UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORMForm 10-K
   
þ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 20062008
OR
   
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period fromto
Commission file number 0-26481000-26481
FINANCIAL INSTITUTIONS, INC.
(Exact name of registrant as specified in its charter)
   
New YorkNEW YORK 16-0816610
(State or other jurisdiction of incorporation)incorporation or organization) (I.R.S. Employer Identification Number)No.)
   
220 Liberty Street, Warsaw, NYLIBERTY STREET, WARSAW, NEW YORK 14569
(Address of principal executive offices) (ZipZIP Code)
Registrant’s telephone number, including area code:
585-786-1100(585) 786-1100
Securities registered pursuant tounder Section 12(b) of the Exchange Act:
   
Title of each class Name of each exchange on which registered
Common stock, par value $0.01$.01 per share NASDAQ Global Select Market
Securities registered pursuant tounder Section 12(g) of the Exchange Act:
NoneNONE
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.
YESYeso NONoþ
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.
YESYeso NONoþ
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 precedingpast 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 Yesþ NONoo
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Formform 10-K or any amendmentsamendment to this Form 10-K.þo
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a non-accelerated filer.smaller reporting company. See definitiondefinitions of “large accelerated filer,” “accelerated filerfiler” and large accelerated filer”“smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check One):
Large Accelerated filero      Accelerated filerþ
Large accelerated fileroAccelerated filerþNon-accelerated fileroSmaller reporting companyo
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES Yeso NONoþ
The aggregate market value of common stock held by non-affiliates of the registrant, as computed by reference to the June 30, 20062008 closing price reported by NASDAQ, was $221,734,895.$160,362,000.
As of March 2, 2007February 28, 2009, there were issued and outstanding, exclusive of treasury shares, 11,336,73010,846,519 shares of the registrant’s common stock.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Registrant’s proxy statement to be filed withProxy Statement for the Securities and Exchange Commission in connection with the 20072009 Annual Meeting of Shareholders are incorporated by reference in Part III of this Annual Report on Form 10-K.III.
 
 

 


 

FINANCIAL INSTITUTIONS, INC.
2006 ANNUAL REPORT ON FORM 10-K
TABLE OF CONTENTS
     
PAGE
    
PART I
     
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 EX-10.21Exhibit 3.1
 EX-10.22Exhibit 3.2
 EX-21Exhibit 3.3
 EX-23Exhibit 3.4
 EX-31.1Exhibit 10.7
 EX-31.2Exhibit 12
 EX-32.1Exhibit 21
 EX-32.2Exhibit 23
Exhibit 31.1
Exhibit 31.2
Exhibit 32

