56%			9.22%			11.24%			8.76%
Tier 1 risk based common capital(8)		11.58	%		11.81	%		10.56	%		9.22	%		11.24	%
Total risk-based capital		15.~~97%~~27	%		1415.~~65%~~97	%		~~13.~~14%.65	%		1513.~~08%~~14	%		1115.~~59%~~08	%
Bank:
Tier 1 (core) capital		8.~~50%~~91	%		78.~~72%~~50	%		7.~~14%~~72	%		87.~~97%~~14	%		78.~~26%~~97	%
Tier 1 risk-based capital		13.~~80%~~65	%		1213.~~56%~~80	%		1112.~~47%~~56	%		1311.~~15%~~47	%		1013.~~34%~~15	%
Total risk-based capital		1514.~~05%~~60	%		1315.~~79%~~05	%		1213.~~55%~~79	%		1412.~~19%~~55	%		1114.~~30%~~19	%

(1) Cash dividends declared per common share divided by diluted earnings per share.

(2)	Common shareholders’ equity less goodwill and intangible assets divided by common shares outstanding.

(3)	Averages presented are daily averages.

(4)	Non-interest income (net of realized gains and losses on securities and non-recurring items) divided by the sum of net interest income and non-interest income (net of realized gains and losses on securities and non-recurring items).

(5)	Non-interest expense divided by the sum of net interest income and non-interest income (net of realized gains and losses on securities and non-recurring items).

(6)	Tax equivalent net interest income divided by average interest-earning assets.

(7) Tier 1 capital excluding junior subordinated obligations issued to unconsolidated trusts divided by total risk-adjusted assets.

(8) We use certain non-GAAP U.S. generally accepted accounting principles or GAAP financial measures, such as the Tangible Common Equity to Tangible Assets ratio (TCE), to provide information for investors to effectively analyze financial trends of ongoing business activities, and to enhance comparability with peers across the financial sector. We believe TCE is useful because it is a measure utilized by regulators, market analysts and investors in evaluating a company’s financial condition and capital strength. TCE, as defined by us, represents common equity less goodwill and intangible assets. A reconciliation from our GAAP Total Equity to Total Assets ratio to the Non-GAAP Tangible Common Equity to Tangible Assets ratio is presented below (dollars in thousands):

	Year ended December 31,
	2011		2010		2009		2008		2007
Total assets		$1,409,090		$1,454,622		$1,417,244		$1,367,358		$1,307,014
Less: Goodwill and intangible assets, net		38,538		39,482		42,148		43,601		45,370
Tangible assets (non-GAAP)		1,370,552		1,415,140		1,375,096		1,323,757		1,261,644
Total Common Equity		143,997		133,131		123,935		117,563		115,560
Less: Goodwill and intangible assets, net		38,538		39,482		42,148		43,601		45,370
Tangible Common Equity (non-GAAP)		105,459		93,649		81,787		73,962		70,190
Total Equity/Total Assets		10.22%		9.15%		8.74%		8.60%		8.84%
Tangible Common Equity/Tangible Assets (non-GAAP)		7.69%		6.62%		5.95%		5.59%		5.56%

~~Summarized~~(7) ~~quarterly~~We use certain non-GAAP U.S. generally accepted accounting principles or GAAP financial measures, such as the Tangible Common Equity to Tangible Assets ratio (TCE), to provide information for investors to effectively analyze financial trends of ongoing business activities, and to enhance comparability with peers across the ~~years~~financial ~~ended~~sector. ~~December 31~~We believe TCE is useful because it is a measure utilized by regulators, ~~2011~~market analysts and ~~2010~~ isinvestors in evaluating a company’s financial condition and capital strength. TCE, as ~~follows:~~defined by us, represents common equity less goodwill and intangible assets. The following table presents a reconciliation from our GAAP Total Equity to Total Assets ratio to the Non-GAAP Tangible Common Equity to Tangible Assets ratio (dollars in thousands):

		Year ended			Year ended			Year ended			Year ended			Year ended
	Year ended December 31,
	Year ended			Three months ended
	2012			2011			2010			2009			2008
	12/31/11			12/31/11			9/30/11			6/30/11			3/31/11
Total assets	$	1,406,357		$	1,409,090		$	1,454,622		$	1,417,244		$	1,367,358
				(Dollars in thousands, except share and per share data)
Less: Goodwill and intangible assets, net		37,671			38,538			39,482			42,148			43,601
Total interest income		$55,759			$12,942			$14,061			$14,494			$14,262
Tangible assets (non-GAAP)		1,368,686			1,370,552			1,415,140			1,375,096			1,323,757
Total interest expense		12,459			2,928			3,064			3,188			3,279
Total Common Equity		146,945			143,997			133,131			123,935			117,563
Net interest income		43,300			10,014			10,997			11,306			10,983
Less: Goodwill and intangible assets, net		37,671			38,538			39,482			42,148			43,601
Provision for credit losses		1,910			800			750			160			200
Tangible Common Equity (non-GAAP)		109,274			105,459			93,649			81,787			73,962
Non-interest income		20,002			5,062			5,919			4,435			4,586
Total Equity/Total Assets		10.45	%		10.22	%		9.15	%		8.74	%		8.60	%
Non-interest expense		43,581			10,640			11,139			10,823			10,979
Tangible Common Equity/Tangible Assets (non-GAAP)		7.98	%		7.69	%		6.62	%		5.95	%		5.59	%
Income before income taxes		17,811			3,636			5,027			4,758			4,390
Income tax expense		4,514			791			1,360			1,279			1,084
Net Income		$13,297			$2,845			$3,667			$3,479			$3,306
Net Income available to common shareholders		$13,297			$2,845			$3,667			$3,479			$3,306
Basic earnings per share		$2.80			$0.60			$0.77			$0.73			$0.70
Diluted earnings per share		$2.80			$0.60			$0.77			$0.73			$0.70
Basic weighted average shares outstanding		4,670,052			4,687,802			4,667,355			4,662,752			4,662,044
Diluted weighted average shares outstanding		4,675,212			4,689,427			4,673,908			4,670,530			4,670,674
Cash dividends declared per share		$1.22			$0.31			$0.31			$0.30			$0.30
Net interest margin (tax equivalent)		3.43%			3.24%			3.48%			3.53%			3.44%
Return on average assets		0.92%			0.80%			1.01%			0.95%			0.90%
Return on average equity		9.88%			8.19%			10.69%			10.45%			10.27%
Return on average tangible common equity		13.91%			11.34%			14.91%			14.80%			14.80%
Non-interest income to total income		30.10%			33.58%			29.47%			28.17%			29.46%
Efficiency ratio		70.35%			70.58%			71.45%			68.76%			70.52%

		Year ended		Year ended		Year ended		Year ended		Year ended
	Year ended		Three months ended
	12/31/10		12/31/10		9/30/10		6/30/10		3/31/10
			(Dollars in thousands, except share and per share data)
Total interest income		$60,342		$14,406		$15,102		$15,378		$15,456
Total interest expense		16,053		3,588		3,942		4,188		4,335
Net interest income		44,289		10,818		11,160		11,190		11,121
Provision for credit losses		4,085		800		1,095		1,095		1,095
Non-interest income		20,505		5,946		5,139		4,859		4,561
Non-interest expense		44,480		11,346		11,210		10,963		10,961
Income before income taxes		16,229		4,618		3,994		3,991		3,626
Income tax expense		4,605		1,825		904		999		877
Net Income		$11,624		$ 2,793		$ 3,090		$ 2,992		$ 2,749
Net Income available to common shareholders		$11,624		$ 2,793		$ 3,090		$ 2,992		$ 2,749
Basic earnings per share		$ 2.49		$ 0.59		$ 0.66		$ 0.64		$ 0.59
Diluted earnings per share		$ 2.48		$ 0.59		$ 0.66		$ 0.64		$ 0.59
Basic weighted average shares outstanding		4,619,718		4,646,934		4,624,819		4,622,660		4,583,617
Diluted weighted average shares outstanding		4,640,097		4,660,463		4,646,889		4,643,679		4,614,060
Cash dividends declared per share		$ 1.16		$ 0.30		$ 0.30		$ 0.28		$ 0.28
Net interest margin (tax equivalent)		3.55%		3.45%		3.57%		3.56%		3.61%
Return on average assets		0.81%		0.77%		0.86%		0.83%		0.77%
Return on average equity		9.17%		8.59%		9.57%		9.62%		8.93%
Return on average tangible common equity		13.64%		12.51%		14.09%		14.48%		13.55%
Non-interest income to total income		30.44%		32.17%		30.21%		30.28%		29.08%
Efficiency ratio		69.86%		71.14%		70.10%		68.31%		69.90%

(8)	Tier 1 capital excluding junior subordinated obligations issued to unconsolidated trusts divided by total risk-adjusted assets

Summarized quarterly financial information for the years ended December 31, 2012 and 2011 is as follows:


	Year ended			Three months ended
	12/31/12			12/31/12			9/30/12			6/30/12			3/31/12
				(Dollars in thousands, except share and per share data)
Total interest income	$	48,251		$	11,592		$	11,979		$	12,217		$	12,463
Total interest expense		8,805			1,946			2,025			2,212			2,622

Net interest income		39,446			9,646			9,954			10,005			9,841
Provision for credit losses		(300	)		—			—			(300	)		—
Non-interest income		18,851			5,267			4,584			4,524			4,476
Non-interest expense		46,442			12,825			11,713			11,016			10,888

Income before income taxes		12,155			2,088			2,825			3,813			3,429
Income tax expense		2,967			742			540			895			790

Net Income	$	9,188		$	1,346		$	2,285		$	2,918		$	2,639


Basic earnings per common share	$	1.92		$	0.28		$	0.48		$	0.61		$	0.55
Diluted earnings per common share	$	1.92		$	0.28		$	0.48		$	0.61		$	0.55
Basic weighted average shares outstanding		4,701,687			4,704,855			4,702,294			4,700,992			4,698,567
Diluted weighted average shares outstanding		4,701,687			4,704,855			4,702,294			4,700,992			4,698,567
Cash dividends declared per common share	$	1.26		$	0.32		$	0.32		$	0.31		$	0.31
Net interest margin (tax equivalent)		3.21	%		3.12	%		3.23	%		3.26	%		3.22	%
Return on average assets		0.65	%		0.38	%		0.64	%		0.82	%		0.74	%
Return on average equity		6.40	%		3.66	%		6.32	%		8.21	%		7.51	%
Return on average tangible common equity		8.71	%		4.93	%		8.57	%		11.22	%		10.33	%
Non-interest income to total income		32.34	%		35.32	%		31.54	%		31.14	%		31.26	%
Efficiency ratio		79.66	%		86.00	%		80.56	%		75.52	%		76.05	%


	Year ended			Three months ended
	12/31/11			12/31/11			9/30/11			6/30/11			3/31/11
				(Dollars in thousands, except share and per share data)
Total interest income	$	55,759		$	12,942		$	14,061		$	14,494		$	14,262
Total interest expense		12,459			2,928			3,064			3,188			3,279

Net interest income		43,300			10,014			10,997			11,306			10,983
Provision for credit losses		1,910			800			750			160			200
Non-interest income		20,002			5,062			5,919			4,435			4,586
Non-interest expense		43,581			10,640			11,139			10,823			10,979

Income before income taxes		17,811			3,636			5,027			4,758			4,390
Income tax expense		4,514			791			1,360			1,279			1,084

Net Income	$	13,297		$	2,845		$	3,667		$	3,479		$	3,306


Basic earnings per common share	$	2.80		$	0.60		$	0.77		$	0.73		$	0.70
Diluted earnings per common share	$	2.80		$	0.60		$	0.77		$	0.73		$	0.70
Basic weighted average shares outstanding		4,670,052			4,687,802			4,667,355			4,662,752			4,662,044
Diluted weighted average shares outstanding		4,675,212			4,689,427			4,673,908			4,670,530			4,670,674
Cash dividends declared per share	$	1.22		$	0.31		$	0.31		$	0.30		$	0.30
Net interest margin (tax equivalent)		3.43	%		3.24	%		3.48	%		3.53	%		3.44	%
Return on average assets		0.92	%		0.80	%		1.01	%		0.95	%		0.90	%
Return on average equity		9.88	%		8.19	%		10.69	%		10.45	%		10.27	%
Return on average tangible common equity		13.91	%		11.34	%		14.91	%		14.80	%		14.80	%
Non-interest income to total income		30.10	%		33.58	%		29.47	%		28.17	%		29.46	%
Efficiency ratio		70.35	%		70.58	%		71.45	%		68.76	%		70.52	%

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

~~2011~~2012 Highlights and Overview

Our results of operations are dependent primarily on net interest income, which is the difference between the income earned on our loans and leases and securities and our cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the provision for credit losses, securities and loan sale activities, loan servicing activities, service charges and fees collected on our deposit accounts, income collected from trust and investment advisory services and the income earned on our investment in bank-owned life insurance. Our expenses primarily consist of salaries and employee benefits, occupancy and equipment expense, marketing expense, professional services, technology expense, amortization of intangible assets, other expense and income tax expense. Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, inflation, government policies and the actions of regulatory authorities.

The following is a summary of key financial results for the year ended December 31, ~~2011~~2012:

—• AtTotal ~~December 31, 2011, total~~ assets were $1.4 billion and total deposits were $1.1 billion at December 31, 2012 and December 31, 2011.

—• Net income was $9.2 million in 2012, compared with $13.3 million in 2011,. ~~compared~~After-tax tomerger related expenses were $112.60 million in ~~2010~~2012.

—• Net income per diluted common share was $21.8092 in ~~2011,~~2012 compared with $2.4880 in ~~2010~~2011. After-tax merger related expenses were $0.43 per diluted common share in 2012.

—• Net interest income was $4339.34 million in ~~2011~~2012, compared towith $4443.3 million in ~~2010~~2011.

—• The tax-equivalent net interest margin was 3.4321% in ~~2011~~2012 ~~and~~compared with 3.5543% in ~~2010~~2011.

—• ~~Provision~~A negative provision for credit losses ~~was~~of $~~1.9~~300,000 ~~million~~was recorded in ~~2011~~2012, compared towith provision expense of $4.1.9 million in ~~2010~~2011.

—• Total ~~nonperforming~~non-performing assets were $115.75 million or 0.8339% of total assets at December 31, ~~2011~~2012 compared with $911.18 million, or 0.6384% at December 31, ~~2010~~2011.

—• Non-interest income, excluding securities gains, was 3032.13% of total revenue in ~~2011~~2012 compared with 30.41% in ~~2010~~2011.

—• Our efficiency ratio was 7079.37% in ~~2011~~2012 compared with 6970.4% in 2011. Excluding merger related expenses, our efficiency ratio was 73.9% in ~~2010~~2012.

~~The~~On ~~following~~October 8, ~~discussion~~2012, iswe ~~intended~~reported tothat ~~assist~~we inentered ~~understanding~~into ~~our~~a ~~financial~~definitive ~~condition~~Merger ~~and~~Agreement ~~results~~with NBT. Under the terms of ~~operations~~the Merger Agreement, NBT will acquire us for approximately $233.4 ~~This~~million ~~discussion~~based ~~should~~on the 5-day average closing price of NBT’s common stock for the period ended October 5, 2012, and we will merge with and into NBT, with NBT being the surviving becorporation ~~read~~(the in“Merger”). ~~conjunction~~Immediately following the Merger, the Bank will be merged with ~~our~~and ~~consolidated~~into ~~financial~~NBT’s ~~statements~~subsidiary bank, NBT Bank and ~~accompanying~~NBT ~~notes~~Bank ~~contained~~will ~~elsewhere~~continue as the surviving bank. Merger related expenses in ~~this~~non-interest ~~report~~expense totaled $3.4 million in 2012 and included $2.7 million for professional fees and $676,000 for personnel related accrual for estimated retention awards. The NBT stockholders voted to approve the Merger Agreement on March 5, 2013, and our shareholders voted to approve the Merger Agreement on March 7, 2013. The Merger is scheduled to be completed on March 8, 2013.

19The following discussion is intended to assist in understanding our financial condition and results of operations. This discussion should be read in conjunction with our consolidated financial statements and accompanying notes included elsewhere in this report.

Average Balance Sheet

The following table sets forth information concerning average interest-earning assets and interest-bearing liabilities and the yields and rates thereon. Interest income and yield information is adjusted for items exempt from federal income taxes and assumes a 34% tax rate. Non-accrual loans have been included in the average balances. Securities are shown at average amortized cost.

	Years ended December 31,
	2011								2010								2009
	2012								2011								2010
	Avg. Balance			Amt. ofInterest		Avg. Yield/ Rate			Avg. Balance			Amt. of Interest		Avg. Yield/ Rate			Avg. Balance			Amt. of Interest		Avg. Yield/ Rate
	Avg.Balance			Amt. ofInterest		Avg.Yield/Rate			Avg.Balance			Amt. ofInterest		Avg.Yield/Rate			Avg.Balance			Amt. ofInterest		Avg.Yield/Rate
	(Dollars in thousands)
Assets:
Interest-earning assets:
Federal funds sold	$	1553,~~890~~325		$	22136		0.1425	%	$	815,~~823~~890		$	822		0.1014	%	$	138,~~084~~823		$	158		0.1110	%
Taxable investment securities		~~342~~266,~~781~~353			106,~~470~~307		32.0437	%		~~314~~342,~~271~~781			10,~~795~~470		3.4304	%		~~256~~314,~~494~~271			10,~~143~~795		3.9543	%
Nontaxable investment securities		7972,~~785~~286			43,~~480~~991		5.6252	%		7479,~~456~~785			4,~~352~~480		5.8462	%		8574,~~173~~456			54,~~172~~352		65.0784	%
FHLB and FRB stock		8,~~842~~067			~~433~~402		4.9099	%		98,~~005~~842			~~499~~433		54.5490	%		109,~~875~~005			~~558~~499		5.1354	%
Residential real estate loans		~~329~~322,~~773~~438			1715,~~108~~751		54.1988	%		~~351~~329,~~922~~773			1817,~~731~~108		5.3219	%		~~344~~351,~~707~~922			1918,~~087~~731		5.5432	%
Commercial loans		~~243~~133,~~871~~946			115,~~868~~667		4.8723	%		~~209~~124,~~574~~464			115,~~084~~414		54.2935	%		~~202~~105,~~020~~424			114,~~221~~933		54.5568	%
Non-taxable commercial loans		9,197			492		5.35	%		8,639			478		5.53	%		9,449			570		6.03	%
Commercial real estate loans		128,274			6,639		5.18	%		119,407			6,454		5.41	%		104,150			6,151		5.91	%
Taxable leases (net of unearned income)		21,455			1,272		5.93	%		39,978			2,384		5.96	%		68,334			4,068		5.95	%
Non-taxable commercial loans		12,161			688		5.66	%		9,197			492		5.35	%		8,639			478		5.53	%
Nontaxable leases (net of unearned income)		11,685			752		6.44	%		13,908			900		6.47	%		16,472			1,069		6.49	%
Taxable leases (net of unearned income)		6,503			400		4.15	%		21,455			1,272		5.93	%		39,978			2,384		5.96	%
Indirect auto loans		165,880			7,214		4.35	%		182,085			9,194		5.05	%		187,919			10,339		5.50	%
Nontaxable leases (net of unearned income)		8,884			574		6.46	%		11,685			752		6.44	%		13,908			900		6.47	%
Consumer loans		90,621			3,594		3.97	%		91,389			3,865		4.23	%		91,387			4,036		4.42	%
Indirect auto loans		184,511			6,163		3.34	%		165,880			7,214		4.35	%		182,085			9,194		5.05	%
Total interest-earning assets		1,319,780			57,705		4.37	%		1,304,050			62,290		4.78	%		1,285,914			66,278		5.15	%
Consumer loans		88,490			3,319		3.75	%		90,621			3,594		3.97	%		91,389			3,865		4.23	%
Total interest-earning assets		1,285,238			50,037		3.89	%		1,319,780			57,705		4.37	%		1,304,050			62,290		4.78	%
Non-interest-earning assets:
Other assets		~~132~~135,~~816~~342								~~137~~132,~~803~~816								~~136~~137,~~512~~803
Allowance for credit losses		(109,~~933)~~357	)							(10,~~370)~~933	)							(910,~~990)~~370	)
Net unrealized gains on available-for-sale securities		1011,~~532~~732								910,~~610~~532								69,~~912~~610
Total	$	1,~~452~~422,~~195~~955							$	1,~~441~~452,~~093~~195							$	1,~~419~~441,~~348~~093
Liabilities & Shareholders’ Equity:
Demand deposits	$	~~147~~153,~~236~~960		$	~~225~~127		0.1508	%	$	~~141~~147,~~124~~236		$	~~490~~225		0.3515	%	$	~~117~~141,~~113~~124		$	~~531~~490		0.4535	%
Savings deposits		~~106~~113,~~279~~961			~~210~~123		0.2011	%		99106,~~799~~279			~~377~~210		0.3820	%		9299,~~114~~799			~~454~~377		0.4938	%
MMDA deposits		~~364~~366,~~800~~292			1,~~609~~038		0.4428	%		~~357~~364,~~572~~800			21,~~675~~609		0.7544	%		~~303~~357,~~344~~572			32,~~347~~675		10.1075	%
Time deposits		~~333~~269,~~138~~363			53,~~673~~564		1.7032	%		~~359~~333,~~532~~138			75,~~216~~673		21.0170	%		~~382~~359,~~420~~532			97,~~622~~216		2.5201	%
Total interest-bearing deposits		~~951~~903,~~453~~576			74,~~717~~852		0.8154	%		~~958~~951,~~027~~453			107,~~758~~717		10.1381	%		~~894~~958,~~991~~027			1310,~~954~~758		1.5613	%
Borrowings		~~143~~127,~~439~~941			43,~~104~~275		2.8656	%		~~146~~143,~~296~~439			4,~~650~~104		32.1886	%		~~193~~146,~~648~~296			54,~~819~~650		3.0118	%
Junior subordinated obligations issued to unconsolidated subsidiary trusts		25,774			~~638~~678		2.4763	%		25,774			~~645~~638		2.~~50%~~47	%		25,774			~~808~~645		32.1350	%
Total interest-bearing liabilities		1,~~120~~057,~~666~~291			128,~~459~~805		10.1183	%		1,~~130~~120,~~097~~666			1612,~~053~~459		1.~~42%~~11	%		1,~~114~~130,~~413~~097			2016,~~581~~053		1.8542	%
Non-interest-bearing liabilities:
Demand deposits		~~181~~205,~~039~~532								~~167~~181,~~912~~039								~~156~~167,~~396~~912
Other liabilities		1516,~~917~~517								1615,~~383~~917								16,~~685~~383
Shareholders’ equity		~~134~~143,~~573~~615								~~126~~134,~~701~~573								~~131~~126,~~854~~701
Total	$	1,~~452~~422,~~195~~955							$	1,~~441~~452,~~093~~195							$	1,~~419~~441,~~348~~093
Net interest income (tax equivalent)				$	4541,~~246~~232							$	4645,~~237~~246							$	4546,~~697~~237
Net interest rate spread							3.2606	%							3.~~36%~~26	%							3.3036	%
Net interest margin (tax equivalent)							3.4321	%							3.~~55%~~43	%							3.55	%
Federal tax exemption on nontaxable investment securities, loans and leases included in interest income					1,~~946~~786								1,~~948~~946								21,~~316~~948
Net interest income				$	4339,~~300~~446							$	4443,~~289~~300							$	4344,~~381~~289

2021

Rate/Volume Analysis

The following table sets forth the dollar volume of increase (decrease) in interest income and interest expense resulting from changes in the volume of interest-earning assets and interest-bearing liabilities, and from changes in rates. Volume changes are computed by multiplying the volume difference by the prior year’s rate. Rate changes are computed by multiplying the rate difference by the prior year’s volume. The change in interest due to both rate and volume has been allocated proportionally between the volume and rate variances.