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PART I
FORWARD LOOKING INFORMATION
Statements in this Annual Report on Form 10-K that are based on other than historical data are forward-looking within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements provide current expectations or forecasts of future events and include, among others:
statements with respect to the beliefs, plans, objectives, goals, guidelines, expectations, anticipations, and future financial condition, results of operations and performance of Financial Institutions, Inc. (“the parent” or “FII”) and its subsidiaries (collectively “the Company,” “we,” “our,” “us”);
statements preceded by, followed by or that include the words “may,” “could,” “should,” “would,” “believe,” “anticipate,” “estimate,” “expect,” “intend,” “plan,” “projects,” or similar expressions.
These forward-looking statements are not guarantees of future performance, nor should they be relied upon as representing management’s views as of any subsequent date. Forward-looking statements involve significant risks and uncertainties and actual results may differ materially from those presented, either expressed or implied, in this Annual Report on Form 10-K, including, but not limited to, those presented in the Management’s Discussion and Analysis. Factors that might cause such differences include, but are not limited to:
the Company’s ability to successfully execute its business plans, manage its risks, and achieve its objectives;
changes in political and economic conditions, including the political and economic effects of the current economic crisis and other major developments, including wars, military actions and terrorist attacks;
changes in financial market conditions, either internationally, nationally or locally in areas in which the Company conducts its operations, including without limitation, reduced rates of business formation and growth, commercial and residential real estate development and real estate prices;
fluctuations in markets for equity, fixed-income, commercial paper and other securities, including availability, market liquidity levels, and pricing;
changes in interest rates, the quality and composition of the loan and securities portfolios, demand for loan products, deposit flows and competition;
acquisitions and integration of acquired businesses;
increases in the levels of losses, customer bankruptcies, claims and assessments;
changes in fiscal, monetary, regulatory, trade and tax policies and laws, including policies of the U.S. Department of Treasury and the Federal Reserve Board (“FRB”);
the Company’s participation or lack of participation in governmental programs implemented under the Emergency Economic Stabilization Act (“EESA”) and the American Recovery and Reinvestment Act (“ARRA”), including without limitation the Troubled Asset Relief Program (“TARP”), the Capital Purchase Program (“CPP”), and the Temporary Liquidity Guarantee Program (“TLGP”) and the impact of such programs and related regulations on the Company and on international, national, and local economic and financial markets and conditions;
the impact of the EESA and the ARRA and related rules and regulations on the business operations and competitiveness of the Company and other participating American financial institutions, including the impact of the executive compensation limits of these acts, which may impact the ability of the Company and other American financial institutions to retain and recruit executives and other personnel necessary for their businesses and competitiveness;
the impact of certain provisions of the EESA and ARRA and related rules and regulations on the attractiveness of governmental programs to mitigate the effects of the current economic crisis, including the risks that certain financial institutions may elect not to participate in such programs, thereby decreasing the effectiveness of such programs;
continuing consolidation in the financial services industry;
new litigation or changes in existing litigation;
success in gaining regulatory approvals, when required;
changes in consumer spending and savings habits;
increased competitive challenges and expanding product and pricing pressures among financial institutions;
demand for financial services in the Company’s market areas;
inflation and deflation;
technological changes and the Company’s implementation of new technologies;
the Company’s ability to develop and maintain secure and reliable information technology systems;
legislation or regulatory changes which adversely affect the Company’s operations or business;

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the Company’s ability to comply with applicable laws and regulations;
changes in accounting policies or procedures as may be required by the Financial Accounting Standards Board or regulatory agencies;
increased costs of deposit insurance and changes with respect to Federal Deposit Insurance Corporation (“FDIC”) insurance coverage levels; and
further declines in the market value of the Company’s publicly traded stock price or declines in the Company’s ability to generate future cash flows may increase the potential that goodwill recorded on the Company’s consolidated statement of financial position be designated as impaired and that the Company may incur a goodwill write-down in the future.
The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advises readers that various factors, including those described above, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected. See also Item 1A, Risk Factors, in this Form 10-K.
Except as required by law, the Company does not undertake, and specifically disclaims any obligation to publicly release any revisions to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.
GLOSSARY OF ACRONYMS
ABSAsset-Backed Security
AFSAvailable-for-Sale
ALCOAsset/Liability Committee
ALMAsset-Liability Management
AMLAnti-Money Laundering
ARMAdjustable Rate Mortgage
ARRAAmerican Recovery and Reinvestment Act
ATMAutomated Teller Machine
BCBSBasel Committee on Banking Supervision
BSABank Secrecy Act
CDOCollateralized Debt Obligation
CMCCapital Management Committee
COSOCommittee of Sponsoring Organizations of the Treadway Commission
CPPCapital Purchase Program
CRACommunity Reinvestment Act
CRECommercial Real Estate
EESAEmergency Economic Stabilization Act
EITFEmerging Issues Task Force
FAMCFederal Agricultural Mortgage Corporation
FASBFinancial Accounting Standards Board
FDICFederal Deposit Insurance Corporation
FHLBFederal Home Loan Bank
FHLMCFederal Home Loan Mortgage Corporation
FINFASB Interpretation
FNMAFederal National Mortgage Association
FRBFederal Reserve Board
FSPFASB Staff Position
FTEFull-Time Equivalent
GNMAGovernment National Mortgage Association
HTMHeld-to-Maturity
MD&AManagement’s Discussion and Analysis
OCIOther Comprehensive Income
OREOOther Real Estate Owned
OTCOver-the-Counter
OTTIOther-Than-Temporary-Impairment
PCAOBPublic Company Accounting Oversight Board
SBASmall Business Administration
SECSecurities and Exchange Commission
SFASStatement of Financial Accounting Standards
TARPTroubled Asset Relief Program
TLGPTemporary Liquidity Guarantee Program
VIEVariable Interest Entity