	2011 Compared to 2010									2010 Compared to 2009
	2012 Compared to 2011									2011 Compared to 2010
	Increase (decrease) due to									Increase (decrease) due to
	Volume			Rate			~~Net Change~~NetChange			Volume			Rate			~~Net Change~~NetChange
	(In thousands)
Federal funds sold	$	~~$ 8~~85		$	~~$ 6~~29		$	~~$ 14~~114		$	~~$ (5)~~8		$	~~$ (2)~~6		$	~~$ (7)~~14
Taxable investment securities		~~944~~(2,094	)		(12,~~269)~~069	)		(~~325)~~4,163	)		~~2,095~~944			(1,~~443)~~269	)		~~652~~(325	)
Non-taxable investment securities		~~298~~(411	)		(~~170)~~78	)		~~128~~(489	)		~~(630)~~298			(~~190)~~170	)		~~(820)~~128
FHLB and FRB stock		(9)39	)		~~(57)~~8			(~~66)~~31	)		(~~101)~~9	)		42(57	)		(~~59)~~66	)
Residential real estate loans		(~~1,169)~~368	)		(~~454)~~989	)		(1,~~623)~~357	)		~~401~~(1,169	)		(~~757)~~454	)		(~~356)~~1,623	)
Commercial loans		~~1,713~~405			(~~929)~~152	)		~~784~~253			~~405~~846			(~~542)~~365	)		~~(137)~~481
Non-taxable commercial loans		30			(16)			14			(47)			(45)			(92)
Commercial real estate loans		467			(282	)		185			852			(549	)		303
Taxable leases (net of unearned income)		(1,100)			(12)			(1,112)			(1,691)			7			(1,684)
Non-taxable commercial loans		166			30			196			30			(16	)		14
Non-taxable leases (net of unearned income)		(144)			(4)			(148)			(166)			(3)			(169)
Taxable leases (net of unearned income)		(918	)		46			(872	)		(1,100	)		(12	)		(1,112	)
Indirect loans		(774)			(1,206)			(1,980)			(315)			(830)			(1,145)
Non-taxable leases (net of unearned income)		(180	)		2			(178	)		(144	)		(4	)		(148	)
Consumer loans		(33)			(238)			(271)			—			(171)			(171)
Indirect loans		750			(1,801	)		(1,051	)		(774	)		(1,206	)		(1,980	)
Total interest-earning assets		(236)			(4,349)			(4,585)			(54)			(3,934)			(3,988)
Consumer loans		(82	)		(193	)		(275	)		(33	)		(238	)		(271	)
Interest-bearing demand deposits		21			(286)			(265)			93			(134)			(41)
Total interest-earning assets		(2,219	)		(5,449	)		(7,668	)		(251	)		(4,334	)		(4,585	)
Savings deposits		23			(190)			(167)			34			(111)			(77)
Interest-bearing demand deposits		10			(108	)		(98	)		21			(286	)		(265	)
MMDA deposits		54			(1,120)			(1,066)			522			(1,194)			(672)
Savings deposits		14			(101	)		(87	)		23			(190	)		(167	)
Time deposits		(498)			(1,045)			(1,543)			(549)			(1,857)			(2,406)
MMDA deposits		7			(578	)		(571	)		54			(1,120	)		(1,066	)
Borrowings		(89)			(457)			(546)			(1,485)			316			(1,169)
Time deposits		(973	)		(1,136	)		(2,109	)		(498	)		(1,045	)		(1,543	)
Junior subordinated obligations issued to unconsolidated subsidiary trusts		—			(7)			(7)			—			(163)			(163)
Borrowings		(420	)		(409	)		(829	)		(89	)		(457	)		(546	)
Total interest-bearing liabilities		(489)			(3,105)			(3,594)			(1,385)			(3,143)			(4,528)
Junior subordinated obligations issued to unconsolidated subsidiary trusts		—			40			40			—			(7	)		(7	)
Net interest income (tax equivalent)		$ 253			$(1,244)			$ (991)			$ 1,331			$ (791)			$ 540
Total interest-bearing liabilities		(1,362	)		(2,292	)		(3,654	)		(489	)		(3,105	)		(3,594	)
Net interest income (tax equivalent)	$	(857	)	$	(3,157	)	$	(4,014	)	$	238		$	(1,229	)	$	(991	)

Comparison of Operating Results for the Years Ended December 31, ~~2011~~2012 and ~~2010~~2011

General

Net income was $139.32 million or $21.8092 per diluted common share for the year ended December 31, ~~2011~~2012, compared with $1113.63 million or $2.4880 per diluted common share in ~~2010~~2011. ~~The~~Expenses ~~increase~~related into ~~net~~our ~~income~~pending inmerger ~~2011~~with ~~resulted~~NBT ~~from~~totaled a $2.20 million ~~decline~~after intax ~~the~~or ~~provision~~$0.43 ~~for~~per ~~credit~~share ~~losses~~in ~~and~~2012. anThe ~~$899,000~~return ~~decrease~~on inaverage ~~non-interest~~assets ~~expenses~~and ~~partially~~return ~~offset~~on byaverage ashareholders’ ~~$989~~equity were 0.65% and 6.40%,~~000~~ ~~decrease~~respectively, in ~~net~~2012, ~~interest~~compared ~~income~~with 0.92% and a9.88%, ~~$503~~respectively,~~000~~ ~~decrease~~ in ~~non-interest income~~2011.

Net interest income decreased $3.9 million in 2012 compared with 2011 due to the continuing pressure on our net interest margin caused by the exceptionally low interest rate environment.

Net Interest Income

Net interest income totaled $4339.34 million in ~~2011~~2012, which was a decrease of $~~989,000~~3.9 million or 28.29% compared with $4443.3 million in ~~2010~~2011. The decrease in net-interest income resulted from a decline in the net interest margin ~~partially~~and ~~offset~~a byslight andecrease ~~increase~~ in average interest-earning assets in 2012.

Average interest-earning assets ~~increased~~were $141.43 ~~million~~billion in ~~2011~~2012, ~~compared~~which ~~with~~was ~~2010,~~a ~~with~~decrease aof $3334.85 million ~~increase~~compared inwith ~~securities offsetting~~2011. aAn $2585.0 8 million decrease in ~~loans~~securities ~~and leases. The tax-equivalent net interest margin~~ was ~~3.43% in 2011, compared to 3.55% in 2010. The tax-equivalent yield on interest-earning assets decreased 40 basis points in 2011 compared to 2010, which was~~ partially offset by a ~~31 basis point decrease in our cost of interest-bearing liabilities over the same period~~$12.7 ~~The~~million ~~tax-equivalent~~increase ~~yield on our interest-earning assets was 4.37%~~ in ~~2011,~~loans ~~compared~~and ~~to 4~~leases.~~78%~~ ~~in 2010. Our cost of interest-bearing liabilities was 1.11% in 2011, compared to 1.42% in 2010.~~

Between September 2007 and December 2008, the Federal Reserve reduced its target fed funds rate from 5.25% to between zero and 0.25%, where the target rate remains. The Federal Reserve’s monetary policy, volatility in equity markets, economic recession and federal government economic stimulus efforts, among other factors, have caused yields on U.S. Treasury securities to drop to exceptionally low levels throughout much of the past four years. The month-end yields on two-year, ten-year and thirty-year treasury securities were lower by 369 basis points, 266 basis points and 192 basis points, respectively at December 31, 2011 compared to September 30, 2007. This persistently low interest rate environment has caused an ongoing decline over the past four years in the returns on our interest-earning assets, consistent with much of the financial industry. Yields on our securities portfolio and on our commercial loans and consumer loans were most affected by the low interest rate environment, due to the significant annual amortization in these portfolios as a result of their relatively shorter duration. Also, our commercial loan and consumer loan portfolios are more sensitive to changes in interest rates due to the variable rate characteristics of a portion of these portfolios. The tax-equivalent yield on our securities portfolio decreased 38 basis points in 2011 compared to 2010. The yield on our commercial loans and consumer (including indirect) loans decreased 42 basis points and 56 basis points, respectively, in 2011.

Changes in our asset mix also contributed to the decline in the interest-earning assets yield in 2011, as securities comprised a larger portion of our earning assets in 2011 as compared to 2010 due to difficulty in growing our loan portfolio as the result of the difficult economic and credit market conditions, and our decision to sell many of our fixed rate residential mortgage originations. The yields on the securities we hold are typically lower than the yields on our loans and leases. Securities comprised 32.0% of average interest-earning assets in 2011, compared with 29.8% in 2010.

The cost of our interest-bearing liabilities decreased 31 basis points in 2011 due to a combination of the low interest rate environment, our deposit pricing strategies and a favorable change in the mix of our interest-bearing liabilities, with lower-cost interest-bearing transaction accounts (savings, demand and money market) comprising a larger portion of our average interest-bearing liabilities in 2011. The average balance of interest-bearing transaction accounts increased $19.8 million or 3.3% in 2011, and totaled $618.3 million or 65.0% of total interest-bearing deposits in 2011, compared to $598.5 million or 62.5% of average interest-bearing deposits in 2011.

Our liability mix remained favorably weighted towards transaction accounts in 2011 as we continued to focus on increasing our transaction account balances and as we refrained from offering premium rates on time accounts. Our effort to increase our transaction account balances has been enhanced by retail and municipal depositor’s reluctance to lock up funds in time accounts at what are very low, yet competitive rates, and to the buildup of cash on corporate customers’ balance sheets. The aggregate average balance of transaction accounts (including non-interest bearing demand deposits) was $799.4 million in 2011, which was an increase of $32.9 million or 4.3% from the aggregate average balances of $766.4 million in 2010. Average transaction account balances comprised 70.6% of total average deposits in 2011, compared with 68.1% in 2010. Average time account balances in 2011 were $333.1 million or 29.4% of total average deposits in 2011, compared with $359.5 million or 31.9% in 2010. Our ability to gather and retain transaction deposits in recent years has been greatly enhanced by our strong financial position and earnings performance, enhanced product offerings including upgraded treasury management and internet banking platforms, and a high positive awareness of our brand. Environmental factors such as equity market volatility, risk aversion among retail investors and a build-up of cash on corporate balance sheets have also played a role in the growth in our transaction accounts.

Our tax-equivalent net interest margin declined over the course of 2011 as decreases in the cost of our interest-bearing liabilities did not keep pace with declines in the yield on our interest-earning assets. Our tax-equivalent net interest margin was 3.24% in the fourth quarter of 2011, compared with 3.44% in the first quarter of the year. The declining trend in our net interest margin that we have experienced in recent quarters is likely to continue in coming quarters as the persistently low interest rate environment continues to negatively affect the return on our loan and investment portfolios, while our ability to further reduce our funding costs is limited. We expect that weak economic conditions and historically low interest rates will likely weigh on asset growth and earnings in the financial sector for the foreseeable future. We also believe loan demand will remain soft while competition intense in our markets, which will likely inhibit loan portfolio growth in future quarters. In addition, we expect our securities portfolio will decline in coming quarters as we may not reinvest some or all of the portfolio amortization given the very low yields available for the types of shorter-duration, non-corporate securities in which we invest. Should any or all of these expectations be realized, it is likely that net interest income will decline in coming quarters.

The tax-equivalent net interest margin was 3.21% in 2012, compared with 3.43% in 2011. The tax-equivalent yield on interest-earning assets decreased 48 basis points in 2012 compared with 2011, which was partially offset by a 28 basis point decrease in our cost of interest-bearing liabilities over the same period. The tax-equivalent yield on our interest-earning assets was 3.89% in 2012, compared with 4.37% in 2011. Our cost of interest-bearing liabilities was 0.83% in 2012, compared with 1.11% in 2011.

Since December 2008, the Federal Reserve has maintained its target fed funds rate between zero and 0.25%, and has carried out a number of policy actions designed to lower long-term interest rates. These monetary policy actions, along with volatility in equity markets, weak economic conditions and federal government economic stimulus efforts, among other factors, have caused yields on U.S. Treasury securities to drop to exceptionally low levels throughout much of the past four years. This persistently low interest rate environment has caused an ongoing decline over the past four years in the returns on our interest-earning assets, consistent with much of the financial industry. As a result the tax-equivalent yield on our securities portfolio decreased 50 basis points in 2012 compared to 2011. The yield on our commercial loans, residential loans and consumer (including indirect) loans decreased 15 basis points, 31 basis points and 74 basis points, respectively, in 2012 compared to 2011.

The cost of our interest-bearing liabilities decreased in 2012 compared to 2011 due to a combination of the low interest rate environment, our deposit pricing strategies and a deposit mix that remains heavily weighted in low-cost interest-bearing transaction accounts (demand, savings and money market) whose rates can be immediately changed at our discretion. However, we have not been able to reduce our cost of our interest-bearing liabilities sufficient to offset our declining asset yields in recent quarters due to the absolute low levels of our deposit rates. The average cost of money market and time deposits dropped 16 basis points and 38 basis points, respectively in 2012 compared to 2011. Average interest-bearing transaction accounts comprised 70.2% of total average interest-bearing deposits in 2012, compared to 65.0% in 2011. We also reduced our cost of borrowings by 30 basis points in 2012 compared to 2011 primarily through a restructuring of FHLB advances totaling $50.0 million in June 2012. The restructurings resulted in prepayment penalties of $2.1 million, which are being amortized as an adjustment to interest expense over the remaining term of the restructured debt in accordance with U.S. generally accepted accounting principles. The restructuring had the effect of extending the maturities of the restructured borrowings by 3.3 years and lowering the annual average effective cost by 148 basis points.

Our liability mix remained favorably weighted towards transaction accounts (including non-interest bearing demand deposits) in 2012 as retail and municipal depositors continue to refrain from investing funds in time accounts at very low, yet competitive rates, and also because of the buildup of cash on corporate customers’ balance sheets. The aggregate average balance of transaction accounts was $839.7 million or 75.7% of total deposits in 2012, compared with $799.4 million or 70.6% in 2011. Average time account balances in 2012 were $269.4 million or 24.3% of total average deposits, compared with $333.1 million or 29.4% in 2011. Our ability to gather and retain transaction deposits in recent years has been greatly enhanced by our strong financial position and earnings performance, enhanced product offerings including upgraded treasury management and internet banking platforms, and a high positive awareness of our brand. Environmental factors such as equity market volatility and risk aversion among retail investors have also played a role in the growth in our transaction accounts.

Our tax-equivalent net interest margin declined in recent quarters as decreases in the cost of our interest-bearing liabilities did not keep pace with declines in the yield on our interest-earning assets. The declining trend in our net interest margin that we have experienced in recent quarters is likely to continue in coming quarters as the persistently low interest rate environment continues to negatively affect the return on our loan and investment portfolios, while our ability to further reduce our funding costs is limited. The pressure on our net interest margin along with weak economic conditions, uneven loan demand and competition may result in further declines in net interest income in coming quarters.

Non-Interest Income

Our non-interest income is comprised of service charges on deposits, fees from investment management and brokerage services, mortgage banking operations that include gains from sales and income from servicing, and other recurring operating income fees from normal banking operations, along with non-core components that primarily consist of net gains or losses from sales of investment securities.

The following table sets forth certain information on non-interest income for the years indicated:

	Years ended December 31,
	2011		2010		Change
	2012		2011		Change
	(In thousands)
Investment management income	$	$ 7,~~746~~603	$	$ 7,~~316~~746	$	~~$ 430~~(143	)	5(1.9%8	)%
Service charges on deposit accounts		4,~~463~~277		4,~~509~~463		(~~46)~~186	)	(14.~~0)%~~2	)%
Card-related fees		2,~~701~~772		2,~~563~~701		~~138~~71		52.4%6	%
Insurance agency income		—		1,283		(1,283)		(100.0)%
Income from bank-owned life insurance		1,258		1,018		240		23.6	%
Income from bank-owned life insurance		1,018		1,058		(40)		(3.8)%
Gain on sale of loans		1,809		1,283		526		41.0	%
Gain on sale of loans		1,283		1,394		(111)		(8.0)%
Gains on sale of securities available-for-sale		—		1,325		(1,325	)	(100.0	)%
Gains on sale of securities available-for-sale		1,325		308		1,017		330.2%
Other non-interest income		1,132		1,466		(334	)	(22.8	)%
Other non-interest income		1,466		2,074		(608)		(29.3)%
Total non-interest income	$	18,851	$	20,002	$	(1,151	)	(5.8	)%
Total non-interest income		$20,002		$20,505		$(503)		(2.5)%

Non-interest income ~~decreased~~was $~~503,000~~18.9 ormillion ~~2.5%~~in to2012, compared with $20.0 million in 2011. ~~Investment~~We ~~management~~did ~~income increased~~not ~~$430,000~~sell orsecurities ~~5.9%~~ in ~~2011 primarily as a result of the impact of changes in equity~~ 2012 and ~~debt~~therefore ~~markets~~gains ~~over the past two years~~ on ~~the~~sales ~~value~~ of ~~assets~~investment ~~under~~securities ~~management. Insurance agency income~~ decreased $1.3 million ~~due~~compared towith ~~the sale of our insurance agency operations in December 2010~~2011. The ~~elimination~~increase ofin ~~the~~income ~~operating~~from ~~expenses~~bank-owned ~~associated~~life ~~with our~~ insurance ~~agency~~resulted ~~substantially~~from ~~offset~~ the ~~revenue~~settlement ~~decline~~of ina ~~2011,~~policy ~~resulting~~on ina noformer ~~significant~~employee ~~net~~in ~~effect on our financial results~~2012. Gains on the sale of ~~securities available-for-sale~~ loans increased to $~~1.3 million in 2011~~526,000 compared with ~~$308,000~~2011 ~~in 2010~~ due to ~~increased~~a ~~sales~~combination ~~activity~~of inhigher ~~2011.~~volumes ~~Other~~of ~~non-interest~~mortgages ~~income~~originated ~~decreased~~and ~~$608,000~~sold in ~~2011~~2012 ~~compared~~along towith ~~2010~~higher ~~due~~premiums ~~primarily to the gain of $815,000 recognized~~ on ~~the~~mortgages ~~sale of the insurance agency in 2010~~sold.

Non-interest income (excluding ~~securities~~ gains ~~and the gain~~ on ~~the~~securities ~~sale of the insurance agency~~sales) ~~comprised~~accounted 30for 32.13% of total revenue in ~~2011~~2012, compared with 30.41% in ~~2010~~2011.

Non-Interest Expenses

The following table sets forth certain information on non-interest expenses for the years indicated:

Years ended December 31

2011

2010

Change

2012

2011

Change

(In thousands)

Salaries and employee benefits

~~$21~~23,~~902~~631

~~$22~~21,~~319~~902

~~$(417)~~1,729

(17.9)%

Occupancy and equipment expenses

7,~~283~~066

7,~~375~~283

(~~92)~~217

)

(13.~~2)%~~0

Communication expense

~~599~~623

~~664~~599

~~(65)~~24

(94.~~8)%~~0

Office supplies and postage expense

1,~~142~~182

1,~~158~~142

~~(16)~~40

(13.~~4)%~~5

Marketing expense

~~898~~772

~~1,068~~898

(~~170)~~126

)

(1514.~~9)%~~0

Amortization of intangible assets

~~944~~867

~~1,127~~944

(~~183)~~77

)

(168.2)%

Professional fees

35,~~087~~372

3,~~250~~087

~~(163)~~2,285

(574.0)%

FDIC insurance premium

~~1,061~~866

1,~~601~~061

(~~540)~~195

)

(3318.~~7)%~~4

Other non-interest expense

6,~~665~~063

56,~~918~~665

~~747~~(602

)

12(9.6%0

Total non-interest expenses

~~$43~~46,~~581~~442

~~$44~~43,~~480~~581

~~$(899)~~2,861

(26.~~0)%~~6

Non-interest expenses ~~decreased~~were $~~899,000~~46.4 ormillion ~~2.0%~~in to2012, compared with $43.6 million in 2011. ~~Salaries~~Merger ~~and~~related ~~benefits~~expenses ~~expense~~totaled ~~decreased~~ $~~417,000 or 1~~3.9%4 ~~due~~million ~~to the discontinuation of salaries and benefits for the insurance agency’s employees~~ in ~~2011~~2012 ~~partially offset by normal base salary increases~~ and ~~higher~~included ~~incentive compensation. FDIC insurance expense decreased~~ $~~540,000 or 33~~2.7% inmillion ~~2011 compared with 2010 primarily due to the change implemented by the FDIC in the basis~~ for ~~calculating~~professional ~~insurance~~fees ~~premiums.~~and ~~Other non-interest expense increased~~ $~~747~~676,000 orfor ~~12.6%~~employee inrelated ~~2011~~accruals ~~compared~~for ~~with~~estimated ~~2010~~retention ~~due primarily to the $555,000 write-down of vacant bank-owned property recorded in the third quarter of 2011~~awards.

23Our efficiency ratio was 79.7% in 2012, compared with 70.4% in 2011. Excluding merger related expenses and other non-recurring items, the efficiency ratio was 73.9% in 2012.

Our efficiency ratio was 70.3% in 2011 compared with 69.9% in 2010.

Income Tax Expense

Our effective tax rate ~~(excluding the gain and related tax on the insurance agency transaction in 2010)~~ was 2524.34% in ~~2011~~2012, compared towith 2425.63% in ~~2010~~2011. The decrease in our effective tax rate ~~for~~from ~~2010~~2011 ~~excludes~~was ~~the~~due ~~$815,000~~to ~~gain~~a onhigher ~~the~~level ~~sale~~ of ~~the assets of the insurance agency and the related~~ tax-exempt ~~expense~~income ofas ~~$806,000 which result from~~ a ~~difference~~percentage into ~~the~~total ~~tax~~taxable income. ~~basis of such assets versus the book value~~

Comparison of Operating Results for the Years Ended December 31, ~~2010~~2011 and ~~2009~~2010

General

Net income was $1113.63 million for the year ended December 31, ~~2010~~ 2011, compared with $11.46 million in ~~2009~~2010. Net income available to common shareholders was $1113.63 million or $2.4880 per diluted share in ~~2010~~2011, compared with $1011.46 million or $2.2448 per diluted share in ~~2009~~2010. Net income for 2009 included gains on sales of securities totaling $1.3 million after taxes or $0.29 per diluted share which offset non-recurring expenses of approximately $482,000 after taxes or $0.11 per diluted share. Preferred stock dividends and the accretion of the preferred stock discount were $1.1 million or $0.24 per diluted share in 2009.

Net Interest Income

Net interest income totaled $44.3 million in 2010, an increase of $908,000 or 2.1% compared with $43.4 million in 2009. The increase in net interest income resulted from growth in interest-earning assets. Average interest-earning assets increased $18.1 million in 2010 compared with 2009, with a $47.1 million increase in securities offsetting a $22.8 million decrease in loans and leases. The tax-equivalent net interest margin was 3.55% in 2010 and 2009. The tax-equivalent yield on interest-earning assets decreased 37 basis points in 2010 compared to 2009, which was offset by a 43 basis point decrease in our cost of interest-bearing liabilities over the same period. The tax-equivalent yield on our interest-earning assets was 4.78% in 2010 compared with 5.15% in 2009. Our cost of interest-bearing liabilities was 1.42% in 2010 compared to 1.85% in 2009.

The significant easing of monetary policy by the Federal Reserve since September 2007, along with volatility in equity markets, economic recession and federal government monetary and economic stimulus efforts, along with other factors have contributed to a sharp decline in the yields on U.S. Treasury securities. The low interest rate environment during this period resulted in declining yields for all of our interest-earning asset, consistent with much of the financial industry. Yields on our securities portfolio and on our commercial loans and consumer loans were most affected by the low interest rate environment. The tax-equivalent yield on our securities portfolio decreased 58 basis points in 2010 compared to 2009. The yield on our commercial loans and consumer (including indirect) loans decreased 26 basis points and 37 basis points, respectively, in 2010.

Changes in our asset mix also contributed to the decline in the interest-earning assets yield in 2010, as securities comprised a larger portion of our earning assets in 2010 as compared to 2009 due to difficulty in growing our loan portfolio as the result of the difficult economic and credit market conditions. The yields on the securities we hold are typically lower than the yields on our loans and leases. Securities comprised 29.8% of average interest-earning assets in 2010, compared with 26.6% in 2009.

The cost of our interest-bearing liabilities decreased in 2010 due to a combination of the low interest rate environment, our deposit pricing strategies and a favorable change in the mix of our interest-bearing liabilities, with lower-cost interest-bearing transaction accounts (savings, demand and money market) comprising a larger portion of our interest-bearing liabilities in 2010. The average balance of interest-bearing transaction accounts increased $85.9 million or 16.8% in 2010. The average cost of money market and time deposits dropped 35 basis points and 51 basis points, respectively in 2010.

Our liability mix changed favorably during 2010 as we continued to focus on increasing our transaction account balances and as we refrained from offering premium rates on time accounts. The aggregate average balance of transaction accounts (including non-interest bearing demand deposits) was $766.4 million in 2010, which was an increase of $97.4 million or 14.6% from the aggregate average balances of $669.0 million in 2009. Average transaction account balances comprised 68.1% of total average deposits in 2010, compared with 63.6% in 2009.

~~Average~~Net ~~time~~Interest ~~account~~Income ~~balances in 2010 were $359.5 million or 31.9% of total average deposits in 2010, compared with $382.4 million or 36.4% in 2009.~~

Net interest income totaled $43.3 million in 2011, a decrease of $989,000 or 2.2% compared with $44.3 million in 2010. The decrease in net interest income resulted from a decline in the net interest margin partially offset by an increase in average interest-earning assets.

Average interest-earning assets increased $14.4 million in 2011 compared with 2010, with a $33.8 million increase in securities offsetting a $25.0 million decrease in loans and leases. The tax equivalent net interest margin was 3.43% in 2011 compared with 3.55% in 2010. The tax-equivalent yield on interest-earning assets decreased 40 basis points in 2011 compared with 2010, which was partially offset by a 31 basis point decrease in our cost of interest-bearing liabilities over the same period. The tax-equivalent yield on our interest-earning assets was 4.37% in 2011, compared to 4.78% in 2010. Our cost of interest-bearing liabilities was 1.11% in 2011, compared with 1.42% in 2010.

The low interest rate environment of the last few years has resulted in declining yields for all of our interest- earning asset, consistent with much of the financial industry. Yields on our securities portfolio and on our commercial loans and consumer loans were most affected in 2011 by the low interest rate environment. The tax-equivalent yield on our securities portfolio decreased 38 basis points in 2011 compared with 2010. The yield on our commercial loans and consumer (including indirect) loans decreased 42 basis points and 56 basis points, respectively, in 2011.

Changes in our asset mix also contributed to the decline in the interest-earning assets yield in 2011, as securities comprised a larger portion of our earning assets in 2011 as compared to 2010 due to difficulty in growing our loan portfolio as the result of weak economic and credit market conditions and the decision to sell many of our fixed rate residential mortgage originations for interest rate risk management purposes. The yields on the securities we hold are typically lower than the yields on our loans and leases. Securities comprised 32.0% of average interest-earning assets in 2011, compared with 29.8% in 2010.

The cost of our interest-bearing liabilities decreased 31 basis points in 2011 due to a combination of the low interest rate environment, our deposit pricing strategies and a favorable change in the mix of our interest-bearing liabilities, with lower-cost interest-bearing transaction accounts (savings, demand and money market) comprising a larger portion of our interest-bearing liabilities in 2011 compared to 2010. The average balance of interest-bearing transaction accounts increased $19.8 million or 3.3% in 2011 and totaled $618.3 million or 65.0% of total interest-bearing deposits in 2011, compared with $598.5 million or 62.5% of average interest-bearing deposits in 2011.

Our liability mix remained favorably weighted toward transaction accounts in 2011 as we continued to focus on increasing our transaction account balances and as we refrained from offering premium rates on time accounts. The aggregate average balance of transaction accounts (including non-interest bearing demand deposits) was $799.4 million in 2011, which was an increase of $32.9 million or 4.3% from the aggregate average balances of $766.4 million in 2010. Average transaction account balances comprised 70.6% of total average deposits in 2011, compared with 68.1% in 2010. Average time account balances in 2011 were $333.1 million or 29.4% of total average deposits, compared with $359.5 million or 31.9% in 2010.

Non-Interest Income

The following table sets forth certain information on non-interest income for the years indicated:

	Years ended December 31,
	2010		2009		Change
	2011		2010		Change
	~~(In thousands)~~		(In thousands)
Investment management income	$	$ 7,~~316~~746	$	$ 7,~~134~~316	$	~~$ 182~~430		25.6%9	%
Service charges on deposit accounts		4,~~509~~463		54,~~037~~509		(~~528)~~46	)	(101.~~5)%~~0	)%
Card-related fees		2,~~563~~701		2,~~248~~563		~~315~~138		145.0%4	%
Insurance agency income		~~1,283~~—		1,~~387~~283		(~~104)~~1,283	)	(7100.~~5)%~~0	)
Income from bank-owned life insurance		1,~~058~~018		1,~~014~~058		44(40	)	4.(3%.8	)%
Gain on sale of loans		1,~~394~~283		~~748~~1,394		~~646~~(111	)	86(8.4%0	)%
Gains on sale of securities available-for-sale		~~308~~1,325		~~2,168~~308		(1,~~860)~~017		~~(85~~330.~~8)%~~2	%
Other non-interest income		21,~~074~~466		12,~~075~~074		~~999~~(608	)	92(29.9%3	)%
Total non-interest income	$	$20,~~505~~002	$	$20,~~811~~505	$	$(~~306)~~503	)	(12.5)%	)%

Non-interest income decreased $~~306~~503,000 or 12.5% to $20.50 million in ~~2010~~2011. ~~Service~~Investment ~~charges~~management onincome ~~deposit accounts~~increased ~~decreased~~ $~~528~~430,000 or ~~10.~~5.9% in 2011 primarily ~~due~~as toa result of the impact of achanges ~~new~~in ~~regulation~~equity ~~covering~~and ~~overdraft~~debt ~~protection~~markets ~~programs,~~on ~~which took effect in~~ the ~~third~~value ~~quarter~~ of ~~2010.~~assets ~~Gains~~under onmanagement. ~~sales~~Insurance ofagency ~~loans~~income ~~increased~~decreased $~~646,000 or 86~~1.4%3 asmillion adue ~~result~~to ofthe asale ~~higher volume~~ of ~~residential~~our ~~mortgage~~insurance ~~sales~~agency operations in December 2010. The Weelimination ~~sold a larger portion~~ of ~~our~~the ~~originations~~operating inexpenses ~~2010~~associated ~~in connection~~ with our ~~balance~~insurance ~~sheet management activities.~~

Gains on sales of investment securities decreased $1.9 million or 85.8% on a sharply lower volume of sales in 2010.

In December 2010, we sold substantially all of the assets of our insurance agency subsidiary, and discontinued its operations. A gain of $815,000 was recognized on the sale of the insurance agency and is included in other non-interest income. The gain was nearly entirely offset by taxes of $806,000 resulting from a difference in the tax basis of such assets versus the book value.

Non-interest income (excluding securities gains and the gain on the sale of the insurance agency) comprised 30.4% of total revenue in 2010 compared with 30.1% in 2009.

Non-Interest Expenses

The following table sets forth certain information on operating expenses for the years indicated:

	Years ended December 31
	2010		2009		Change
	(In thousands)
Salaries and employee benefits		$22,319		$20,428		$1,891	9.3%
Occupancy and equipment expenses		7,375		7,047		328	4.7%
Communication expense		664		756		(92)	(12.2)%
Office supplies and postage expense		1,158		1,337		(179)	(13.4)%
Marketing expense		1,068		932		136	14.6%
Amortization of intangible assets		1,127		1,453		(326)	(22.4)%
Professional fees		3,250		2,893		357	12.3%
FDIC insurance premium		1,601		2,284		(683)	(29.9)%
Other non-interest expense		5,918		6,078		(160)	(2.6)%
Total non-interest expenses		$44,480		$43,208		$1,272	2.9%

Non-interest expenses increased $1.3 million or 2.9% to $44.5 million in 2010. Salaries and benefits expense increased $1.9 million or 9.3% compared to 2009. Approximately $1.3 million or 67% of the increase in salaries and benefits represents incremental recurring expense from a combination of new customer service and business development positions and normal salary increases. As required under generally accepted accounting principles, the deferral of salaries and benefits expense in connection with successfully originated loans was approximately $317,000 or 17% of the increase in salaries and benefits in 2010 compared to the same period in 2009, due to substantially higher residential mortgage origination volume in 2009.

~~Professional~~ agency ~~fees~~substantially ~~increased~~offset ~~$357,000~~the orrevenue ~~12.3%~~decline in ~~2010~~2011. ~~due~~Gains ~~primarily~~on tothe ~~outside~~sale ~~consulting services~~of ~~related~~securities toavailable-for-sale ~~various~~increased ~~projects~~to $1.3 ~~The~~million ~~FDIC~~in ~~insurance~~2011 ~~premium~~compared ~~decreased~~with $~~683~~308,000 ~~or 29.9%~~ in 2010 due to aincreased ~~special~~sales activity ~~assessment~~in ~~required~~2011. ofOther ~~all FDIC~~non-~~insured~~interest ~~banks~~income decreased $608,000 in ~~2009.~~2011 Wecompared ~~paid~~with a2010 ~~special~~due ~~assessment~~primarily to the gain of $~~676~~815,000 inrecognized on the ~~second~~sale ~~quarter~~ of ~~2009~~the insurance agency in 2010.

~~Our~~Non-interest ~~efficiency~~income ~~ratio~~(excluding ~~was~~securities 69gains and the gain on the sale of the insurance agency) comprised 30.91% of total revenue in ~~2010~~2011 compared with 6930.741% in ~~2009~~2010.

Non-Interest Expenses

The following table sets forth certain information on operating expenses for the years indicated:


	Years ended December 31
	2011		2010		Change
			(In thousands)
Salaries and employee benefits	$	21,902	$	22,319	$	(417	)	(1.9	)%
Occupancy and equipment expenses		7,283		7,375		(92	)	(1.2	)%
Communication expense		599		664		(65	)	(9.8	)%
Office supplies and postage expense		1,142		1,158		(16	)	(1.4	)%
Marketing expense		898		1,068		(170	)	(15.9	)%
Amortization of intangible assets		944		1,127		(183	)	(16.2	)%
Professional fees		3,087		3,250		(163	)	(5.0	)%
FDIC insurance premium		1,061		1,601		(540	)	(33.7	)%
Other non-interest expense		6,665		5,918		747		12.6	%

Total non-interest expenses	$	43,581	$	44,480	$	(899	)	(2.0	)%

Non-interest expenses decreased $899,000 or 2.0% to $43.6 million in 2011. Salaries and benefits expense decreased $417,000 or 1.9% due to discontinuation of salaries and benefits for the insurance agency’s employees in 2011. FDIC insurance expense decreased $540,000 or 33.7% in 2011 compared with 2010 primarily due to the change implemented by the FDIC in the basis for calculating insurance premiums Other non-interest expense increased $747,000 or 12.6% in 2011 compared with 2010 due primarily to the $555,000 write-down of vacant bank-owned property recorded in the third quarter of 2011.

Our efficiency ratio was 70.3% in 2011 compared with 69.9% in 2010.

Income Tax Expense

Our effective tax rate (excluding the gain and related tax on the sale of the insurance agency) was 2425.63% in ~~2010~~2011 and 2324.16% in ~~2009~~2010.

Comparison of Financial Condition at December 31, ~~2011 and~~2012 and December 31, ~~2010~~2011

General

Total assets were $1.4 billion at December 31, ~~2011~~2012, awhich ~~decrease~~was ofnearly ~~$45.5~~unchanged ~~million or 3.1%~~ from ~~December 31, 2010. Securities available-for-sale decreased $40.1 million in 2011 to $374.3 million at~~ the end of 2011. ~~Total~~Loans ~~loans~~ and leases (net of unearned income) ~~decreased~~were $25928.81 million toat the end of 2012, representing growth of $~~872~~55.74 million atfrom ~~December 31,~~the end of 2011. The ~~decrease~~growth in our loan ~~and lease~~ portfolio ~~resulted~~was ~~from~~funded ~~the~~primarily ~~planned~~through ~~and~~cash ~~actively~~generated ~~managed~~from ~~runoff~~amortization ~~of the lease portfolio~~ and ~~our~~maturities ~~decision to sell a large portion~~ of ~~our~~investment ~~residential mortgage originations~~securities, which ~~was~~decreased ~~substantially~~$37.8 ~~offset~~million byin ~~strong commercial loan growth~~2012.

Securities

The securities portfolio is designed to provide a favorable total return utilizing low-risk, high-quality securities while at the same time assisting in meeting the liquidity needs of our loan and deposit operations, and supporting our interest rate risk objectives. Our securities portfolio is predominately comprised of investment grade mortgage-backed securities, securities issued by U.S. government sponsored corporations and municipal securities. We classify the majority of our securities as available-for-sale. We do not engage in securities trading or derivatives activities in carrying out our investment strategies.

The following table sets forth the amortized cost and market value for our available-for-sale securities portfolio:

	At December 31,
	2011				2010				2009
	Amortized Cost		Fair Value		Amortized Cost		Fair Value		Amortized Cost		Fair Value
Securities available for sale:		(In thousands)
Debt securities:
U.S. Treasury obligations		$ —		$ —		$ —		$ —		$ 100		$ 101
Obligations of U.S. government-sponsored corporations		3,134		3,190		4,020		4,186		5,864		6,129
Obligations of states and political subdivisions		77,541		82,299		77,246		78,212		75,104		77,147
Mortgage-backed securities - residential		279,393		285,706		324,294		329,010		273,499		275,680
Total debt securities		360,068		371,195		405,560		411,408		354,567		359,057
Stock investments:
Equity securities		—		—		1,852		1,995		1,958		2,104
Mutual funds		3,000		3,111		1,000		1,007		1,000		997
Total stock investments		3,000		3,111		2,852		3,002		2,958		3,101
Total available for sale		363,068		374,306		408,412		414,410		357,525		362,158
Net unrealized gains on available-for-sale securities		11,238				5,998				4,633
Total carrying value		$374,306				$414,410				$362,158

We decreased the size of our securities portfolio in 2011 in order to manage our interest-rate risk, given the very low yields available for the types of shorter-duration, non-corporate securities in which we invest. Our securities

~~portfolio~~The ~~totaled~~following ~~$374.3~~table ~~million~~sets atforth ~~December 31, 2011, compared with $414.4 million at December 31, 2010. Our portfolio is comprised entirely of investment grade securities,~~ the ~~majority~~ ofamortized ~~which~~cost ~~are~~and ~~rated~~market ~~“AAA”~~value byfor ~~one or more of the nationally recognized rating agencies. The breakdown of~~ our ~~securities portfolio at December 31, 2011 was 76% government~~available-~~sponsored entity guaranteed mortgage~~for-~~backed~~sale securities, 22% municipal securities and 1% obligations of U.S. government sponsored corporations. Mortgage-backed securities, which totaled $285.7 million at December 31, 2011, are comprised primarily of pass-through securities backed by conventional residential mortgages and guaranteed by Fannie-Mae, Freddie-Mac or Ginnie Mae, which in turn are backed by the U.S. government. Our municipal bond portfolio,: which totaled $82.3 million at the end of 2011, is comprised primarily of general obligation bonds issued by local municipalities and school districts in New York State. We do not invest in any securities backed by sub-prime, Alt-A or other high-risk mortgages. We also do not hold any preferred stock, corporate debt or trust preferred securities in our portfolio.

Net unrealized gains in our securities portfolio totaled $11.2 million at December 31, 2011, compared with net unrealized gains of $6.0 million at December 31, 2010.


	At December 31,
	2012				2011				2010
	Amortized		Fair		Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value		Cost		Value
	(In thousands)
Securities available for sale:
Debt securities:
U.S. Treasury obligations	$	15,147	$	15,148	$	—	$	—	$	—	$	—
Obligations of U.S. government-sponsored corporations		—		—		3,134		3,190		4,020		4,186
Obligations of states and political subdivisions		66,479		71,230		77,541		82,299		77,246		78,212
Mortgage-backed securities - residential		241,482		246,982		279,393		285,706		324,294		329,010

Total debt securities		323,108		333,360		360,068		371,195		405,560		411,408

Stock investments:
Equity securities		—		—		—		—		1,852		1,995
Mutual funds		3,000		3,133		3,000		3,111		1,000		1,007

Total stock investments		3,000		3,133		3,000		3,111		2,852		3,002

Total available for sale		326,108		336,493		363,068		374,306		408,412		414,410
Net unrealized gains on available-for-sale securities		10,385				11,238				5,998

Total carrying value	$	336,493			$	374,306			$	414,410

~~The~~Investment ~~following~~securities ~~table sets~~totaled ~~forth~~$336.5 asmillion ofat December 31, ~~2011~~2012, ~~the~~compared ~~maturities~~with ~~and~~$374.3 ~~the~~million ~~weighted-average~~at ~~yields~~December 31, 2011. Our portfolio is comprised entirely of ~~our~~investment ~~debt~~grade securities, the majority of which ~~have~~are ~~been~~rated ~~calculated~~“AAA” onby one or more of the ~~basis~~nationally recognized rating agencies. The breakdown of the ~~amortized~~securities ~~cost~~portfolio at December 31, 2012 ~~weighted~~was ~~for~~73.4% ~~scheduled~~government-sponsored ~~maturity~~entity ofguaranteed ~~each~~mortgage-backed ~~security~~securities, 21.2% municipal securities and ~~adjusted~~4.5% toobligations aof ~~fully~~U.S. government-sponsored corporations. Mortgage-backed securities, which totaled $247.0 million at ~~tax~~December 31, 2012, are comprised primarily of pass-~~equivalent~~through ~~basis~~securities (backed by conventional residential mortgages and guaranteed by Fannie-Mae, Freddie-Mac or Ginnie Mae, which in ~~thousands):~~turn are backed by the U.S. government. Our municipal securities portfolio, which totaled $71.2 million at the end of 2012, is primarily comprised of highly rated general obligation bonds issued by local municipalities in New York State.

	At December 31, 2011
	AmountMaturingWithin One Year or Less		AmountMaturingAfter OneYear butWithin Five Years		AmountMaturingAfter FiveYears butWithin Ten Years		AmountMaturing After Ten Years		Total Amortized Cost
Obligations of U.S. government-sponsored corporations		$ 3,134		$ —		$ —		$ —		$ 3,134
Obligations of states and political subdivisions		11,506		19,174		37,200		9,661		77,541
Mortgage-backed securities		88,578		153,496		29,378		7,941		279,393
Total debt securities available-for-sale		$103,218		$172,670		$66,578		$17,602		$360,068
Weighted average yield at year end (1)		2.94%		2.91%		3.96%		4.00%		3.16%

We had net unrealized gains of approximately $10.4 million in our securities portfolio at December 31, 2012, compared with net unrealized gains of $11.2 million at December 31, 2011.

~~(1)~~In ~~Weighted~~the ~~average~~first ~~yields~~quarter onof ~~the~~2013, ~~tax~~we sold mortgage-~~exempt~~backed ~~obligations~~securities ~~have~~with ~~been~~an ~~computed~~aggregate oncarrying value of $70.4 million, and recognized $1.6 million of gains before taxes. The securities sold had an aggregate par value of $66.8 million, a ~~fully~~weighted ~~tax-equivalent~~average ~~basis~~maturity ~~assuming~~of 2.7 years, a ~~marginal~~weighted ~~federal~~average ~~tax~~coupon ~~rate~~of 3.94%, and a weighted average yield of 341.75%. ~~These~~The ~~yields~~proceeds ~~are~~were anreinvested ~~arithmetic~~in ~~computation~~similar government-guaranteed mortgage-backed securities with a weighted average maturity of ~~interest~~4.7 ~~income~~years, ~~divided~~a byweighted average ~~balance~~coupon of 1.48% and ~~may~~a ~~differ~~weighted ~~from~~average yield of 1.51%. The purpose of the ~~yield~~sale and reinvestment transactions was to ~~maturity,~~reduce ~~which~~our exposure ~~considers~~to higher coupon securities and the ~~time~~associated risk that an increase in prepayments on the underlying mortgage loans could negatively impact the value of ~~money~~these securities.

Loans and Leases

The loan and lease portfolio is the largest component of our interest-earning assets and it generates the largest portion of our interest income. We provide a full range of credit products through our branch network and through our commercial lending line of business. Consistent with our focus on providing community banking services, we generally do not attempt to diversify geographically by making a significant amount of loans to borrowers outside of our primary service area. Loans are primarily internally generated and the majority of our lending activity takes place in the New York State counties of Cortland, Madison, Onondaga, Oneida, Oswego and nearby counties. In addition, we originate indirect auto loans in the western counties of New York State. In connection with our ongoing strategic planning and balance sheet management processes, Alliance Leasing, Inc. ceased origination of new transactions in the third quarter of 2008. The operations of Alliance Leasing are currently limited to servicing the existing lease portfolio.

Total loans and leases, net of unearned income and deferred costs, were $872.7 million at December 31, 2011, compared with $898.5 million at December 31, 2010.

Residential mortgages totaled $316.8 million at the end of 2011, which was a decrease of $18.1 million or 5.4% from the end of 2010. We originated $107.5 million of residential mortgages in 2011, compared to $119.7 million in 2010. Our portfolio declined in 2011 as we sold a large portion of our originations on the secondary market in order to manage our overall interest rate risk position. Sales of residential mortgages totaled $59.6 million in 2011, compared with $66.2 million in 2010. In the first quarter of 2012 we changed our strategy as it relates to residential mortgages and will retain most fixed rate mortgages with terms of 15 years or less in portfolio for the foreseeable

~~future.~~The ~~Fixed~~following ~~rate,~~table ~~monthly-payment~~sets ~~mortgages~~forth ~~with~~as ~~terms~~of ~~greater~~December 31, ~~than~~2012, 15the ~~years~~maturities ~~will~~and ~~still~~the beweighted-average ~~sold~~yields of inour ~~the~~debt ~~secondary~~securities, ~~market.~~which ~~Substantially~~have ~~all~~been ~~our~~calculated ~~residential~~on ~~mortgage~~the ~~originations~~basis ~~are~~of ~~conventional mortgages~~the ~~originated~~amortized incost, ~~our~~weighted ~~market~~for ~~area.~~scheduled Wematurity doof ~~not~~each ~~originate sub-prime~~security, ~~Alt-A,~~and ~~negative~~adjusted ~~amortizing~~to ora ~~other~~fully ~~higher~~tax-equivalent ~~risk~~basis ~~residential~~(in ~~mortgages.~~thousands):

Commercial loans and mortgages increased $28.4 million or 11.4% in 2011 with approximately 70% of the growth resulting from new loans net of portfolio amortization, and the remainder from increased utilization on existing commercial lines of credit. Commercial loan and mortgage originations (excluding lines of credit) for 2011 totaled $75.9 million, compared to 2010’s originations of $80.4 million.


	At December 31, 2012
	Amount Maturing Within One Year or Less			Amount Maturing After One Year but Within Five Years			Amount Maturing After Five Years but Within Ten Years			Amount Maturing After Ten Years			Total Amortized Cost

U.S. Treasury obligations	$	15,147			—			—			—		$	15,147
Obligations of states and political subdivisions		5,808			24,783			29,392			6,496			66,479
Mortgage-backed securities		77,811			126,687			26,970			10,014			241,482

Total debt securities available-for-sale	$	98,766		$	151,470		$	56,362		$	16,510		$	323,108

Weighted average yield at year end ⁽¹⁾		2.10	%		2.72	%		3.54	%		3.63	%		2.72	%

~~Our~~(1) ~~lease~~Weighted ~~portfolio~~average ~~(net~~yields ofon ~~unearned~~the ~~income)~~tax-exempt ~~continued~~obligations tohave ~~amortize~~been incomputed ~~2011~~on as a ~~result~~fully oftax-equivalent ~~our~~basis ~~previously~~assuming ~~announced~~a ~~decision~~marginal tofederal ~~cease~~tax ~~new lease~~rate ~~originations.~~of ~~Leases decreased $16~~34%.8 ~~million~~These oryields ~~39.6%~~are inan ~~2011~~arithmetic tocomputation ~~$25.6~~of ~~million~~interest atincome ~~the~~divided ~~end~~by ofaverage ~~the~~balance ~~year.~~and ~~Leases~~may ~~are~~differ ~~expected~~from tothe ~~continue~~yield to ~~amortize~~maturity, ~~down~~which atconsiders athe ~~similar~~time ~~rate~~value inof ~~2012~~money.

~~Indirect~~Loans auto loan balances decreased $17.3 million or 9.8% in 2011 due largely to intense rate driven competition. We originated $68.8 million of indirect auto loans in 2011, compared with $79.5 million in 2010. We adjusted our indirect auto rates down in January 2012 with the goal of modestly growing our indirect loan portfolio in 2012. We originate auto loans through a network of reputable, well-established automobile dealers located in central and ~~western~~Leases New York. Applications received through our indirect lending program are subject to the same comprehensive underwriting criteria and procedures as are employed in its direct lending programs. Credit quality metrics within this portfolio remain stable and compare favorably to the industry.

The ~~following~~loan and lease portfolio is the largest component of our ~~table~~interest-earning ~~sets~~assets ~~forth~~and it generates the ~~composition~~largest portion of our ~~loan~~interest income. We provide a full range of credit products through our branch network and ~~lease~~through ~~portfolio~~our atcommercial lending line of business. Consistent with our focus on providing community banking services, we generally do not attempt to diversify geographically by making a significant amount of loans to borrowers outside of our primary service area. Loans are primarily generated internally and the ~~dates~~majority ~~indicated:~~of our lending activity takes place in the New York State counties of Cortland, Madison, Onondaga, Oneida, Oswego and nearby counties. In addition, we originate indirect auto loans in the western counties of New York State. In connection with our ongoing strategic planning and balance sheet management processes, Alliance Leasing, Inc. ceased origination of new transactions in the third quarter of 2008. The operations of Alliance Leasing are currently limited to servicing the existing lease portfolio.

	At December 31,
	2011				2010				2009				2008				2007
	Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent		Amount		Percent
	(Dollars in thousands)
Residential real estate		$316,823		36.4%		$334,967		37.4%		$356,906		39.2%		$314,039		34.6%		$273,465		30.6%
Commercial loans		151,420		17.4%		133,787		14.9%		111,243		12.2%		118,756		13.1%		121,204		13.6%
Commercial real estate		126,863		14.6%		116,066		13.0%		96,753		10.7%		95,559		10.5%		95,932		10.8%
Leases, net of unearned income		25,636		3.0%		42,466		4.8%		68,224		7.5%		104,655		11.6%		131,300		14.7%
Indirect auto loans		158,813		18.3%		176,125		19.7%		184,947		20.3%		182,807		20.2%		176,115		19.7%
Other consumer loans		89,776		10.3%		91,619		10.2%		92,022		10.1%		90,906		10.0%		94,246		10.6%
		869,331		100.0%		895,030		100.0%		910,095		100.0%		906,722		100.0%		892,262		100.0%
Net deferred loan costs		3,390				3,507				4,067				4,033				3,271
Total loans and leases		872,721				898,537				914,162				910,755				895,533
Allowance for credit losses and lease losses		(10,769)				(10,683)				(9,414)				(9,161)				(8,426)
Net loans and leases		$861,952				$887,854				$904,748				$901,594				$887,107

Total loans and leases, net of unearned income and deferred costs, were $928.1 million at December 31, 2012, compared with $872.7 million at December 31, 2011. Loan origination volumes in 2012 increased $106.6 million, or 42%, to $361.9 million, compared with $255.3 million in 2011 on increased demand in each of our commercial, residential mortgage and indirect lending businesses.

~~The~~Residential ~~following~~mortgages ~~table~~outstanding ~~shows~~increased $12.2 million to $329.0 million at the ~~amount~~end of ~~loans~~2012. ~~and~~Originations ~~leases~~of ~~outstanding~~residential mortgages astotaled of$151.2 ~~December 31,~~million ~~2011,~~in ~~which~~2012, ~~based~~ oncompared ~~remaining~~with ~~scheduled~~$107.5 ~~payments~~million ofin ~~principal,~~2011. ~~are~~We ~~due~~retained in portfolio approximately $68.5 million of the ~~periods~~2012 ~~indicated:~~originations that were bi-weekly payment mortgages or monthly payment mortgages with maturities of 15 years or less.

	Maturing withinone year or less		Maturingafter one butwithin five years		Maturing afterfive butwithin ten years		Maturingafterten years		Total
	(In thousands)
Residential real estate		$ 13,363		$ 57,203		$ 73,276		$172,981		$316,823
Commercial loans and commercial real estate		66,614		114,825		51,444		45,400		278,283
Leases, net of unearned income		9,859		11,136		4,641		—		25,636
Indirect auto loans		50,511		106,325		1,684		293		158,813
Other consumer loans		21,104		42,598		22,408		3,666		89,776
Total loans and leases, net of unearned income		$161,451		$332,087		$153,453		$222,340		$869,331

Commercial loans and mortgages increased $19.0 million in 2012 and totaled $297.3 million at December 31, 2012. Originations of commercial loans and mortgages in 2012 (excluding lines of credit) totaled $76.5 million, compared with $75.9 million in 2011.

~~The~~Leases ~~following~~(net ~~table~~of ~~sets~~unearned ~~forth~~income) ~~the~~decreased ~~sensitivity~~$15.4 tomillion ~~changes~~ in ~~interest~~2012 ~~rates~~ as a result of ~~December 31,~~our ~~2011:~~previously announced decision to cease new lease originations.

	Fixed Rate		Variable Rate		Total
	(In thousands)
Due after one year, but within five years		$224,105		$107,982		$332,087
Due after five years		266,652		109,141		375,793

Indirect auto loan balances were $199.3 million at the end of 2012, which was an increase of $40.5 million from the end of 2011. We originated $129.6 million of indirect auto loans in 2012, compared with $68.8 million in 2011. The increase in originations in 2012 is attributable to a change in the rate structure designed to increase our market share without lowering our underwriting standards, along with the implementation of an electronic application system. We originate auto loans through a network of reputable, well-established automobile dealers located in central and western New York. Applications received through our indirect lending program are subject to the same comprehensive underwriting criteria and procedures as employed in its direct lending programs.

The following table sets forth the composition of our loan and lease portfolio at the dates indicated:


	At December 31,
	2012						2011						2010						2009						2008
	Amount			Percent			Amount			Percent			Amount			Percent			Amount			Percent			Amount			Percent
	(Dollars in thousands)
Residential real estate	$	329,009			35.6	%	$	316,823			36.4	%	$	334,967			37.4	%	$	356,906			39.2	%	$	314,039			34.6	%
Commercial loans		155,512			16.8	%		151,420			17.4	%		133,787			14.9	%		111,243			12.2	%		118,756			13.1	%
Commercial real estate		141,760			15.4	%		126,863			14.6	%		116,066			13.0	%		96,753			10.7	%		95,559			10.5	%
Leases, net of unearned income		10,247			1.1	%		25,636			3.0	%		42,466			4.8	%		68,224			7.5	%		104,655			11.6	%
Indirect auto loans		199,284			21.6	%		158,813			18.3	%		176,125			19.7	%		184,947			20.3	%		182,807			20.2	%
Other consumer loans		87,572			9.5	%		89,776			10.3	%		91,619			10.2	%		92,022			10.1	%		90,906			10.0	%

		923,384			100.0	%		869,331			100.0	%		895,030			100.0	%		910,095			100.0	%		906,722			100.0	%

Net deferred loan costs		4,710						3,390						3,507						4,067						4,033

Total loans and leases		928,094						872,721						898,537						914,162						910,755
Allowance for credit losses and lease losses		(8,571	)					(10,769	)					(10,683	)					(9,414	)					(9,161	)

Net loans and leases	$	919,523					$	861,952					$	887,854					$	904,748					$	901,594

The following table shows the amount of loans and leases outstanding as of December 31, 2012, which, based on remaining scheduled payments of principal, are due in the periods indicated:


	Maturing within one year or less		Maturing after one but within five years		Maturing after five but within ten years		Maturing after ten years		Total
	(In thousands)
Residential real estate	$	13,866	$	60,225	$	73,387	$	181,531	$	329,009
Commercial loans and commercial real estate		75,473		128,017		60,537		33,245		297,272
Leases, net of unearned income		2,456		5,090		2,701		—		10,247
Indirect auto loans		58,421		138,081		2,572		210		199,284
Other consumer loans		18,653		41,657		24,107		3,155		87,572

Total loans and leases, net of unearned income	$	168,869	$	373,070	$	163,304	$	218,141	$	923,384

The following table sets forth the sensitivity to changes in interest rates as of December 31, 2012:


	Fixed Rate		Variable Rate		Total
	(In thousands)
Due after one year, but within five years	$	287,290	$	85,780	$	373,070
Due after five years		307,555		73,890		381,445

Asset Quality and the Allowance for Credit Losses

The following table summarizes delinquent loans and leases grouped by the number of days delinquent at the dates indicated:

Delinquent loans and leases	December 31, ~~2011~~2012					December 31, ~~2010~~2011
	$		%(1)			$		%(1)
	(Dollars in thousands)
30 days past due	$	~~$ 5~~6,~~202~~280		0.~~60%~~68	%	$	~~$ 6~~5,~~711~~202		0.~~75%~~60	%
60 days past due		~~584~~1,116		0.~~06%~~12	%		~~1,083~~584		0.~~12%~~06	%
90 days past due and still accruing		—35		—			19—		— %
Non-accrual		114,~~287~~769		10.~~30%~~52	%		811,~~474~~287		01.~~95%~~30	%
Total	$	~~$17~~12,~~073~~200		1.~~96%~~32	%	$	~~$16~~17,~~287~~073		1.~~82%~~96	%

(1)	As a percentage of total loans and leases, excluding deferred costs

The following table represents information concerning the aggregate amount of nonperforming assets:

	December 31,
	2011		2010		2009		2008		2007
	(In thousands)
Non-accrual loans and leases:
Residential real estate		$ 3,062		$ 3,543		$2,843		$1,506		$1,118
Commercial loans and commercial real estate		7,452		3,296		4,013		1,997		4,988
Leases		107		697		1,418		595		320
Indirect auto		293		212		109		101		83
Consumer		373		726		199		153		158
Total non-accrual loans and leases		11,287		8,474		8,582		4,352		6,667
Accruing loans and leases past due 90 days or more		—		19		—		126		39
Total nonperforming loans		11,287		8,493		8,582		4,478		6,706
Other real estate owned and other repossessed assets		485		652		445		657		229
Total nonperforming assets		$11,772		$9,145		$9,027		$5,135		$6,935
Restructured loans not included in above		$ 1,653		$1,131		$ 110		$ —		$ —
Total nonperforming loans and leases to total loans and leases		1.30%		0.95%		0.94%		0.49%		0.75%
Total nonperforming assets to total assets		0.84%		0.63%		0.64%		0.38%		0.53%
Allowance for credit losses to nonperforming loans and leases		95.4%		125.8%		109.7%		204.6%		125.7%
Allowance for credit losses to total loans and leases		1.24%		1.19%		1.03%		1.01%		0.94%

Delinquent loans and leases (including nonperforming) totaled $17.1 million at December 31, 2011, compared to $16.3 million at the end of 2010. Nonperforming assets, defined as non-accruing loans and leases plus loans and leases 90 days or more past due, along with other real estate owned and other repossessed assets were $11.8 million or 0.84% of total assets at December 31, 2011, compared to $9.1 million or 0.63% of total assets at the end of 2010. Included in nonperforming assets at the end of 2011 were nonperforming loans and leases totaling $11.3 million, compared with $8.5 million at the end of 2010. Conventional residential mortgages comprised $3.1 million (48 loans) or 27.1% of nonperforming loans and leases at December 31, 2011. Nonperforming commercial loans and mortgages totaled $7.5 million (38 loans) or 66.0% of nonperforming loans and leases and leases on nonperforming status totaled $107,000 (5 leases) or 0.9% of nonperforming loans and leases at the end of 2011.

As disclosed in our Quarterly Report on Form 10-Q for the period ended September 30, 2011, one commercial relationship totaling $3.6 million was placed on nonperforming status during the third quarter. The relationship is comprised of a $3.0 million secured working capital line of credit and two first mortgages totaling $641,000. The line of credit is secured by receivables of the business and is also collateralized by second lien positions on the real estate securing the two mortgages. During the fourth quarter, the borrower’s business continued to weaken, which led to an increase in our impairment allowance on this relationship by $400,000 to $2.1 million, of which $1.0 million was charged off in the fourth quarter. Our exposure to this borrower, net of the write-down recorded in the fourth quarter and included in nonperforming assets, was $2.6 million at December 31, 2011, and the impairment allowance remaining on this net exposure was $1.1 million at the end of the fourth quarter. The impairment allowance is based on our current estimate of the collectability of receivables, the amount and priority of the borrower’s liabilities and on recently appraised values of the real estate collateral. The impairment allowance may

~~need~~The tofollowing betable ~~increased~~represents ininformation ~~coming~~concerning ~~quarters if~~ the ~~borrowers~~aggregate ~~business deteriorates further or if circumstances require negative adjustments to our assumptions as to the collectability of receivables, the~~ amount ~~and priority~~ of ~~the~~nonperforming ~~borrower’s liabilities and/or the value of the real estate.~~ assets:


	December 31,
	2012			2011			2010			2009			2008
	(In thousands)
Non-accrual loans and leases:
Residential real estate	$	2,533		$	3,062		$	3,543		$	2,843		$	1,506
Commercial loans and commercial real estate		939			7,452			3,296			4,013			1,997
Leases		676			107			697			1,418			595
Indirect auto		226			293			212			109			101
Consumer		395			373			726			199			153

Total non-accrual loans and leases		4,769			11,287			8,474			8,582			4,352

Accruing loans and leases past due 90 days or more		35			—			19			—			126

Total nonperforming loans		4,804			11,287			8,493			8,582			4,478
Other real estate owned and other repossessed assets		725			485			652			445			657

Total nonperforming assets	$	5,529		$	11,772		$	9,145		$	9,027		$	5,135

Restructured loans not included in above	$	3,029		$	1,653		$	1,131		$	110		$	—
Total nonperforming loans and leases to total loans and leases		0.52	%		1.30	%		0.95	%		0.94	%		0.49	%
Total nonperforming assets to total assets		0.39	%		0.84	%		0.63	%		0.64	%		0.38	%
Allowance for credit losses to nonperforming loans and leases		178.4	%		95.4	%		125.8	%		109.7	%		204.6	%
Allowance for credit losses to total loans and leases		0.93	%		1.24	%		1.19	%		1.03	%		1.01	%

Delinquent loans and leases (including non-performing) totaled $12.2 million at December 31, 2012, compared with $17.1 million at December 31, 2011. Non-performing assets, defined as non-accruing loans and leases plus loans and leases 90 days or more past due, along with other real estate owned and repossessed assets, were $5.5 million or 0.39% of total assets at December 31, 2012, compared with $11.8 million or 0.84% of total assets at December 31, 2011. The decline in non-performing assets in 2012 resulted primarily from non-accrual loans returning to accrual status as a result of satisfactory payment performance, charge-offs and pay-offs of non-performing loans.

Included in nonperforming assets at the end of 2012 are non-performing loans and leases totaling $4.8 million, compared with $11.3 million at December 31, 2011. Conventional residential mortgages comprised $2.5 million (43 loans) or 52.7% of non-performing loans and leases, and commercial loans and mortgages totaled $938,000 (16 loans) or 19.5% of non-performing loans and leases at the end of 2012.

The economy in our market area is a relatively stable, slow growth economy, with few conditions that give rise to boom and bust cycles. The housing market generally does not exhibit significant volatility and is not significantly impacted by speculative influences. These external factors, combined with our disciplined credit culture and consistently sound underwriting guidelines, are the primary reasons that our levels of delinquent loans and nonperforming assets have remained relatively low in recent years despite significant industry-wide asset quality issues.

As a recurring part of our portfolio management program, we have identified ~~approximately~~ approximately $109.23 million in potential problem loans at December 31, ~~2011~~2012, as compared towith $1610.62 million at December 31, ~~2010~~2011. The average balance of identified potential problem loans was $~~237~~301,000 and $~~339~~237,000 at December 31, ~~2011 and~~2012 and December 31, ~~2010~~2011, respectively. Potential problem loans are loans that are currently performing, but where the borrower’s operating performance or other relevant factors could result in potential credit problems, and are classified by ~~our~~ our loan rating system as “substandard.” At December 31, ~~2011~~2012, potential problem loans primarily consisted of commercial loans and leases and commercial real estate. There can be no assurance that additional loans will not become nonperforming, require restructuring, or require increased provision for loan losses.

We have a loan and lease monitoring program that evaluates nonperforming loans and leases and the loan and lease portfolio in general. The loan and lease review program continually audits the loan and lease portfolio to confirm management’s loan and lease risk rating system, and systematically tracks such problem loans and leases to ensure compliance with loan and lease policy underwriting guidelines, and to evaluate the adequacy of the allowance for credit losses.

Our policy is to place a loan or lease on non-accrual status and recognize income on a cash basis when a loan or lease is more than 90 days past due, unless in the opinion of management, the loan or lease is well secured and in the process of collection. The impact of interest not recognized on non-accrual loans and leases was $~~301~~85,000 in ~~2011~~2012, $277,000 in 2010, and $342,000 in 2009. We consider a loan or lease impaired when, based on current information and events, it is probable that we will be unable to collect the scheduled payments of principal and interest when due according to the contractual terms of the loan or lease agreement.

The allowance for credit losses represents management’s best estimate of probable incurred losses in our loan and lease portfolio. Management’s quarterly evaluation of the allowance for credit losses is a comprehensive analysis that builds a total allowance by evaluating the probable incurred losses within each loan and lease portfolio segment. Our portfolio segments are as follows: commercial loan and commercial real estate loans, commercial leases, residential real estate, indirect consumer loans and other consumer loans. Our allowance for credit losses consists of specific valuation allowances based on probable credit losses on specific loans, historical valuation allowances based on loan loss experience for similar loans with similar characteristics and trends and general valuation allowances based on general economic conditions and other qualitative risk factors both internal and external to the organization.

Historical valuation allowances are calculated for commercial loans and leases based on the historical loss experience of specific types of loans and leases and the internal risk grade 24 months prior to the time they were charged off. The internal credit risk grading process evaluates, among other things, the borrower’s ability to repay, the underlying collateral, if any, and the economic environment and industry in which the borrower operates. Historical valuation allowances for residential real estate and consumer loan segments are based on the average loss rates for each class of loans for the time period that includes the current year and two full prior years. We calculate historical loss ratios for pools of similar consumer loans based upon the product of the historical loss ratio and the principal balance of the loans in the pool. Historical loss ratios are updated quarterly based on actual loss experience. Our general valuation allowances are based on general economic conditions and other qualitative risk factors which affect our company. Factors considered include trends in our delinquency rates, macro-economic and credit market conditions, changes in asset quality, changes in loan and lease portfolio volumes, concentrations of credit risk, the changes in internal loan policies, procedures and internal controls, experience and effectiveness of lending personnel. Management evaluates the degree of risk that each one of these components has on the quality of the loan and lease portfolio on a quarterly basis.

~~For~~ $301,000 ~~commercial~~in ~~loan~~2011, and ~~lease segments~~$277,000 ~~we maintain a specific allocation methodology for those classified~~ in ~~our~~2010. ~~internal~~We ~~risk~~consider ~~grading system as substandard, doubtful or loss with~~ a ~~principal balance in excess of $200,000. A~~ loan or lease ~~is considered~~ impaired when, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal orand interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on the estimated fair value of the collateral. Loans with modified terms in which a concession to the borrower has been made that it would not otherwise consider unless the borrower was experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. As of December 31, 2011, there was $9.1 million in impaired loans for which $2.1 million in related allowance for credit losses was allocated. There was $3.9 million in impaired loans for which $421,000 in related allowance for credit losses was allocated as of December 31, 2010.

During the third quarter of 2012, we added a qualitative factor to address the potential risk of credit losses that could result from conversion related distractions and potential turnover that may occur in connection with the proposed merger with NBT, and the potential effects on the underwriting process and relationship management. Management believes the development of a qualitative factor for this risk is appropriate since the risk of such negative events occurring cannot be eliminated. Management is committed to the continuation of loan portfolio monitoring and underwriting standards that was in place prior to the merger announcement. The merger related qualitative factor increased our qualitative allocation by $305,000 as of December 31, 2012.

For commercial loan and lease segments, we maintain a specific allocation methodology for those classified in our internal risk grading system as substandard, doubtful or loss with a principal balance in excess of $200,000. A loan or lease is considered impaired, based on current information and events, if it is probable that we will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan or lease agreement. The measurement of impaired loans and leases is generally discounted at the historical effective interest rate, except that all collateral-dependent loans and leases are measured for impairment based on the estimated fair value of the collateral. Loans with modified terms in which a concession to the borrower has been made that it would not otherwise consider unless the borrower was experiencing financial difficulties, are considered troubled debt restructurings and classified as impaired. As of December 31, 2012, there was $4.3 million in impaired loans for which $265,000 in related allowance for credit losses was allocated. There was $9.1 million in impaired loans for which $2.1 million in related allowance for credit losses was allocated as of December 31, 2011.

Loans and leases are charged against the allowance for credit losses, in accordance with our loan and lease policy, when they are determined by management to be uncollectible. Recoveries on loans and leases previously charged off are credited to the allowance for credit losses when they are received. When management determines that the allowance for credit losses is less than adequate to provide for probable incurred losses, a direct charge to operating income is recorded.

The following table summarizes changes in the allowance for credit losses arising from loans and leases charged off, recoveries on loans and leases previously charged off and additions to the allowance, which have been charged to expense.

	Years ended December 31,
	2011		2010		2009		2008		2007
	(In thousands)
Balance at beginning of year		$10,683		$9,414		$9,161		$8,426		$7,029
Loans and leases charged-off:
Residential real estate		224		322		76		276		103
Commercial loans and commercial real estate		1,268		634		1,622		1,940		545
Leases		343		1,345		4,122		1,844		881
Indirect auto		326		251		317		295		211
Consumer		1,010		1,055		1,135		1,284		1,487
Total loans and leases charged off		3,171		3,607		7,272		5,639		3,227
Recoveries of loans and leases previously charged off:
Residential real estate		45		54		59		32		1
Commercial loans and commercial real estate		137		34		514		113		48
Leases		455		81		165		40		13
Indirect auto		192		133		133		91		119
Consumer		518		489		554		596		653
Total recoveries		1,347		791		1,425		872		834
Net loans and leases charged off		1,824		2,816		5,847		4,767		2,393
Provision for credit losses		1,910		4,085		6,100		5,502		3,790
Balance at end of year		$10,769		$10,683		$9,414		$9,161		$8,426

The provision for credit losses decreased 53.2% in 2011 compared to 2010 due primarily to a 35.2% decrease in net charge-offs in 2011 and to relatively low and stable delinquencies. The provision expense was $1.9 million in 2011 compared to $4.1 million in 2010.

Net charge-offs totaled $1.8 million in 2011 compared to $2.8 million in 2010. The decrease in net charge-offs was largely the result of a 74.5% drop in lease charge-offs in 2011 compared to 2010, and a 462% increase in 2011 in recoveries of previously charged-off leases resulting from our ongoing collection efforts. Net recoveries of leases totaled $112,000 in 2011, compared to net charge-offs of $1.3 million in 2010. Net charge-offs in our commercial portfolio increased $530,000 or 89% in 2011 compared to 2010, largely due to the write-down on the $3.6 million impaired credit discussed previously in this report.

Total net charge-offs equaled 0.21% of average loans and leases in 2011, compared to 0.31% in 2010. The provision for credit losses as a percentage of net charge-offs was 105% in 2011, compared to 145% in 2010. The allowance for credit losses was $10.8 million at December 31, 2011, compared with $10.7 million at the end of 2010. The ratio of the allowance for credit losses to total loans and leases was 1.24% at December 31, 2011, compared with 1.19% at December 31, 2010. The ratio of the allowance for credit losses to nonperforming loans and leases was 95% at December 31, 2011, compared with 126% at the end of 2010.

The portion of the allowance for credit losses that is based on loans and leases that are evaluated individually for impairment increased $1.7 million or 398% at December 31, 2011 compared to the end of 2010 due primarily to the classification of the $2.6 million commercial relationship as impaired in the third quarter of 2011. Conversely, the portion of the allowance for credit losses that is based on loans and leases evaluated collectively for impairment decreased $1.7 million or 18% over the same period. This decrease was due to a sharp decline in charge-offs in our lease portfolio in 2011 compared to 2010 and 2009 and to a $16.8 million decrease in the balance of our lease portfolio in 2011, which resulted in a reduced collective impairment allowance allocation for this portfolio totaling $1.1 million along with a reduction of $476,000 of allowance out of the collective impairment evaluation category in the third quarter related to the above-mentioned $2.6 million impaired relationship. The $1.1 million reduction in the allowance allocated to our lease portfolio was effectively re-allocated primarily to commercial loans that were placed on non-accrual status in 2011, which is the primary reason that the allowance for credit losses as a percentage of non-performing loans decreased in 2011.


	Years ended December 31,
	2012			2011		2010		2009		2008
	(In thousands)
Balance at beginning of year	$	10,769		$	10,683	$	9,414	$	9,161	$	8,426
Loans and leases charged-off:
Residential real estate		102			224		322		76		276
Commercial loans and commercial real estate		2,148			1,268		634		1,622		1,940
Leases		14			343		1,345		4,122		1,844
Indirect auto		138			326		251		317		295
Consumer		862			1,010		1,055		1,135		1,284

Total loans and leases charged off		3,264			3,171		3,607		7,272		5,639
Recoveries of loans and leases previously charged off:
Residential real estate		16			45		54		59		32
Commercial loans and commercial real estate		456			137		34		514		113
Leases		318			455		81		165		40
Indirect auto		114			192		133		133		91
Consumer		462			518		489		554		596

Total recoveries		1,366			1,347		791		1,425		872

Net loans and leases charged off		1,898			1,824		2,816		5,847		4,767
Provision for credit losses		(300	)		1,910		4,085		6,100		5,502

Balance at end of year	$	8,571		$	10,769	$	10,683	$	9,414	$	9,161

AsNet ~~discussed~~charge-offs ~~above,~~were we$1.9 ~~assess~~million ain ~~number~~2012, ofcompared ~~quantitative~~with ~~and~~$1.8 ~~qualitative~~million ~~factors~~in at2011. ~~the~~As ~~individual~~was ~~portfolio~~previously ~~level~~disclosed in ~~determining~~ ~~the~~our ~~adequacy~~2012 quarterly ofreports ~~the~~on ~~allowance~~Form ~~for credit losses each quarter. In addition~~10-Q, we ~~analyze~~recorded ~~certain broader, non~~write-~~portfolio~~downs ~~specific~~totaling ~~factors~~$2.7 inmillion ~~assessing~~on ~~the~~one ~~adequacy~~$3.6 ofmillion ~~the~~impaired ~~allowance~~commercial ~~for~~relationship ~~credit~~between ~~losses, such as~~ the ~~allowance~~fourth asquarter ~~a percentage~~ of ~~total~~2011 ~~loans~~ and ~~leases,~~ the ~~allowance~~third asquarter ~~a percentage~~ of ~~nonperforming~~2012. ~~loans~~Approximately ~~and~~$1.7 ~~leases~~million ~~and~~or ~~the~~52% ~~provision expense as a percentage~~ of ~~net~~the gross charge-offs~~. As~~ ~~our~~recognized ~~asset quality metrics and net charge-off levels have improved~~ in ~~recent quarters,~~2012 anwere ~~increasing~~on ~~portion~~this ofone ~~the allowance for credit losses has been considered “unallocated~~relationship,” which ~~means~~was ittransferred isto ~~not~~real ~~based~~estate onowned ~~either~~at ~~quantitative~~a ornet ~~qualitative~~amount ~~factors~~of ~~but~~$898,000 onin the ~~broader,~~third ~~non-portfolio~~quarter ~~specific~~of ~~factors~~2012. ~~At December 31,~~ ~~2011,~~Net ~~$991,000~~charge-offs orannualized 9equaled 0.221% of ~~the~~average ~~allowance~~loans ~~for~~and ~~credit~~leases ~~losses~~in ~~was considered to be “unallocated~~2012,” compared with ~~to $874,000 or 8~~0.221% ofin ~~the allowance at December 31, 2010~~2011. We ~~consider~~Our ~~the~~annualized ~~current~~net ~~“unallocated” amount~~charge-off torate behas ataveraged or0.26% ~~near~~over ~~a maximum level and, absent any material deterioration in credit quality from recent trends, or material growth in~~ the ~~loan~~past ~~and~~six ~~lease portfolio~~quarters, ~~some portion~~ of ~~this~~which ~~“unallocated”~~all ~~allowance~~but ~~may~~5 bebasis ~~reduced~~points byis ~~future credit~~attributable ~~losses,~~to ~~which would have~~ the ~~effect~~losses ofrecognized ~~lowering~~on the ~~amount~~one ~~of provision expense relative to net charge-offs compared to recent quarters (e~~$3.g.6 ~~less~~million ~~than~~commercial ~~dollar-for-dollar)~~relationship.

~~The~~Approximately ~~allowance~~$1.9 million or 58% of the gross charge-offs recognized in 2012 were on loans that were considered impaired at the end of 2011 and for which ~~credit~~impairment ~~losses~~reserves ~~has~~were ~~been~~largely ~~allocated~~established ~~within~~due to the ~~following~~identification ~~categories~~of probable “loss events” in the fourth quarter of ~~loans~~2011. Charge-offs on these impaired credits were recognized in 2012 upon the occurrence of events confirming the existence of the losses, including further deterioration in the respective borrower’s financial condition and ~~leases~~negotiated atsettlements. A substantial portion of the ~~dates~~allowance ~~indicated~~allocated ~~with~~to these impaired credits in 2011 came from the release ~~corresponding~~of ~~percent~~a portion of ~~loans~~the general allowance for our lease portfolio. During 2011, approximately $1.2 million of the allowance that had been allocated from our lease portfolio prior to ~~total~~2011 ~~loans~~was ~~for~~released ~~each~~due ~~category~~to a substantial decline in charge-offs in our lease portfolio in 2011 compared with 2010 and 2009 (~~dollars~~the years in ~~thousands~~which provisions for possible lease losses were charged to earnings): and to a $16.8 million decrease in the balance of that portfolio during 2011.

	At December 31,
	2011				2010				2009				2008				2007
	Amount of Allowance		Percent of Loans to Total Loans		Amount of Allowance		Percent of Loans to Total Loans		Amount of Allowance		Percent of Loans to Total Loans		Amount of Allowance		Percent of Loans to Total Loans		Amount of Allowance		Percent of Loans to Total Loans
Residential real estate		$ 750		36.4%		$ 946		37.4%		$ 891		39.2%		$ 850		34.6%		$ 978		30.6%
Commercial(1)		6,994		32.0%		5,568		27.9%		3,771		22.9%		3,988		23.6%		4,097		24.4%
Leases		503		3.0%		1,583		4.8%		2,212		7.5%		2,673		11.6%		1,951		14.7%
Indirect auto		784		18.3%		933		19.7%		973		20.3%		879		20.2%		685		19.7%
Consumer		747		10.3%		779		10.2%		818		10.1%		771		10.0%		715		10.6%
Unallocated		991		—%		874		—%		749		—%		—		—		—		—
Total		$10,769		100.0%		$10,683		100.0%		$9,414		100.0%		$9,161		100.0%		$8,426		100.0%

A negative provision expense of $300,000 was recorded in 2012, compared to provision expense of $1.9 million in 2011. Alliance assesses a number of quantitative and qualitative factors at the individual portfolio level in determining the adequacy of the allowance for credit losses and the required provision expense each quarter. In addition, Alliance analyzes certain broader, non-portfolio specific factors in assessing the adequacy of the allowance for credit losses, such as the allowance as a percentage of total loans and leases, the allowance as a percentage of non-performing loans and leases and the provision expense as a percentage of net charge-offs. In doing so, a portion of the allowance has been considered “unallocated”, which means it is not based on either quantitative or qualitative factors, but on the broader, non-portfolio specific factors mentioned above. At December 31, 2012, $279,000 or 3% of the allowance for credit losses was considered to be “unallocated,” compared to $991,000 or 9% at December 31, 2011. Consistent with the improvement in our asset quality metrics and net charge-off levels in recent quarters (excluding the charge-offs related to the one commercial relationship discussed above), the relative level of unallocated allowance to the total allowance has trended downward in 2012. Absent any material deterioration in credit quality or material growth in the loan and lease portfolio, some portion of this “unallocated” allowance may be reduced by future probable credit losses, which would have the effect of lowering the amount of provision expense relative to net charge-offs compared with past quarters, which was the case in the fourth quarter of 2012.

(The allowance for credit losses was $8.6 million at December 31, 2012, compared with $10.8 million at December 31, 2011. The ratio of the allowance for credit losses to total loans and leases was 0.93% at December 31, 2012, compared with 1).24% ~~includes~~at December 31, ~~commercial~~2011. ~~real~~The ~~estate~~ratio of the allowance for credit losses to non-performing loans and leases was 178% at December 31, 2012, compared with 96% at December 31, 2011.

The allowance for credit losses is allocated according to the amount deemed to be reasonably necessary to provide for the probable incurred losses within each category of loans and leases. Increases in the amount allocated to the commercial and lease portfolios reflect the higher outstanding balances of these portfolios coupled with the higher inherent risk of these portfolios compared with residential and consumer lending.

The allowance for credit losses has been allocated within the following categories of loans and leases at the dates indicated with the corresponding percent of loans to total loans for each category (dollars in thousands):


	At December 31,
	2012					2011					2010					2009					2008
	Amount of Allowance		Percent of Loans to Total Loans			Amount of Allowance		Percent of Loans to Total Loans			Amount of Allowance		Percent of Loans to Total Loans			Amount of Allowance		Percent of Loans to Total Loans			Amount of Allowance		Percent of Loans to Total Loans

Residential real estate	$	977		35.6	%	$	750		36.4	%	$	946		37.4	%	$	891		39.2	%	$	850		34.6	%
Commercial⁽¹⁾		5,282		32.2	%		6,994		32.0	%		5,568		27.9	%		3,771		22.9	%		3,988		23.6	%
Leases		278		1.1	%		503		3.0	%		1,583		4.8	%		2,212		7.5	%		2,673		11.6	%
Indirect auto		1,053		21.6	%		784		18.3	%		933		19.7	%		973		20.3	%		879		20.2	%
Consumer		701		9.5	%		747		10.3	%		779		10.2	%		818		10.1	%		771		10.0	%
Unallocated		280		—	%		991		—	%		874		—	%		749		—	%		—		—

Total	$	8,571		100.0	%	$	10,769		100.0	%	$	10,683		100.0	%	$	9,414		100.0	%	$	9,161		100.0	%

(1)	Includes commercial real estate loans

Deposits

Our primary source of funds is deposits, consisting of demand, savings, money market and time accounts, of retail, commercial and municipal customers gathered through our branch network. We continuously monitor market pricing, competitors’ rates, and internal interest rate spreads to maintain and promote growth and profitability.

The following table sets forth the composition of our deposits by business line at year-end (dollars in thousands):

	December 31, 2011
	December 31, 2012
	Retail		Commercial		Municipal		Total		Percent
Non-interest checking	$	~~$ 46~~52,~~580~~440	$	~~$135~~171,~~252~~962	$	~~$ 3~~6,~~904~~153	$	~~$ 185~~230,~~736~~555		1721.1%	%
Interest checking		~~110~~118,~~886~~069		1618,~~831~~400		1821,~~168~~434		~~145~~157,~~885~~903		1314.5%4	%
Total checking		~~157~~170,~~466~~509		~~152~~190,~~083~~362		2227,~~072~~587		~~331~~388,~~621~~458		3035.6%5	%
Savings		92101,~~240~~210		1113,~~367~~103		3,~~704~~428		~~107~~117,~~311~~741		910.9%8	%
Money market		8899,~~056~~218		~~122~~125,~~195~~554		~~119~~127,~~749~~548		~~330~~352,~~000~~320		3032.5%1	%
Time deposits		~~237~~168,~~929~~800		2619,~~907~~872		4947,~~297~~802		~~314~~236,~~133~~474		2921.0%6	%
Total deposits	$	~~$575~~539,~~691~~737	$	~~$312~~348,~~552~~891	$	~~$194~~206,~~822~~365	$	$1,~~083~~094,~~065~~993		100.0%	%
	December 31, 2010
	Retail		Commercial		Municipal		Total		Percent
Non-interest checking		$ 41,962		$133,979		$ 3,977		$ 179,918		15.9%
Interest checking		109,682		12,906		29,306		151,894		13.3%
Total checking		151,644		146,885		33,283		331,812		29.2%
Savings		88,785		11,646		2,668		103,099		9.1%
Money market		88,870		109,282		159,733		357,885		31.5%
Time deposits		257,489		23,677		60,636		341,802		30.2%
Total deposits		$586,788		$291,490		$256,320		$1,134,598		100.0%

Total deposits were $1.1 billion at December 31, 2011, which was a decrease of $51.5 million or 4.5% compared with December 31, 2010. Municipal deposits decreased $61.5 million in 2011, following an increase of $52.5 million in 2010, reflecting typical fluctuations of large balance municipal accounts. The deposit growth we experienced in 2009 and 2010 abated in 2011, due to low deposit account rates and a general decline in the flight to safety which drove banking industry deposits substantially higher over the past three years. Our deposit mix at the end of the year continued to be weighted heavily in lower cost demand, savings and money market accounts (transaction accounts). Transaction accounts totaled $768.9 million or 71.0% of total deposits at the end of 2011, compared to $792.8 million or 69.9% at the end of 2010, as a decline in municipal money market accounts offset growth in retail and commercial transaction account balances. Our ability to gather and retain transaction deposits over the past three years has been greatly enhanced by our strong financial position and earnings performance, enhanced product offerings including upgraded treasury management and internet banking platforms, and a high positive awareness of Alliance’s brand. Environmental factors such as equity market volatility and risk aversion among retail investors, and the buildup of cash on corporate balance sheets have also played a role in the growth in our transaction accounts.


	December 31, 2011
	Retail		Commercial		Municipal		Total		Percent
Non-interest checking	$	46,580	$	135,252	$	3,904	$	185,736		17.1	%
Interest checking		110,886		16,831		18,168		145,885		13.5	%

Total checking		157,466		152,083		22,072		331,621		30.6	%

Savings		92,240		11,367		3,704		107,311		9.9	%
Money market		88,056		122,195		119,749		330,000		30.5	%
Time deposits		237,929		26,907		49,297		314,133		29.0	%


Total deposits	$	575,691	$	312,552	$	194,822	$	1,083,065		100.0	%

~~Time~~Total deposits inwere ~~excess~~$1.1 ofbillion ~~$100~~at December 31,~~000~~ 2012, which ~~tend~~was tonearly beunchanged ~~more~~from ~~volatile~~December 31, ~~and~~2011. ~~sensitive~~Our deposit tomix ~~interest~~at ~~rates,~~the ~~totaled~~end ~~$123.4~~of ~~million~~the atyear ~~December 31,~~continued ~~2011,~~to ~~representing~~be ~~39.3%~~weighted ofheavily ~~total~~in ~~time~~lower ~~deposits~~cost demand, savings and ~~11.4% of~~money ~~total~~market ~~deposits~~accounts (transaction accounts). ~~These~~Transaction ~~deposits~~accounts totaled $~~137~~858.05 million, ~~representing~~or 4078.04% of total ~~time~~ deposits ~~and~~at 12the end of 2012, compared to $769.9 million or 71.1% of total deposits at ~~year-~~the end ~~2010.~~of 2011, as we continued to

The following table schedules the amount of our time deposits of $100,000 or more by time remaining until maturity as of December 31, 2011 (in thousands):

Less than three months			$ 32,792
Three months to six months			23,779
Six months to one year			37,665
Over one year			29,159
Total			$123,395

experience a shift in customer deposits from maturing time accounts into transaction accounts as retail and municipal depositors continue to prefer transaction accounts over time accounts in the low interest rate environment.

Our ability to gather and retain transaction deposits over the past three years has been greatly enhanced by our strong financial position and earnings performance, enhanced product offerings including upgraded treasury management and internet banking platforms, and a high positive awareness of our brand. Environmental factors such as equity market volatility and risk aversion among retail investors, and the buildup of cash on corporate balance sheets have also played a role in the growth in our transaction accounts.

Time deposits in excess of $100,000, which tend to be more volatile and sensitive to interest rates, totaled $100.9 million at December 31, 2012, representing 43% of total time deposits and 9% of total deposits. These deposits totaled $123.4 million, representing 39% of total time deposits and 11% of total deposits at year-end 2011.

The following table schedules the amount of our time deposits of $100,000 or more by time remaining until maturity as of December 31, 2012 (in thousands):


Less than three months	$	21,568
Three months to six months		24,845
Six months to one year		18,906
Over one year		35,548

Total	$	100,867

Borrowings

We offer retail repurchase agreements primarily to our larger business customers. Under the terms of the agreements, we sell investment portfolio securities to the customer and agree to repurchase the securities on the next business day. We use this arrangement as a deposit alternative for our business customers. As of December 31, ~~2011~~2012, retail repurchase agreement balances amounted to $2621.32 million compared towith balances of $2526.83 million at December 31, ~~2010~~2011.

During ~~2011~~2012, we utilized collateralized repurchase agreements with various brokers and advances from the Federal Home Loan Bank of New York (FHLB) as alternative sources of funding and as a liability management tool. At December 31, ~~2011~~2012, the combination of repurchase agreements and FHLB advances was $~~110~~100.0 million, compared with $~~117~~110.0 million at December 31, ~~2010~~2011. Detailed information regarding our borrowings is included in Note 7 in the consolidated financial statements ~~contained~~included elsewhere in this report.

Total borrowings decreased $615.51 million or 411.51% in ~~2011~~2012 as we used our net cash inflows from securities and loan and lease amortization to pay down borrowings maturing during the year.

Capital

We use certain non-GAAP financial measures, such as the Tangible Common Equity to Tangible Assets ratio (TCE), to provide information for investors to effectively analyze financial trends of ongoing business activities, and to enhance comparability with peers across the financial sector. We believe TCE is useful because it is a measure utilized by regulators, market analysts and investors in evaluating a company’s financial condition and capital strength. TCE, as defined by us, represents common equity less goodwill and intangible assets. A reconciliation from the our GAAP Total Equity to Total Assets ratio to the Non-GAAP Tangible Common Equity to Tangible Assets ratio is presented below:

(in thousands)	December 31, ~~2011~~2012
Total assets	$	$1,~~409~~406,~~090~~357
Less: Goodwill and intangible assets, net		3837,~~538~~671
Tangible assets (non-GAAP)		1,~~370~~368,~~552~~686
Total Common Equity		~~143~~146,~~997~~945
Less: Goodwill and intangible assets, net		3837,~~538~~671
Tangible Common Equity (non-GAAP)		~~105~~109,~~459~~274
Total Equity/Total Assets		10.~~22%~~45	%
Tangible Common Equity/Tangible Assets (non-GAAP)		7.~~69%~~98	%

Shareholders’ equity was $144.0 million at December 31, 2011, compared with $133.1 million at December 31, 2010. Net income for 2011 increased shareholders’ equity by $13.3 million and was partially offset by common stock dividends declared of $5.8 million or $1.22 per common share. Common stock and paid-in surplus increased $1.6 million in 2011, on the exercise of employee stock options, purchases of our common stock under our Directors’ Stock-Based Deferral Plan and amortization of unvested restricted stock grants. Accumulated other comprehensive income increased $2.2 million due to a $3.2 million increase in unrealized securities gain, net of tax, partially offset by a $1.0 million increase in the unrecognized loss for benefit obligations, net of tax which resulted from a lower discount rate used to calculate our benefit obligations because of lower market interest rates.

Our consolidated Tier 1 leverage ratio was 9.09% and our consolidated total risk-based capital ratio was 15.97% at the end of 2011, both of which exceeded regulatory minimum thresholds for capital adequacy purposes. Our tangible common equity capital ratio was 7.69% at the end of 2011.

We are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of our assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to

~~ensure~~Shareholders’ ~~capital~~equity ~~adequacy~~was ~~require~~$146.9 ~~Alliance~~million ~~and~~at ~~the~~December 31, ~~Bank~~2012, tocompared ~~maintain~~with ~~minimum~~$144.0 ~~amounts~~million ~~and ratios~~at December 31, as2011. ~~defined~~Net inincome ~~the~~for ~~regulations,~~2012 ofincreased ~~total~~shareholders’ equity by $9.2 million and ~~risk-based~~was ~~capital,~~partially ~~Tier~~offset 1by ~~capital~~common tostock ~~risk-weighted assets~~dividends ~~and~~declared of ~~Tier~~$6.0 1million ~~Capital~~or to$1.26 ~~average~~per ~~assets~~common share.

AsOur ofconsolidated ~~December 31,~~Tier ~~2011,~~1 ~~the~~leverage ~~most~~ratio ~~recent~~was ~~notification~~9.37% ~~from~~and ~~the~~our ~~OCC categorized~~consolidated ~~the~~total ~~Bank~~risk-based ascapital ~~“well~~ratio ~~capitalized,”~~was ~~under the regulatory framework for prompt corrective action~~15.27% ~~Management~~at ~~believes~~the ~~that,~~end as of ~~December 31~~2012, ~~2011,~~both ~~Alliance~~of ~~and~~which exceeded ~~the~~regulatory ~~Bank~~minimum ~~met~~thresholds ~~all~~for capital adequacy ~~requirements to which they were subject~~purposes. AOur ~~more~~tangible ~~comprehensive~~common ~~analysis~~equity ~~of regulatory~~ capital ~~requirements,~~ratio ~~including~~was ~~ratios~~7.98% ~~for~~at ~~Alliance and~~ the ~~Bank,~~end ~~is included in Note 18~~ of ~~the consolidated financial statements contained elsewhere in this report~~2012.

As of December 31, 2012, the most recent notification from the OCC categorized the Bank as “well capitalized,” under the regulatory framework for prompt corrective action. Management believes that, as of December 31, 2012, Alliance and the Bank met all capital adequacy requirements to which they were subject. A more comprehensive analysis of regulatory capital requirements, including ratios for Alliance and the Bank, is included in Note 18 of the consolidated financial statements included elsewhere in this report.

Liquidity and Capital Resources

Our liquidity is primarily measured by our ability to provide funds to meet loan requests, to accommodate possible outflows of deposits, and to take advantage of market interest rate opportunities. Funding of loan commitments, providing for liability outflows, and management of interest rate fluctuations require continuous analysis in order to match the maturities of specific categories of short-term loans and investments with specific types of deposits and borrowings. Liquidity is normally considered in terms of the nature and mix of our sources and uses of funds. Our Asset Liability Management Committee (ALCO) is responsible for implementing the policies and guidelines for the maintenance of prudent levels of liquidity. Management believes, as of December 31, ~~2011~~2012, that our liquidity measurements are in compliance with our policy guidelines.

Our principal sources of funds for operations are cash flows generated from earnings, deposits, securities, loan and lease repayments, borrowings from the FHLB, and securities sold under repurchase agreements. During the year ended December 31, ~~2011~~2012, cash and cash equivalents ~~increased~~decreased by $2019.31 million, as net cash provided by operating ~~and investing~~ activities of $8317.81 million was ~~partially~~ offset by net cash used in investing financing activities of $6336.52 million. Net cash ~~provided~~used byin ~~operating~~investing activities ~~was~~ primarily ~~provided~~resulted byfrom a net increase ~~income~~in loans and leases of $1358.3 million., ~~Net~~partly ~~cash~~offset ~~provided~~ by ~~investing~~net ~~activities~~cash ~~primarily~~used ~~resulted~~in ~~from~~ securities sales, maturities and principal repayments exceeding securities ~~purchases~~purchased by $4133.40 million ~~combined with a net decrease in loans and leases of $22~~.8 ~~million.~~ Net cash used in financing activities primarily resulted from ~~a net decrease in deposits of~~ $5115.51 million, ~~$6.5 million~~ in net repayments on borrowings and $57.85 million in cash dividends paid to common shareholders, partly offset by a net increase in time deposits of $11.9 million.

As a member of the FHLB, the Bank is eligible to borrow up to an established credit limit against certain residential mortgage loans and investment securities that have been pledged as collateral. As of December 31, 2011, the Bank’s credit limit with the FHLB was $287.5 million with outstanding borrowings in the amount of $110.0 million.

The Bank had a $132.9 million line of credit at December 31, 2011 with the Federal Reserve Bank of New York through its Discount Window, and has pledged as collateral indirect auto loans and securities totaling $158.6 million and $4.9 million, respectively, at December 31, 2011. We did not draw any funds on this line of credit in 2011. At December 31, 2011 and 2010, the Bank also had available $72.5 million of federal funds lines of credit with other financial institutions, none of which was in use at December 31, 2011 and 2010, respectively.

In December 2003, we formed Alliance Financial Capital Trust I, a wholly owned subsidiary of Alliance. The trust was formed for the purpose of issuing $10.0 million of Company-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and investing the proceeds from the sale of such capital securities solely in our junior subordinated debt securities. The debentures held by the trust are the sole assets of that trust. Distributions on the capital securities issued by the trust are payable quarterly at a rate per annum equal to the interest rate being earned by the trust on the debentures held by the trust. The capital securities have a variable annual coupon rate that resets quarterly based upon three-month LIBOR plus 285 basis points (3.28% at December 31, 2011). The capital securities have a 30-year maturity and are redeemable at par beginning in January 2009.

In September 2006, we formed Alliance Financial Capital Trust II, a wholly owned subsidiary of the Company. The trust was formed for the purpose of issuing $15.0 million of Company-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and investing the proceeds from the sale of such capital securities solely in our junior subordinated debt securities. The debentures held by the trust are the sole assets of that trust. Distributions on the capital securities issued by the trust are payable quarterly at a rate per annum equal to the interest rate being earned by the trust on the debentures held by the trust. The capital securities have a variable annual coupon rate that resets quarterly based upon three-month LIBOR plus 165 basis points (2.20% at December 31, 2011). The capital securities have a 30-year maturity and are redeemable at par in September 2011 and any time thereafter.

As a member of the FHLB, the Bank is eligible to borrow up to an established credit limit against certain residential mortgage loans and investment securities that have been pledged as collateral. As of December 31, 2012, the Bank’s credit limit with the FHLB was $164.3 million with outstanding borrowings in the amount of $100.0 million.

The Bank had a $164.3 million line of credit at December 31, 2012 with the Federal Reserve Bank of New York through its Discount Window, and has pledged as collateral indirect auto loans and securities totaling $160.1 million and $4.2 million, respectively, at December 31, 2012. We did not draw any funds on this line of credit in 2012. At December 31, 2012 and 2011, the Bank also had available $62.5 million of federal funds lines of credit with other financial institutions, none of which was in use at December 31, 2012 and 2011, respectively.

In December 2003, we formed Alliance Financial Capital Trust I, a wholly owned subsidiary of Alliance. The trust was formed for the purpose of issuing $10.0 million of Company-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and investing the proceeds from the sale of such capital securities solely in our junior subordinated debt securities. The debentures held by the trust are the sole assets of that trust. Distributions on the capital securities issued by the trust are payable quarterly at a rate per annum equal to the interest rate being earned by the trust on the debentures held by the trust. The capital securities have a variable annual coupon rate that resets quarterly based upon three-month LIBOR plus 285 basis points (3.16% at December 31, 2012). The capital securities have a 30-year maturity and are redeemable at par beginning in January 2009.

In September 2006, we formed Alliance Financial Capital Trust II, a wholly owned subsidiary of the Company. The trust was formed for the purpose of issuing $15.0 million of Company-obligated mandatorily redeemable capital securities (the capital securities) to third-party investors and investing the proceeds from the sale of such capital securities solely in our junior subordinated debt securities. The debentures held by the trust are the sole assets of that trust. Distributions on the capital securities issued by the trust are payable quarterly at a rate per annum equal to the interest rate being earned by the trust on the debentures held by the trust. The capital securities have a variable annual coupon rate that resets quarterly based upon three-month LIBOR plus 165 basis points (1.96% at December 31, 2012). The capital securities have a 30-year maturity and are redeemable at par in September 2011 and any time thereafter.

Contractual Obligations, Commitments, and Off-Balance Sheet Arrangements

Contractual Obligations

We have various financial obligations, including contractual obligations and commitments that may require future cash payments. The following table presents as of December 31, ~~2011~~2012, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements included elsewhere in this report.

Payments Due In

Note Reference

OneYear or Less

One toThree Years

Three to Five Years

OverFive Years

Total

NoteReference

OneYearor Less

One toThreeYears

Three toFive Years

OverFiveYears

Total

(Dollars in thousands)

Time deposits*

~~$220~~168,~~450~~529

~~$85~~57,~~555~~560

$810,~~080~~385

~~$48~~—

~~$314~~236,~~133~~474

Borrowings*

3621,~~310~~169

6050,000

4035,000

—15,000

~~136~~121,~~310~~169

Junior subordinated obligations issued to unconsolidated subsidiaries*

—

25,774

Operating leases

1,~~072~~086

1,~~884~~717

1,~~675~~629

32,~~663~~872

87,~~294~~304

Purchase obligations

~~172~~152

~~344~~304

~~324~~303

1,~~214~~062

21,~~053~~821

Total

~~$258~~190,~~004~~936

~~$147~~109,~~782~~581

~~$50~~47,~~079~~317

~~$30~~44,~~699~~708

~~$486~~392,~~564~~542

* Excludes interest

We have obligations under our pension, post-retirement plan, directors’ retirement and supplemental executive retirement plans as described in Note 12 to the consolidated financial statements. The supplemental executive retirement, pension and postretirement benefit and directors’ retirement payments represent actuarially determined future benefit payments to eligible plan participants.

Commitments and Off-Balance Sheet Arrangements

In the normal course of business, to meet the financing needs of our customers and to reduce our exposure to fluctuations in interest rates, we are a party to financial instruments with off-balance sheet risk, held for purposes other than trading. The financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. Our exposure to credit loss in the event of nonperformance by the other party to the financial instrument, for loan commitments and standby letters of credit, is represented by the contractual amount of those instruments, assuming that the amounts are fully advanced and that collateral or other security is of no value. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet loans. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on management’s credit evaluation of the borrower. Collateral held varies, but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial properties. Commitments to originate loans, unused lines of credit, and un-advanced portions of construction loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Many of the commitments are expected to expire without being drawn upon. Therefore, the amounts presented below do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance by a customer to a third party. These guarantees are issued primarily to support public and private borrowing arrangements, bond financing, and similar transactions. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan commitments to customers.

The following table details the amounts and expected maturities of significant commitments and off-balance sheet arrangements as of December 31, 2011. Further discussion of these commitments and off-balance sheet arrangements is included in Note 15 to the consolidated financial statements contained elsewhere in this report.

Commitments to extend credit:	One Year or Less		One to Three Years		Three to Five Years		Over Five Years		Total
	(Dollars in thousands)
Residential real estate		$15,360		$ —		$ —		$ —		$ 15,360
Commercial loans and leases		45,857		9,549		581		23,372		79,359
Revolving home equity lines		3,310		14,508		9,623		27,522		54,963
Consumer revolving credit		31,656		—		—		—		31,656
Standby letters of credit		3,620		—		—		—		3,620
Total		$98,803		$24,057		$10,204		$50,894		$184,958

Commitments and Off-Balance Sheet Arrangements

The following table details the amounts and expected maturities of significant commitments and off-balance sheet arrangements as of December 31, 2012. Further discussion of these commitments and off-balance sheet arrangements is included in Note 15 to the consolidated financial statements included elsewhere in this report.


Commitments to extend credit:	One Year or Less		One to Three Years		Three to Five Years		Over Five Years		Total
	(Dollars in thousands)
Residential real estate	$	22,991	$	—	$	—	$	—	$	22,991
Commercial loans and leases		53,352		9,640		2		21,718		84,712
Revolving home equity lines		3,114		12,380		11,848		28,438		55,780
Consumer revolving credit		32,422		—		—		—		32,422
Standby letters of credit		4,568		—		—		—		4,568

Total	$	116,447	$	22,020	$	11,850	$	50,156	$	200,473

Application of Critical Accounting Policies

Our consolidated financial statements are prepared in accordance with GAAP. Application of these principles requires management to make estimates, assumptions, and judgments that affect the amounts reported in the financial statements and accompanying notes. These estimates, assumptions, and judgments are based on information available as of the date of the financial statements; accordingly, as this information changes, the financial statements could reflect different estimates, assumptions, and judgments. Certain policies inherently have a greater reliance on the use of estimates, assumptions, and judgments and as such have a greater possibility of producing results that could be materially different than originally reported. Estimates, assumptions, and judgments are necessary when assets and liabilities are required to be recorded at fair value or when an asset or liability needs to be recorded contingent upon a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and information used to record valuation adjustments for certain assets and liabilities are based on quoted market prices or are provided by other third-party sources, when available. When third-party information is not available, valuation adjustments are estimated in good faith by management.

Our most significant accounting policies are presented in Note 1 to the consolidated financial statements included elsewhere in this ~~Annual Report on Form 10-K~~report. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined. Based on the valuation techniques used and the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has identified the determination of the allowance for credit losses, accrued income taxes, ~~pensions and post-~~retirement plan obligations, ~~and~~ the fair value analysis of goodwill and intangible assets and the fair value of financial instruments to be the accounting areas that require the most subjective and complex judgments, and as such could be the most subject to revision as new information becomes available. Actual results could differ from those estimates.

The allowance for credit losses represents management’s estimate of probable incurred loan and lease losses in the loan and lease portfolio. Determining the amount of the allowance for credit losses is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans and leases, estimated losses on pools of homogeneous loans and leases based on historical loss experience, and consideration of current economic trends and conditions, all of which may be susceptible to significant change. The loan and lease portfolio also represents the largest asset type on the consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for credit losses, and a discussion of the factors driving changes in the amount of the allowance for credit losses is included in this report.

We estimate our tax expense based on the amount we expect to owe the respective tax authorities. Taxes are discussed in more detail in Note 10 to the consolidated financial statements section of this report. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account statutory, judicial and regulatory guidance in the context of our tax position. If the final resolution of taxes payable differs from our estimates due to regulatory determination or legislative or judicial actions, adjustments to tax expense may be required.

In 2011, we performed a qualitative goodwill impairment assessment to determine whether it is more likely than not that the fair value of our reporting unit was less than the carrying amount in accordance with new accounting guidance issued in the current year. In our qualitative assessment analysis we considered several factors including macroeconomic conditions, industry and market considerations, our financial performance and changes in the composition or carrying amount of our reporting unit. In prior years, we utilized significant estimates and assumptions in determining the fair value of our goodwill and intangible assets for purposes of impairment testing.

The ~~valuation~~allowance ~~requires~~for ~~the~~credit ~~use~~losses ofrepresents ~~assumptions,~~management’s ~~including,~~estimate ~~among~~of ~~others,~~probable ~~discount~~incurred ~~rates,~~loan and lease ~~rates~~losses ofin ~~return~~the onloan ~~assets,~~and ~~account~~lease ~~attrition~~portfolio. ~~rates~~Determining ~~and~~the ~~costs~~amount of ~~servicing.~~the ~~Impairment~~allowance ~~testing~~ for ~~goodwill~~credit ~~requires~~losses ~~that~~is ~~the~~considered ~~fair~~a ~~value~~critical ofaccounting ~~each~~estimate ofbecause ~~our~~it ~~reporting~~requires ~~units~~significant bejudgment ~~compared~~and the use of estimates related to the ~~carrying~~ amount and timing of expected ~~its~~future ~~net~~cash ~~assets,~~flows ~~including~~on ~~goodwill. Determining~~impaired ~~the~~loans ~~fair~~and ~~value~~leases, estimated losses on pools of ahomogeneous ~~reporting~~loans ~~unit~~and ~~requires~~leases usbased toon ~~use~~historical aloss ~~high~~experience, ~~degree~~and consideration of ~~subjective~~current ~~judgment.~~economic Wetrends ~~utilize~~and ~~both~~conditions, ~~market-based~~all ~~valuation~~of ~~multiples~~which ~~and~~may ~~discounted~~be ~~cash~~susceptible ~~flow~~to significant ~~valuation~~change. ~~models~~The ~~that~~loan ~~incorporate~~and ~~such~~lease ~~variables~~portfolio asalso ~~revenue~~represents ~~growth rates,~~the ~~expense~~largest ~~trends,~~asset ~~interest~~type ~~rates~~on ~~and~~the ~~terminal~~consolidated ~~values~~balance sheet. ~~Based~~Note ~~upon~~1 anto ~~evaluation~~the ofconsolidated ~~key~~financial ~~data~~statements ~~and~~included ~~market~~elsewhere ~~factors,~~in wethis ~~select~~report describes the ~~specific~~methodology ~~variables~~used to bedetermine the ~~incorporated~~allowance ~~into~~for ~~the~~credit ~~valuation~~losses, ~~model.~~and ~~Future~~a ~~changes~~discussion inof the ~~economic~~factors ~~environment~~driving ~~or operations~~changes ofin ~~our~~the ~~reporting~~amount ~~units~~of ~~could~~the ~~cause~~allowance ~~changes~~for tocredit ~~these~~losses ~~variables,~~is ~~which~~included ~~could result~~ in ~~impairment~~this ~~being identified~~report.

~~The~~We ~~valuation~~utilized ofsignificant ~~our~~estimates ~~obligations~~and ~~associated~~assumptions ~~with~~in ~~pension,~~determining ~~post-retirement,~~the ~~directors’~~fair ~~retirement~~value of our goodwill and ~~supplemental~~intangible ~~executive retirement~~assets ~~plans~~for ~~utilize~~purposes ~~various~~of ~~actuarial~~impairment ~~assumptions~~testing. ~~These~~The valuation requires the use of assumptions, including, ~~include~~among others, discount ~~rate~~rates, ~~rate~~rates of ~~future~~return ~~compensation~~on ~~increases~~assets, account attrition rates and ~~expected~~costs ~~return~~of onservicing. ~~plan~~Impairment testing for goodwill requires that the fair value of our reporting unit be compared to the carrying amount of its net assets, including goodwill. ~~Specific~~In ~~discussion~~2012, the fair value of our reporting unit was determined using the ~~assumptions~~acquisition ~~used~~price bythat ~~management~~NBT iswill ~~discussed~~acquire Alliance specified in ~~Note 12~~the toMerger Agreement. Future changes in the ~~consolidated~~economic ~~financial~~environment ~~statements~~or ~~section~~operations of ~~this~~our reporting ~~report~~units could cause changes to these variables, which could result in impairment being identified.

We estimate our tax expense based on the amount we expect to owe the respective tax authorities. Taxes are discussed in more detail in Note 10 to the consolidated financial statements included elsewhere in this report. Accrued taxes represent the net estimated amount due or to be received from taxing authorities. In estimating accrued taxes, management assesses the relative merits and risks of the appropriate tax treatment of transactions, taking into account statutory, judicial and regulatory guidance in the context of our tax position. If the final resolution of taxes payable differs from our estimates due to regulatory determination or legislative or judicial actions, adjustments to tax expense may be required.

The valuation of our obligations associated with pension, post-retirement, directors’ retirement and supplemental executive retirement plans utilize various actuarial assumptions. These assumptions include discount rate, rate of future compensation increases and expected return on plan assets. Specific discussion of the assumptions used by management is discussed in Note 12 to the consolidated financial statements included elsewhere in this report.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices, and equity prices. ~~Our~~Alliance’s market risk arises principally from interest rate risk in its lending, investing, deposit gathering and ~~borrowing~~ borrowing activities. Other types of market risks do not arise in the normal course of our business activities.

The Bank’s ALCO is responsible for reviewing the interest rate sensitivity position and establishing policies to monitor and manage exposure to interest rate risk. The policies and guidelines established by the ALCO are reviewed and approved by the Company’s Board of Directors annually.

Interest rate risk is monitored primarily through financial modeling of net interest income and net portfolio value estimation (discounted present value of assets minus discounted present value of liabilities). Both measures are highly assumption dependent and change regularly as the balance sheet and interest rates change; however, taken together, they represent a reasonably comprehensive view of the magnitude of interest rate risk, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. The key assumptions employed by these measures are analyzed and reviewed monthly by the ALCO.

The table that follows is provided pursuant to the market risk disclosure rules set forth in Item 305 of Regulation S-K of the ~~SEC~~Securities and Exchange Commission. The information provided in the following table is based on significant estimates and assumptions and constitutes, like certain other statements included herein, a forward-looking statement. The base case (no rate change) information in the table shows (1) an estimate of our net portfolio value at December 31, ~~2011~~2012, arrived at by discounting estimated future cash flows at current market rates and (2) an estimate of net interest income for the ~~twelve~~12 months ending December 31, ~~2012~~2013, assuming that maturing assets or liabilities are replaced with new balances of the same type, in the same amount, and at current (December 31, ~~2011~~2012) rate levels and repricing balances are adjusted to current (December 31, ~~2011~~2012) rate levels. The rate change information (rate shocks) in the table shows estimates of net portfolio value at December 31, ~~2011~~2012 and net interest income for the ~~twelve~~12 months ending December 31, ~~2012~~2013, assuming instantaneous rate changes of up 100, 200, and 300 basis points and down 100 basis points. Cash flows for non-maturity deposits are based on a decay or runoff rate based on average account age. Rate changes in the rate shock scenario are assumed to be shock or immediate changes and occur uniformly across the yield curve. In projecting future net interest income under the rate shock scenarios, activity is simulated by replacing maturing balances with new balances of the same type, in the same amount, but at the assumed post shock rate levels. Balances that reprice are assumed to reprice at post shock rate levels.

Based on the foregoing assumptions and as depicted in the table that follows, an immediate increase in interest rates of 100, 200, or 300 basis points would have a negative effect on net interest income over a twelve month time period. This is principally because the Bank’s interest-bearing deposit accounts are assumed to reprice faster than its loans and investment securities. However, if the Bank does not increase the rates paid on its deposit accounts as quickly or to the same magnitude as increases in market interest rates, the negative impact on net interest income will likely be lower. Over a longer period of time, and assuming that interest rates remain stable after the initial rate increase and the Bank purchases securities and originates loans at yields higher than those maturing and reprices loans at higher yields, the impact of an increase in interest rates should be positive. This occurs primarily because with the passage of time more loans and investment securities will reprice at the higher rates and there will be no

~~offsetting~~basis ~~increase~~points. Cash inflows ~~interest~~for ~~expense~~non-maturity ~~for~~deposits ~~those~~are ~~loans~~based ~~and~~on ~~investment~~a ~~securities~~decay ~~funded~~or byrunoff ~~noninterest-bearing~~rate ~~checking~~based ~~deposits~~on ~~and~~average ~~capital~~account age. ~~Generally,~~Rate changes in the ~~reverse~~rate ~~should~~shock bescenario ~~true~~are ofassumed anto be shock or immediate ~~decrease~~changes inand ~~interest~~occur ~~rates~~uniformly ofacross ~~100~~the ~~basis~~yield ~~points~~curve. ~~However,~~In ~~the~~projecting ~~positive~~future ~~impact on~~ net interest income ofunder athe ~~decline~~rate inshock ~~interest~~scenarios, ~~rates~~activity is simulated by replacing maturing balances with new balances of ~~100~~the ~~basis~~same ~~points~~type, isin ~~currently~~the ~~constrained~~same byamount, but at the ~~absolute~~assumed ~~low~~post ~~level~~shock ofrate ~~deposit~~levels. ~~and~~Balances ~~borrowing~~that ~~rates~~reprice are assumed to reprice at post shock rate levels.

~~There~~Based ison ~~little~~the ~~difference~~foregoing assumptions and as depicted in the ~~amount~~table that follows, an immediate increase in interest rates of ~~our~~100, 200, or 300 basis points would have a negative effect on net ~~portfolio~~interest ~~value~~income inover a 12 month time period. This is principally because the Bank’s upinterest-bearing ~~100~~deposit accounts are assumed to reprice faster than its loans and ~~200~~investment ~~basis~~securities. However, ~~point~~if ~~rate~~the ~~shocks~~Bank ~~primarily~~does not increase the rates paid on its deposit accounts as quickly or to the same magnitude as increases ~~because~~in market interest rates, the ~~absolute~~negative ~~low~~impact ~~level~~on net interest income will likely be lower. Over a longer period of ~~current~~time, and assuming that interest rates ~~tempers~~remain stable after the ~~potential~~initial ~~negative~~rate ~~effect~~increase ofand the Bank purchases securities and originates loans at yields higher than those maturing and reprices loans at higher yields, the impact of an increase in interest rates onshould ~~loan~~be ~~prepayments~~positive. This occurs primarily because with the passage of time more loans and investment securities will reprice at the higher rates and there will be no offsetting increase in interest expense for those loans and investment securities funded by noninterest-bearing checking deposits and capital. In previous years, Net Portfolio Value and Net Interest Income resulting from an immediate and sustained 100 basis point decrease in rates were reported; however these ~~two~~measures ~~rate~~have ~~shock~~been ~~scenarios~~omitted this quarter as the absolute low level of rates renders the results under this scenario not meaningful.

			Net Portfolio Value at Dec 31, 2011												Net Interest Income Twelve Months Ending Dec 31, 2012
													Net Interest Income
							Change from Base												Change from Base
	Net Portfolio Value at Dec 31, 2012												Twelve Months Ending Dec 31, 2013
Rate Change Scenario			Amount				Dollar				Percent				Amount				Dollar				Percent
					Change from Base												Change from Base
			(Dollars in thousands)
Rate Change Scenario	Amount				Dollar				Percent				Amount				Dollar				Percent
+300 basis point rate shock				$295,798				$(9,422)				(3.1)%				$29,844				$(10,180)				(25.4)%
	(Dollars in thousands)
+200 basis point rate shock				302,322				(2,898)				(0.9)%				33,060				(6,963)				(17.4)%
+300 basis point rate shock	$	242,235			$	11,615				5.0	%		$	27,357			$	(10,887	)			(28.5	)%
+100 basis point rate shock				302,767				(2,453)				(0.8)%				36,449				(3,575)				(8.9)%
+200 basis point rate shock		237,329				6,709				2.9	%			30,802				(7,442	)			(19.5	)%
Base case (no rate change)				305,220				—				—%				40,024				—				—%
+100 basis point rate shock		228,061				(2,559	)			(1.1	)%			34,586				(3,658	)			(9.6	)%
-100 basis point rate shock				277,060				(28,160)				(9.2)%				37,713				(2,311)				(5.8)%
Base case (no rate change)		230,620				—				—	%			38,244				—				—	%

Item 8. Financial Statements and Supplementary Data

Our ~~Consolidated~~consolidated ~~Financial~~financial ~~Statements~~statements and accompanying notes may be found beginning on page F-1 of this report.

Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure

None.

Item 9A. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

Management, including our President and Chief Executive Officer and Chief Financial Officer, has evaluated the effectiveness of our disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) as of the end of the period covered by this report. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the disclosure controls and procedures were effective to ensure that information required to be disclosed in the reports we file and submit under the Exchange Act (i) is recorded, processed, summarized and reported as and when required and (ii) accumulated and communicated to our management including the Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely discussion regarding required disclosure.

Management’s Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with policies or procedures may deteriorate. Our internal control over financial reporting is a process designed under the supervision of our principal executive officer and principal financial officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external reporting purposes in accordance with U.S. generally accepted accounting principles.

~~Under~~39 the supervision and with the participation of management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under that framework, management concluded that our internal control over financial reporting was effective as of December 31, 2011. In addition, based on our assessment, management has determined that there were no material weaknesses in our internal controls over financial reporting.

Under the supervision and with the participation of management, including our principal executive officer and principal financial officer, we conducted an evaluation of the effectiveness of our internal control over financial reporting based on the framework in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our evaluation under that framework, management concluded that our internal control over financial reporting was effective as of December 31, 2012. In addition, based on our assessment, management has determined that there were no material weaknesses in our internal controls over financial reporting.

Attestation Report of the Registered Public Accounting Firm

The effectiveness of our internal control over financial reporting as of December 31, ~~2011~~2012 has been audited by Crowe Horwath LLP, our independent registered public accounting firm, as stated in its report, which is set forth on Page F-2 under the heading “Report of Independent Registered Public Accounting Firm” and is incorporated herein by reference.

Changes in Internal Control Over Financial Reporting

We regularly assess the adequacy of our internal control over financial reporting and enhance our controls in response to internal control assessments and internal and external audit and regulatory recommendations. There have been no changes in our internal control over financial reporting identified in connection with the evaluation that occurred during our last fiscal quarter that has materially affected, or that is reasonably likely to materially affect, our internal control over financial reporting.

Item 9B. Other Information

None.

PART III

Item 10. Directors and Executive Officers of the Registrant and Corporate Governance

~~The information required by this Item 10 is incorporated herein by reference to the sections entitled “~~Information About Our ~~Board~~ ~~of Directors” and “Information About Our Executive Officers,” “Information about the~~ Board ofOf Directors and Corporate Governance,” “Code of Ethics,” “Section 16(a) Beneficial Ownership Reporting Compliance,” “Committees of the Board of Directors – Corporate Governance Committee,” “Committees of the Board of Directors – Audit Committee” and “Report of the Audit Committee of the Board of Directors” in our Proxy Statement.

Our Board of Directors currently consists of 12 members. The name, age and length of service of each of our members of our Board of Directors are set forth below:


Director	Age⁽¹⁾	Term Expires	Position(s) Held with Alliance	Director Since⁽²⁾

Donald H. Dew	61	2013	Lead Director	1988
Charles E. Shafer	63	2013	Director	1998
Charles H. Spaulding	64	2013	Director	1993
Deborah F. Stanley	63	2013	Director	2006
Mary Pat Adams	53	2013	Director	2000
Samuel J. Lanzafame	62	2013	Director	1988
Lowell A. Seifter	60	2013	Director	2006
Jack H. Webb	60	2013	Chairman, President and Chief Executive Officer	2000
Donald S. Ames	70	2014	Director	1986
Margaret G. Ogden	67	2014	Director	2001
Paul M. Solomon	69	2014	Director	2001
John H. Watt, Jr.	54	2014	Executive Vice President and Director	2007

(1)	At February 18, 2013.

(2)	Represents the year in which the Director was first elected or appointed to the Board of Directors of Alliance or of the Bank.

The principal occupation and business experience of each director are set forth below:

Donald H. Dew was the Chairman and Chief Executive Officer of Diemolding Corporation until his retirement in 2007 and as Director until 2009. Mr. Dew is a Director of the Rotary Club of Oneida. Additionally, Mr. Dew is a member of the advisory board of the Board of Cooperative Educational Services. Mr. Dew formerly was a Director of the Manufacturers Association of Central New York and Higbee Gaskets. Mr. Dew received a B.S degree from Ripon College and attended the Executive Management Program and Manufacturing Management Program at The Pennsylvania State University and the Wharton School of Business at the University of Pennsylvania.

Charles E. Shafer is founder and owner of Green Lake Associates, LLC. Additionally, Mr. Shafer is the co-founder and co-owner of a power supply manufacturer, Applied Concepts, Inc. and was the managing partner of Riehlman, Shafer and Shafer. Mr. Shafer serves as Director and Secretary for People’s Equal Action and Community Effort, Inc. and is a member of the Vermont Law School Board of Trustees. Mr. Shafer received a B.A. from the State University of New York at Brockport and a J.D. degree from the Vermont Law School.

Charles H. Spaulding is currently President and Director of George B. Bailey Agency, Inc. and Director of Mid York Associates, Inc. Mr. Spaulding additionally serves on the Board of Directors of the SUNY Cortland College Foundation and J.M. Murray Center Inc. Mr. Spaulding received a B.A. degree from Union College and a J.D. degree from Syracuse University.

Deborah F. Stanley has been the President and Chief Administrative Officer of the State University of New York at Oswego since 1997. Ms. Stanley was interim president from 1995 to 1997. Prior to 1995, Ms. Stanley held the office of Vice President for academic affairs and provost and served as executive assistant to the president. Ms. Stanley is a Director on the board of CenterState CEO (formerly Metropolitan Development Association) and serves on its Executive Committee, and is a Director on the board of the Metropolitan Development Foundation and serves as its Chair. Ms. Stanley also serves on the board of the Oswego College Foundation. Ms. Stanley was formerly a Director and Chairman of Oswego County National Bank and Bridge Street Financial, both of which were acquired by Alliance Financial. Ms. Stanley received a J.D. and a B.A. degree from Syracuse University.

Mary Pat Adams is a licensed Associate Broker, CRS, GRI with Hunt Real Estate ERA, formerly Prudential First Properties, and is currently Vice President and a member of the Board of Directors of the Oneida City School District Foundation and is also a member of the Board of Directors of United Way of Greater Oneida. Previously, Mrs. Adams was a member of the Board of Directors of Oneida Valley Securities Corporation until its dissolution in December 2008. Mrs. Adams received a B.B.A. degree from James Madison University.

Samuel J. Lanzafame was the President, Chief Executive Officer and Director of Datacom Systems, Inc. until February 2012 when he became Chairman of the Board. Mr. Lanzafame has over 30 years of executive management experience in overseeing the operations in both public and private companies, including Oneida Ltd. and The Cambridge Filter Corporation. Mr. Lanzafame currently serves as the Chairman of the Audit Committee of the Board of Directors of the Madison County Industrial Development Agency. Mr. Lanzafame received an M.B.A. degree from The University of Notre Dame and a B.A. degree from Holy Cross.

Lowell A. Seifter is a Senior Vice President and General Counsel of St. Joseph’s Hospital Health Center. He was a founding member of Green & Seifter Attorneys, PLLC (now known as Bousquet Holstein Attorneys, PLLC) and served as the senior member of the board of managers until January 2012 when he joined St. Joseph’s Hospital Health Center. From 2002 until 2006, Mr. Seifter was a member of the Board of Directors of Bridge Street Financial, Inc. and its banking subsidiary, Oswego County National Bank. Mr. Seifter also serves on the Board of Directors of G&S Northway Plaza, Inc. and GSA Development Corp. and formerly served on the Board of Directors of the Sagamore Institute of the Adirondacks, Inc. Mr. Seifter received a J.D. and a B.A. degree from Syracuse University and is a certified public accountant.

Jack H. Webb has been our Chairman and Chief Executive Officer since January 2002 and is also the President and Chief Executive Officer of the Bank. Mr. Webb joined us in May 2000 as President of the Bank after a 26-year career with Chase Manhattan Bank. Mr. Webb is also a Director of Alliance Leasing, Inc. Mr. Webb is President of the Board of Trustees of The Gifford Foundation and serves on the Advisory Board of CNY Lifetime Healthcare. Mr. Webb graduated from the Rochester Business Institute.

Donald S. Ames is the owner and President of Cortland Laundry, Inc., and has been in the commercial laundry business for over 45 years providing services to several businesses including major health care organizations around central New York. Mr. Ames also founded and operated Ames Linen Service from 1964 until his retirement in 2008. Mr. Ames received a B.A. degree from Hobart College.

Margaret G. Ogden is the founder and principal of Peggy Ogden LLC. Prior to founding Peggy Ogden LLC in 2008, Ms. Ogden was the President and Chief Executive Officer of Central New York Community Foundation. Ms. Ogden is a Director of United Way of CNY and Allyn Foundation and serves on the Museum of Science and Technology Foundation Board. Ms. Ogden received an M.B.A. degree from Syracuse University and a B.A. degree from Albion College.

Paul M. Solomon is currently managing partner of a venture capital firm, PJ Equities, LLP. In July 2005, Mr. Solomon co-founded US Beverage Net and currently serves as Chairman of its Board of Directors. Additionally, Mr. Solomon is a member and Director of bc Restaurant LLC. Mr. Solomon serves as a Vice Chairman and Treasurer as a Board Member of the Board of Trustees of Millbrook School. Mr. Solomon received a degree from Syracuse University and is a graduate of the Millbrook School.

John H. Watt, Jr. has been our Executive Vice President since September 2005. Mr. Watt is also a Director of Alliance Leasing, Inc. and is an Advisory Board Member of the Summer Street Capital Partners Fund II. Mr. Watt is President of the Board of OnPoint for College, a Syracuse based not-for-profit and serves as a member of the Investment Committee of The Episcopal Diocese of Central New York. Mr. Watt spent 18 years at J.P. Morgan Chase and its predecessors in various capacities. Mr. Watt received a J.D. from George Washington University and a B.A. degree from Rutgers University.

Information About Our Executive Officers

The principal occupation and business experience of each of our executive officers are set forth below:

J. Daniel Mohr, age 47, has been our Treasurer and Chief Financial Officer since May 2006 and Executive Vice President since January 2010. Prior to joining us, Mr. Mohr was Senior Vice President and Chief Financial Officer of Partners Trust Financial Group and was also the Chief Financial Officer of the Pioneer Companies. Mr. Mohr has more than 16 years of banking and financial experience, including 11 years as a chief financial officer and approximately four years as a Certified Public Accountant with KPMG LLP where he concentrated in the financial institutions audit practice group. Mr. Mohr received a B.S. in accounting from the State University of New York at Binghamton.

James W. Getman, age 64, has been our Executive Vice President and Senior Loan Officer since February 1999. Mr. Getman is also Chief Executive Officer of Alliance Leasing, Inc. Prior to joining us, Mr. Getman served as Vice President and Senior Credit Officer of Cayuga Bank and as Vice President and Group Manager responsible for corporate and personal banking relationships at Chase Manhattan Bank. Mr. Getman attended the NACM Graduate School at Dartmouth College, the Credit Management School at the University of Buffalo and received his B.A. in economics from Union College.

Steven G. Cacchio, age 49, has been our Senior Vice President of Retail Banking Sales and Service since February 2005. Prior to joining us, Mr. Cacchio was a bank examiner with the Comptroller of the Currency focusing on compiling and analyzing federal regulatory requirements for various banks. Mr. Cacchio received a Master of Science in Accounting from Syracuse University and a B.S. in economics and finance from the University of Hartford.

Section 16(a) Beneficial Ownership Reporting Compliance

Section 16(a) of the Securities Exchange Act of 1934, as amended, requires our directors and executive officers, and persons who own more than 10% of our common stock, to report to the Securities and Exchange Commission their initial ownership of our common stock and any subsequent changes in that ownership. Specific due dates for these reports have been established by the Securities and Exchange Commission and we are required to disclose in this proxy statement any late filings or failures to file.

Based solely on its review of the copies of such reports furnished to us and written representations that no other reports were required during the fiscal year ended December 31, 2012, all Section 16(a) filing requirements applicable to our executive officers and directors during fiscal 2012 were met with the exception of Donald S. Ames, who failed to timely file a Form 4 reporting one transaction.

Code of Ethics

We have adopted a Code of Conduct, which applies to all employees and officers of Alliance and the Bank. We have also adopted a Code of Ethics for Chief Executive Officer and Senior Financial Officers, which applies to our chief executive officer, chief financial officer, chief accounting officer, controller and the senior vice president of marketing and investor relations. The Code of Ethics for Chief Executive Officer and Senior Financial Officers (“Code of Ethics”) meets the requirements of a “code of ethics” as defined by Item 406 of Regulation S-K. The Code of Ethics for Chief Executive Officer and Senior Financial Officers is available to shareholders on our website at www.alliancefinancialcorporation.com under the tab “Investor Relations.”

We intend to satisfy the disclosure requirement under Item 5.05(c) of Form 8-K regarding an amendment to, or a waiver from, a provision of our Code of Ethics that applies to our chief executive officer, chief financial officer, chief accounting officer, or other persons performing similar functions, by posting such information on our website at the Internet address set forth above. We did not amend or grant any waivers of a provision of our Code of Ethics during 2012.

Audit Committee

During 2012, the Audit Committee was chaired by Director Lanzafame, with Directors Ogden, Solomon and Spaulding as members. The Audit Committee assists the Board by overseeing the audit coverage and monitoring the accounting, financial reporting, data processing, regulatory and internal control environments.

As set forth in the Audit Committee Charter, the primary duties and responsibilities, among other responsibilities, of the Audit Committee are to:

(1)

oversee the accounting and financial reporting principles and policies and internal accounting controls and procedures;

(2)

oversee the financial statements and the independent audit thereof;

(3)

select, oversee and, where deemed appropriate, replace the independent auditors;

(4)

evaluate the qualifications, independence and performance of the independent auditors;

(5)

monitor the performance of the internal audit function;

(6)

monitor compliance with legal and regulatory requirements; and

(7)

prepare the report required by the rules of the Securities and Exchange Commission to be included in the annual proxy statement.

The Board of Directors reviews the Nasdaq listing standards definition of independence for Audit Committee members on an annual basis and has determined that all members of our Audit Committee are independent (as independence is currently defined in Rule 5605(a)(2) of the Nasdaq listing standards). The Board of Directors has also determined that Mr. Lanzafame qualifies as an “audit committee financial expert” as defined in applicable SEC rules. The Board of Directors has adopted a written charter for the Audit Committee that is available to shareholders on our website at www.alliancefinancialcorporation.com under the tab “Investor Relations.”

Director Nominations

In accordance with our Bylaws, nominations of individuals for election to the Board at an annual meeting of shareholders may be made by any shareholder of record entitled to vote for the election of directors at such meeting who provides timely notice in writing to our Secretary. To be timely, a shareholder’s notice must be delivered to the Secretary not less than 90 days nor more than 120 days immediately preceding the date of the meeting. The notice must contain (i) the name, age, business address and residence address of each proposed nominee; (ii) the principal occupation and employment of each proposed nominee; (iii) the total number of shares of our stock owned by each proposed nominee; (iv) the name and residence address of the notifying shareholder; (v) the number of shares of our stock owned by the notifying shareholder; and (vi) any other information relating to such person that is required to be disclosed in solicitations for proxies for the election of directors, or otherwise required pursuant to Regulation 14A under the Securities Exchange Act of 1934. Nominations not made in accordance with this procedure may be disregarded at the annual meeting. Shareholder nominations are evaluated in the same manner as other nominations.

Item 11. Executive Compensation

~~The information required by this Item 11 is incorporated herein by reference to the sections entitled “~~Compensation Discussion and Analysis,” ~~“Executive and Director Compensation Tables” and “Committees of the Board of Directors-Compensation Committee” in our Proxy Statement.~~

Overview

The Compensation Committee of our board of directors, comprises five independent directors and has responsibility for establishing and implementing our executive compensation philosophy as well as monitoring adherence to the policies and practices of the compensation programs maintained by us for our employees. This section is intended to help our shareholders understand our compensation philosophy, objectives, components and practices. The section also describes decisions made by the Compensation Committee in 2012 related to the compensation of our named executive officers, (“NEOs”).

The following officers have been identified as NEOs by our board of directors:

•

Jack H. Webb, Chief Executive Officer

•

John H. Watt, Jr., Executive Vice President

•

J. Daniel Mohr, Executive Vice President and Chief Financial Officer

•

James W. Getman, Executive Vice President and Senior Loan Officer, Alliance Bank

•

Steven G. Cacchio, Senior Vice President, Retail Banking Sales and Service, Alliance Bank

At our annual meeting of shareholders held on May 10, 2011, (the “2012 Annual Meeting”), we held an advisory vote on executive compensation. Although the vote was non-binding, the Compensation Committee has considered and will continue to consider the outcome of the vote when determining compensation policies and setting NEO compensation. Approximately 93% of the shares of our common stock that were voted on the proposal were voted for the approval of the compensation of the NEOs as disclosed in our 2011 proxy statement. The Compensation Committee believes that the result of this advisory vote shows especially strong support for our compensation policies and procedures. Additionally, at the 2012 Annual Meeting, shareholders voted, on a non-binding, advisory basis, to conduct the advisory vote on executive compensation every three years. Based upon the voting results, our board of directors determined that we will hold such vote every three years.

Executive Summary

It is the intent of the Compensation Committee to provide the NEOs with a market competitive compensation package that promotes the achievement of our strategic objectives and maximizes shareholder value without encouraging excessive risk. Base salary is the largest component of the NEOs total compensation. NEOs are also eligible to participate in our incentive compensation programs.

The Compensation Committee took the following actions related to the NEO’s 2012 compensation:

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Base salaries and annual incentive opportunities for 2012 were tied to our financial performance and the roles, responsibilities and performance of each NEO, and were supported by the competitive executive compensation assessment conducted by an independent compensation consultant in 2012.

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Equity awards were granted to the NEOs in February 2012 pursuant to the 2010 Restricted Stock Plan. The board of directors considers long-term equity compensation an important component of compensation by which shareholder and management interests are aligned.

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As a result of our financial performance in 2012, the NEOs earned payments under its short-term incentive program, which were paid in December 2012. The performance goals and related payments under this program are discussed more fully under the caption “Short-Term Incentive Compensation” below.

Compensation Philosophy and Objectives

The Compensation Committee believes that the most effective compensation programs are those designed to attract, develop and retain the best available executive officers in key leadership positions as well as the best available employees at all levels in the organization. In implementing this philosophy, the compensation plans in which the NEOs participate are intended to motivate them to maximize performance for our shareholders and to reward them for the achievement of specific annual, strategic and long-term goals, including the appreciation of shareholder value.

Our compensation programs:

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are not overly complex in design or administration;

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are designed with prudent defined objectives and goals that prevent an expectation of receiving rewards for inappropriate or excessive risk that could have a material effect on Alliance;

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have base salary as the largest component of total compensation for all employees, including those eligible to earn incentive compensation;

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are not excessive in that they are designed to provide incentive compensation opportunities that are a percentage of base salary rather than a multiple of base salary; and

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do not reward employees, including the NEOs, in a way that results in the receipt of compensation that is excessive for the position, or the performance and contribution of the employee.

Generally, the types of compensation paid to the NEOs are similar to those provided to other executive officers. To support Alliance’s compensation philosophy and objectives, the NEOs compensation package provides the following:

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competitive base salary and benefits;

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short-term incentive compensation programs intended to reward employee contributions to the attainment of Alliance’s annual performance or line of business goals; and

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long-term equity compensation intended to reward the NEOs and other key executives for their contributions to Alliance’s sustainable, long-term success and growth in shareholder value.

Our board of directors considers long-term equity compensation an important component of total compensation, a retention tool, and an effective means of linking the executives’ compensation with the value of our common stock and long-term success of the organization. The 2010 Restricted Stock Plan enables the our board of directors to continue using this vital component of compensation.

Executive Compensation Administration

The Compensation Committee is responsible for the design and approval of our executive compensation programs and the specific compensation for each executive officer, including the NEOs, taking into consideration the recommendations of the Chief Executive Officer and the Compensation Committee’s own deliberations. The Chief Executive Officer recommends salary adjustments, short-term incentive plan opportunities and payouts as well as equity grants for each executive. These recommendations are based upon our financial performance, an assessment of each executive’s individual performance, performance of the executive’s respective business unit or function, retention considerations, periodic competitive executive compensation assessments and market factors.

The Chief Executive Officer does not play any role in the Compensation Committee’s deliberation of matters impacting his own compensation.

The Compensation Committee periodically engages an independent compensation consultant to advise it on board and executive compensation matters and to provide guidance on compensation plan structure and design. The most recent such engagement was in 2011 when the Compensation Committee hired Pearl Meyer & Partners, or Pearl Meyer, to conduct a competitive assessment of the compensation programs provided to the Alliance NEOs, also referred to as the Assessment. Pearl Meyer does not perform any additional services for Alliance.

The Assessment included publicly reported compensation information for comparable executive officers of financial institutions, which the Compensation Committee determined to be appropriate to consider as our peer group. The peer group consisted of 21 publicly traded banks with asset size between $1.0 billion and $4.0 billion located in the Mid-Atlantic and Northeast regions. The 21 banks, as listed below, are located in non-metropolitan markets in New York, Pennsylvania, western Massachusetts, Vermont and Maine.


• ACNB Corp. (ACNB)		• ESSA Bancorp, Inc. (ESSA)
• Arrow Financial Corporation (AROW)		• Financial Institutions, Inc. (FISI)
• Bar Harbor Bankshares (BHB)		• Hingham Institution for Savings (HIFS)
• Berkshire Hills Bancorp, Inc. (BHLB)		• Merchant Bancshares, Inc. (MBVT)
• Bryn Mawr Bank Corp. (BMTC)		• Metro Bancorp, Inc. (METR)
• Camden National Corp. (CAC)		• Orrstown Financial Services, Inc. (ORRF)
• Century Bancorp, Inc. (CNBKA)		• Tompkins Financial Corporation (TMP)
• Citizens & Northern Corp. (CZNC)		• United Financial Bancorp, Inc. (UBNK)
• CNB Financial Corporation (CCNE)		• Univest Corporation of Pennsylvania (UVSP)
• Enterprise Bancorp, Inc. (EBTC)		• Westfield Financial, Inc. (WFD)
• ESB Financial Corporation (ESBF)

The Compensation Committee considered the results of the Assessment and its own compensation philosophy, among other considerations, in setting base salaries and annual incentive plan design targets effective in 2012, which are described in this section.

2012 Executive Compensation Components

For the fiscal year ended December 31, 2012, the NEOs were eligible to receive the following compensation components:

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base salary;

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performance-based short-term incentive compensation;

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discretionary bonus awards;

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long-term incentive compensation awards;

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retirement and other benefits; and

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perquisites and other personal benefits.

In making decisions regarding compensation for the NEOs, the Compensation Committee believes that a certain level of discretion is appropriate in determining the amount of compensation to be paid, the mix of compensation components, and the relationship between compensation levels provided to the Chief Executive Officer and other NEOs. As such, the Compensation Committee has not established formal policies for the following:

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the allocation between cash and non-cash compensation;

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the allocation of short-term and long-term equity incentive compensation; or

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the percentage in which other NEOs compensation opportunity should be in relation to the Chief Executive Officer’s compensation.

The Compensation Committee concluded that, based on the individual NEO’s performance and our financial performance in 2011 relative to its own internal goals and to that of its peer group, the total cash compensation of the NEOs for 2012 should be approximately that of the 70^th percentile of the peer group. The amount of total cash compensation paid to the NEOs will vary year-to-year based on the factors discussed previously in this section. The Short-Term Incentive Compensation Plan is the primary means by which changes to total cash compensation is affected.

Base Salary

Base salaries are determined based on the NEOs position, scope of responsibilities, assessment of individual performance and expected future contributions, competitive assessments, as well as their professional, interactive, leadership and business area related technical skills. The NEOs are also eligible for merit-based salary increases in accordance with the same annual evaluation process that is applicable to all employees.

The Compensation Committee conducts an annual performance review of Mr. Webb, based on input from the entire board of directors, and makes recommendations to the board of directors, for its approval, regarding his compensation. Mr. Webb completes the annual performance reviews for Messrs. Watt, Mohr, Getman and Cacchio, which establishes the basis for his recommendation to the Compensation Committee for any salary increases for these executives.

In February 2012, the NEOs, except for Messrs. Mohr and Cacchio, received merit increases to their 2012 base salary averaging approximately 3%. The 2012 base salary increases for Messrs. Mohr and Cacchio were at the discretion of the peer group in the Assessment. The 2012 merit increases were paid retroactively to the beginning of the year. In January 2013, the Compensation Committee and the Alliance board of directors approved 2013 base salaries for the NEOs as follows:


Named Executive Officer	2012 Salary		Percentage Increase (2012)			2013 Salary		Percentage Increase (2013)
Mr. Webb	$	400,000		2.2	%	$	410,000		2.5	%
Mr. Watt	$	223,000		3.0	%	$	230,000		3.1	%
Mr. Mohr	$	215,000		9.7	%	$	222,000		3.3	%
Mr. Getman	$	172,000		3.0	%	$	177,000		2.9	%
Mr. Cacchio	$	170,000		10.0	%	$	175,000		2.9	%

Short-term Compensation

The NEOs and certain key executives in leadership positions are eligible to participate in a short-term incentive program that rewards employees upon the attainment of certain annual performance goals. The Compensation Committee has concluded that awards granted pursuant to the short-term incentive program should be determined based on actual performance against multiple metrics. The Compensation Committee, in its discretion, chose return on equity, tangible common equity and non-performing assets/total assets as the performance metrics for 2012, collectively referred herein as the 2012 Performance Goals. The 2012 Performance Goals were based on our 2012 business plan, which contained details regarding our short-term goals and objectives, and assumptions regarding environmental factors such as market interest rates and economic and financial market conditions.

The 2012 Performance Goals must be met for payment of awards under the “base” component of the program and net income must exceed budget to trigger payment of awards under the “incremental” component of the program. Under the base component of the program, if the 2012 Performance Goals are met, the NEOs and other senior executives are eligible for a certain percentage of their base salary, which may be increased or decreased based on the executive’s job performance and area of responsibility. Under the incremental component of the program, if the 2012 net income exceeds budget, the NEOs and other senior executives are eligible for additional incentive compensation. A pool is established of up to 25% of the net income that exceeds the target goal and is allocated as additional incentive compensation to each eligible executive based on their job performance and area of responsibility.

We did not include any assumptions for mergers or acquisitions in setting its 2012 Performance Goals, which is consistent with past practice. As a result, the Compensation Committee, in its discretion, adjusted our actual 2012 net income to exclude pre-tax merger related expenses of $3.4 million ($2.0 million after tax) from the determination of the amounts to be paid for 2012 under the Short-Term Incentive Compensation Plan, as these costs are outside of its normal business operations upon which 2012’s Performance Goals were based.

Below is a summary of the target, actual and adjusted 2012 Performance Goals:


Performance Measure	2012 Goal			2012 Actual			Adjusted 2012 Excluding Merger Costs
Return on Average Equity(1)		7.05	%		6.40	%		7.98	%
Tangible Common Equity/Tangible Assets(2)		7.96	%		7.98	%		8.14	%
Non-performing Assets/Total Assets		0.71	%		0.39	%		0.39	%
Net Income	$	10,277,000		$	9,188,000		$	11,462,000

(1)	Net income divided by average shareholders’ equity.

(2)	Total common equity less goodwill and intangible assets divided by total assets less goodwill and intangible assets.

A weighted point system is used to set the threshold for our Short-Term Incentive Compensation Plan. Attainment of 100 points or more is required for payments to be made under the Short-Term Incentive Compensation Plan. The three 2012 Performance Goals were weighted as follows:


2012 Performance Goals		Weighting Factor
Return on equity		75
Tangible common equity at year-end		15
Non-performing assets/total assets		10

The weighting factor for each of the 2012 Performance Goals is multiplied by the percentage attained for each goal. Alliance achieved an adjusted return on equity, or ROE, for 2012 of 7.98%, which was 113.2% of the 2012 goal of 7.05%. The points “earned” for this performance goal under the terms of the Short-Term Incentive Compensation Plan were 84.9 (113.2% times 75). Our tangible common equity was 102.3% of goal in 2012, while the non-performing assets to total assets was 45.1% better than goal, resulting in a total of 115 points, which exceeded the threshold for payment of incentive compensation of 100 points.

We believe these three metrics and their weightings appropriately balances the short-term performance considerations of the plan (ROE) with metrics (tangible common equity and non-performing assets/total assets) designed to avoid excessive risk taking.

Our 2012 adjust net income exceeded the target goal, thus qualifying the NEOs and other executives for additional incentive compensation payments under the Short-Term Incentive Compensation Plan, which were approved by the Compensation Committee and our board of directors in December 2012. The following table presents, for each NEO, the 2012 short-term incentive award amounts that were paid in December 2012 for achieving and exceeding the 2012 Performance Goals.


Name	Base Salary		Base Award as Percentage of Base Salary			Base Award		Incremental Pool Award as Percentage of Base Salary			Incremental Pool Award		Total Award		Total Award as Percentage of Base Salary
Mr. Webb	$	400,000		40.0	%	$	160,000		5.0	%	$	19,800	$	179,800		45.0	%
Mr. Watt	$	223,000		30.0	%	$	66,900		12.1	%	$	27,000	$	93,900		42.1	%
Mr. Mohr	$	215,000		30.0	%	$	64,500		13.5	%	$	29,000	$	93,500		43.5	%
Mr. Getman	$	172,000		25.0	%	$	43,000		7.4	%	$	12,700	$	55,700		32.4	%
Mr. Cacchio	$	170,000		25.0	%	$	42,500		11.1	%	$	18,800	$	61,300		36.1	%

The NEOs received approximately 60% of the amount of incentives paid under the Short-Term Incentive Compensation Plan.

Payments under the Short-Term Incentive Compensation Plan for 2012 performance were made to all participating employees in December 2012, which was approximately three months earlier than past practice. Our board of directors elected to accelerate the payment schedule due to the close proximity of the normal February payment date to the anticipated closing date of the proposed merger.

The employment agreements with Messrs. Webb, Watt and Mohr contain certain “claw-back” language, as further discussed below, which would be applicable to this program.

Discretionary Bonus Awards

Our board of directors considers discretionary cash bonus awards in certain situations to recognize significant efforts or individual contributions. None of the NEOs received discretionary bonus compensation for 2012.

Long-Term Incentive Compensation

Our board of directors believes that long-term equity-based incentive compensation is an important component of our total compensation philosophy. Restricted stock awards are issued to recognize the responsibility and contributions of the NEOs, and other key executives, in meeting our long-term goals and strategies. Additionally, long-term incentive compensation is considered necessary to compete with other organizations in the recruitment and retention of key executives.

The decision to grant restricted stock to the NEOs and certain key employees is at the discretion of the Compensation Committee, and the decision is generally made annually in the first quarter. Should a grant be authorized by the Compensation Committee, the dollar value of shares granted to the NEOs is equal to a fixed percentage of their base salary. The fixed percentages are 30% for Mr. Webb and 25% for Messrs. Watt, Mohr, Getman and Cacchio. The number of shares granted is equal to the dollar value of the grant divided by the closing price for our common stock as reported on the NASDAQ Stock Market on the date of the grant. In addition, the Compensation Committee establishes a pool of restricted stock to be allocated to other key employees at the discretion of Mr. Webb. Our board of directors approves grants of restricted stock to the NEOs. There were 18,465 restricted shares granted in February 2012, with 10,068 shares allocated to the NEOs and a pool of 8,397 shares allocated to 15 key employees.

All restricted stock awards will automatically vest in the event of the death or disability of a participant or in the event of a Change of Control of Alliance (each as defined in the 2010 Restricted Stock Plan). In awarding restricted stock, the Compensation Committee considered the individual’s role and their contributions toward our success.

The following table sets forth grants of restricted stock to the NEOs in 2012:


Name	Restricted Stock Grant February 28, 2012
Mr. Webb		3,929
Mr. Watt		1,811
Mr. Mohr		1,639
Mr. Getman		1,397
Mr. Cacchio		1,292

All such grants are made pursuant to the terms of the 2010 Restricted Stock Plan, which permits the grant of shares of restricted stock to our directors, certain key officers and employees and such grants are evidenced by restricted stock agreements with each participant setting forth the terms, conditions and restrictions of the restricted stock award. Subject to the terms and conditions of the restricted stock agreement, a participant holding restricted stock will have the right to receive cash dividends on the shares of restricted stock during the restriction period and to vote the vested and unvested shares of restricted stock. Subject to the terms of the 2010 Restricted Stock Plan and the restricted stock agreement, the restrictions on the restricted stock lapse at the end of the restriction period and the participant is entitled to receive unrestricted shares of common stock at that time. Subject to adjustments allowed under the 2010 Restricted Stock Plan, we may award up to 200,000 shares of restricted stock under the 2010 Restricted Stock Plan. Currently, 130,149 shares remain eligible for award. If any award of restricted stock expires or is terminated, surrendered or canceled without being fully vested, the unused shares covered by such award shall again be available for grants under the 2010 Restricted Stock Plan.

Under the terms of the Merger Agreement, we are not permitted to issue any additional restricted stock awards.

Retirement and Other Benefits

Executive Incentive Retirement Program

Our board of directors approved our Executive Incentive Retirement Program, (“EIRP”), in March 2008. The EIRP was designed to assist us in retaining and attracting officers of exceptional ability and rewarding them for meeting or exceeding specific business program objectives or performance measurements. There are eight officers currently participating in the EIRP, including all of the NEOs except Mr. Webb.

The deferred bonus award vests at the rate of 20% per year while the participant is employed by the Bank Bank, and automatically vests upon (i) the participant’s death or disability, (ii) upon the occurrence of a change of control, or (iii) upon the participant’s separation from service at or after attaining normal retirement age. Our board of directors elected to cease paying deferred bonuses under this plan in 2009 because it determined that the total compensation paid to the NEOs was appropriate without additional benefits from the EIRP.

Supplemental Executive Retirement Agreement (SERP) and Split Dollar Life Insurance Agreement

Mr. Webb has a SERP, which was negotiated as a component of his total compensation package when he joined us. Pursuant to the SERP, we are required to pay Mr. Webb an annual benefit equal to 70% of his final average compensation in excess of his other retirement benefits. The retirement benefit will be paid to Mr. Webb in the form of a straight life annuity in monthly installments for life. For purposes of the SERP, Mr. Webb’s final average compensation means the annualized monthly base salary actually paid by us over the three-year period ending on the date of his termination of employment. The amounts due to him under the SERP are to be distributed upon the occurrence of a triggering event, including:

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Mr. Webb’s termination of employment with us, except upon his termination with cause; or

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His attaining the age of 65.

We must begin paying the benefit to Mr. Webb either on the first day of the seventh month following Mr. Webb’s termination of employment or on the first day of the first month following his attaining age 65, whichever is earlier. The benefit due Mr. Webb may be reduced if payment commences prior to August 1, 2017. In addition, the SERP provides Mr. Webb the right to receive payment of the benefit upon a change of control of Alliance. Mr. Webb is the only NEO covered by a SERP.

On January 27, 2010, we entered into the first amendment to the Amended and Restated Supplemental Retirement Agreement, dated November 28, 2006, with Mr. Webb (the “Restated SERP”). The Restated SERP amended and restated the original Supplemental Retirement Agreement, dated May 1, 2000, for certain changes related to the requirements of Section 409A of the Code. The first amendment provides the ability to designate beneficiaries, clarifies the definition of “Death” for purposes of determining time of payment under the agreement, and requires Mr. Webb to prudently manage his other retirement benefits (outside of the Restated SERP) in order to preserve the potential offset of benefits otherwise payable under the Restated SERP.

Additionally, on January 27, 2010, we entered into a split dollar life insurance agreement with Mr. Webb. If Mr. Webb is employed by us at the time of his death, then Mr. Webb’s designated beneficiaries will receive a lump sum payment equal to the employee’s interest, as defined in the agreement. The remainder of the insurance proceeds will be paid to us. We pay the premiums to keep the insurance policies in force, it retains the right to terminate the insurance policies and is the owner of the cash surrender value of the insurance policies. Any successor to us will be required to assume and perform this split dollar life insurance agreement as if no succession had occurred.

In connection with the execution of the Merger Agreement, Mr. Webb entered into an employment agreement with NBT pursuant to which Mr. Webb will be employed by NBT following the Merger. Mr. Webb’s employment agreement with NBT provides that the SERP will remain in full force and effect following the commencement of Mr. Webb’s employment with NBT the (“Commencement Date”). In accordance with the terms of the SERP, Mr. Webb will continue to accrue a benefit under the SERP during his employment with NBT. Mr. Webb’s employment agreement further provides that the SERP will be amended to provide that “Final Average Compensation” for purposes of the SERP shall mean the annualized salary of Mr. Webb’s monthly base salary actually paid by us over the 36 consecutive month period ending on the Commencement Date.

Mr. Webb’s employment agreement with NBT also provides that the split dollar life insurance agreement will be amended to provide that Mr. Webb’s employment with NBT shall constitute continued employment for purposes of the split dollar life insurance agreement and shall not trigger a “Termination of Employment” as defined therein.

401(k) Retirement Program

The NEOs are eligible to participate in the 401(k) retirement program on the same terms as other employees. Employees are eligible to make salary deferrals (contributions) at the beginning of the month following their hire date. We will match the employee’s contributions $0.50 per dollar deferred up to a maximum of 6% of the employees covered compensation. In addition, 1% of an eligible employee’s annual earnings are contributed by us regardless of whether the employee is contributing to the program.

Group Term Life Insurance

The NEOs are covered under the same benefit program available to all other employees, which are paid for by us. Employees are covered for four-times their annual earnings up to a maximum of $750,000. Accidental death and dismemberment insurance is provided in an amount equal to the life insurance.

Group Long-Term Disability Insurance

The NEOs are covered under the same benefit program available to all other employees, which are paid for by us. The coverage provides for 60% salary continuation in the event of disability, as defined in the policy, up to a maximum monthly benefit of $15,000. The NEOs are insured for the following monthly income replacement amounts.


Webb		Watt		Mohr		Getman		Cacchio
$	15,000	$	15,000	$	15,000	$	14,333	$	14,167

Other Benefits

The NEOs are eligible for the same benefits available to all other employees such as health and dental insurance, personal and sick leave, vacations, and holidays.

Perquisites and Personal Benefits

The NEOs are provided with perquisites and other personal benefits that the Compensation Committee believes are modest, reasonable, and similar in nature to those provided to executives at competing financial institutions, and are designed to assist these executives in carrying out their duties.

The NEOs have the use of a company-provided automobile. Club memberships are provided to Messrs. Webb, Watt and Getman for business meeting purposes and for their personal use. At the recommendation of the Compensation Committee, a health club membership is also provided to Mr. Webb.

Employment, Separation Agreements and Change of Control Agreements

We have employment and change of control agreements with the NEOs and certain key executives. Our board of directors views these agreements as integral in ensuring the continued dedication of our executives and promoting stability of management, particularly in the event of a change of control.

Employment Agreements

Messrs. Webb, Watt and Mohr each have employment agreements with us effective as of January 26, 2010, which have an initial term of one year. Thereafter, each of the employment agreements will automatically extend for successive one-year terms, unless previously terminated or either us or the executive provides notice that it will not be extended. In addition to the base annual salary, the employment agreements provide for, among other things, participation in incentive programs and other employee benefit plans applicable to executive employees.

In the event of involuntary termination without “cause” or voluntary termination with “good reason” (each as defined in the agreements), each executive is entitled to receive a severance benefit equal to the greater of the unpaid compensation and benefits that would have been paid under the terms of this employment agreement if the executive had remained employed, or the unpaid compensation and benefits that would have been paid under the terms of this employment agreement (including any accrued bonus) for a period of one year following the termination. Upon change of control (as defined in the agreements), which results in the termination of the executive without cause or certain resignations for good reason, the executive will receive a lump sum payment equivalent to a multiple of the average annual compensation paid to the executive by us and included in the executive’s gross income for income tax purposes for the three full taxable years that immediately precede the year during which the change of control occurs (adjusted to include bonuses paid, rather than accrued, in respect of such years) which multiple shall be three times such annual average amount in the case of Mr. Webb and two times the annual average amount in the case of

Messrs. Watt and Mohr. In addition, under such circumstances, each executive will also receive a lump sum payment equal to a multiple of our annual cost of providing health, life and long-term disability coverages and other fringe benefits equal to three times such amount in the case of Mr. Webb and equal to two times such amount in the case of Messrs. Watt and Mohr. Further, if there is a change of control, then all forms of equity-based compensation, including unexpired stock options and unvested restricted stock will accelerate. In the event that any amounts payable under the employment agreements would be nondeductible to us by reason of Section 280G of the Code, then such amounts shall be reduced to the extent necessary that such payments will no longer be ineligible for deduction by reason of Section 280G.

The employment agreements also provide for a clawback of any incentive paid to, credit to an account on behalf of, or vested to the executive within the prior 24 months under certain circumstances if it is later determined that the incentive is directly attributable to materially misleading financial statements.

In connection with the execution of the Merger Agreement, Mr. Webb entered into an employment agreement with NBT pursuant to which Mr. Webb will be employed by NBT following the Merger.

Settlement Agreements

In connection with the execution of the Merger Agreement, each of Messrs. Watt and Mohr entered into a settlement agreement with NBT and us, with identical terms, pursuant to which each executive will receive the payments and benefits provided under the executive’s settlement agreement in satisfaction of all rights to payments and benefits under the executive’s individual employment agreement with us. Rights to these payments under the executive’s employment agreement would have otherwise been triggered absent the settlement agreement due to the executive’s termination of employment in connection with the merger. Under the settlement agreements, upon termination of their employment on the closing date of the merger, Messrs. Watt and Mohr will receive lump sum severance payments of $725,850 and $677,570, respectively. The settlement agreements also provide that the executives will receive ownership and title of the company-provided automobile utilized by the executive at the time of his termination of employment. The executives must enter into a general release of claims in favor of NBT and us to receive the settlement payment under the settlement agreement.

Change of Control Agreements

Messrs. Getman and Cacchio have change of control agreements with us with identical terms. Upon a “change of control” (as defined in the agreement) resulting in termination, the executive will receive a lump sum severance payment equal to 200% of the executive’s annual base salary in effect as of the date of termination. If the executive constitutes a qualified beneficiary and elects continued coverage under COBRA, his health care coverage will be paid for by us for up to two years following termination or shorter period until obtaining new employment offering health insurance. In December 2012, we amended the change of control agreements to include the transfer to the executive of ownership and title of the company-provided automobile utilized by the executive at the time of his termination of employment following a change of control.

Compensation Committee Report⁽¹⁾

The Compensation Committee has reviewed and discussed the foregoing Compensation Discussion and Analysis with management. Based upon such review, the related discussions and such other matters deemed relevant and appropriate by the Compensation Committee, the Compensation Committee has recommended to the board of directors that the Compensation Discussion and Analysis be included in our Annual Report on Form 10-K, for the year-ended December 31, 2012

Lowell A. Seifter, Chairperson

Donald S. Ames

Donald H. Dew

Samuel J. Lanzafame

Deborah F. Stanley

(1)

The material in this report is not “soliciting material,” is not deemed “filed” with the SEC and is not to be incorporated by reference in any filing we make under the Securities Act of 1933 or the Exchange Act, whether made before or after the date hereof and irrespective of any general incorporation language in any such filing.

Compensation Committee Interlocks and Insider Participation

The Compensation Committee is composed of five directors: Donald S. Ames, Donald H. Dew, Samuel J. Lanzafame, Lowell A. Seifter and Deborah F. Stanley, with Director Seifter serving as Chairperson. None of our executive officers served as a member of another entity’s board of directors or as a member of the compensation committee (or other board committee performing equivalent functions) during 2012, which entity had an executive officer serving on our board of directors or as a member of our Compensation Committee. There are no interlocking relationships between us and other entities that might affect the determination of the compensation of our executive officers or NEOs.

Summary Compensation Table

The following table sets forth information regarding compensation earned by the NEOs for service during each of the last three completed fiscal years, as applicable:


Name and Principal Positions	Year		Salary (1)($)		Stock Awards (2)($)		Non-Equity Incentive Plan Compensation (3)($)		Change in Pension Value and Nonqualified Deferred Compensation Earnings (4)($)		All Other Compensation (5)($)		Total ($)
Jack H. Webb		2012		400,000		117,438		179,800		73,249		39,724		810,211
Chairman and Chief Executive Officer		2011		391,500		113,989		200,000		347,295		37,625		1,090,409
Chairman and Chief Executive Officer		2010		380,000		193,296		175,000		193,620		33,983		975,899

John H. Watt, Jr.		2012		223,000		54,131		93,900		—		31,679		402,710
Executive Vice President		2011		216,500		52,497		125,000		—		31,799		425,796
Executive Vice President		2010		210,000		90,891		115,000		—		27,452		443,343

J. Daniel Mohr		2012		215,000		48,990		93,500		—		22,520		380,010
Executive Vice President and Chief Financial Officer		2011		196,000		47,493		123,000		—		18,876		385,369
Executive Vice President and Chief Financial Officer		2010		190,000		86,882		100,000		—		13,524		390,406

James W. Getman		2012		172,000		41,756		55,700		—		20,479		289,935
Executive Vice President and Senior Loan Officer		2011		167,000		40,616		70,000		—		19,723		297,339
Executive Vice President and Senior Loan Officer		2010		162,500		53,591		57,000		—		16,199		289,290

Steven G. Cacchio		2012		170,000

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Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Table of Contents

Filing Compare · ALLIANCE FINANCIAL CORP /NY/