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ItemITEM 1. BusinessBUSINESS
Forward Looking Statements
This Annual Report on Form 10-K, especially in Management’s Discussion and Analysis of Financial Condition and Results of Operation, contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. In general, the use of such words as estimate, project, believe, intend, anticipate, plan, seek, expect and similar expressions are intended to identify “forward-looking statements” and may include:
Statements regarding our business plans, and prospects;
Statements of our goals, intentions and expectations;
Statements regarding our growth and operating strategies;
Statements regarding the quality of our loan and investment portfolios; and
Estimates of our risks and future costs and benefits.
The Private Securities Litigation Reform Act of 1995 provides a safe harbor for forward-looking statements. In order to comply with the terms of the safe harbor, the Company notes that a variety of factors could cause the Company’s actual results and experience to differ materially from the anticipated results or other expectations expressed in the Company’s forward-looking statements. Some of the risks and uncertainties that may affect the operations, performance, development and results of the Company’s business, the interest rate sensitivity of its assets and liabilities, and the adequacy of its allowance for loan losses, include but are not limited to the following:
Significantly increased competition between depository and other financial institutions;
Changes in the interest rate environment that reduces our margins or the fair value of financial instruments;
General economic conditions, either nationally or in our market areas, that are worse than expected;
Declines in the value of real estate, equipment, livestock and other assets serving as collateral for our loans outstanding;
Legislative or regulatory changes that adversely affect our business;
Changes in consumer spending, borrowing and savings habits;
Changes in accounting policies and practices, as generally accepted in the United States of America; and
Actions taken by regulators with jurisdiction over the Company or its subsidiaries.
The Company cautions readers not to place undue reliance on any forward-looking statements, which speak only as of the date made, and advises readers that various factors, including those described above, could affect the Company’s financial performance and could cause the Company’s actual results or circumstances for future periods to differ materially from those anticipated or projected.
Except as required by law, the Company does not undertake, and specifically disclaims any obligation, to publicly release any revisions to any forward-looking statements to reflect the occurrence of anticipated or unanticipated events or circumstances after the date of such statements.

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GeneralGENERAL
Financial Institutions, Inc. (“FII”),is a bankfinancial holding company organized in 1931 under the laws of New York State, andState. Through its subsidiaries, (collectively the “Company”) provideincluding its wholly-owned, New York State chartered banking subsidiary, Five Star Bank, Financial Institutions, Inc. provides deposit, lending and other financial services to individuals and businesses in Central and Western New York State. All references in this Form 10-K to the parent company are to Financial Institutions, Inc. (“FII”). Unless otherwise indicated or unless the context requires otherwise, all references in this Form 10-K to “the Company” means Financial Institutions, Inc. and its subsidiaries on a consolidated basis. Five Star Bank is referred to as Five Star Bank, “FSB” or “the Bank”. The Companyparent company is subject to regulation by certain federal and state agencies.
The Company for many years operated under a decentralized, “Super Community Bank” business model, withlegal entity separate and largely autonomousdistinct from its subsidiaries, assisting those subsidiaries by providing financial resources and management. The Company’s executive offices are located at 220 Liberty Street, Warsaw, New York.
We conduct our business primarily through our banking subsidiary, banks whose Boards and management had the authority to operate within guidelines set forthFive Star Bank, which adopted its current name in broad corporate policies established at the holding company level. During 2005 FII’s Board of Directors decided to implement changes to the Company’s business model and governance structure. Effective December 3, 2005,when the Company merged three of its bank subsidiaries, Wyoming County Bank, (100% owned) (“WCB”), National Bank of Geneva (100% owned) (“NBG”) and Bath National Bank (100% owned) (“BNB”) into its New York State-charteredState chartered bank subsidiary, First Tier Bank & Trust, (100% owned) (“FTB”), which was then renamed Five Star Bank (“FSB” or the “Bank”). The merger was accounted for at historical cost as a combination of entities under common control.
FII formerly qualified as a financial holding company under the Gramm-Leach-Bliley Act, which allowed expansion ofBank. In addition, our business operations to include financial services subsidiaries, namely,a broker-dealer subsidiary, Five Star Investment Services, Inc. (100% owned) (“FSIS”) (formerly known as The FI Group, Inc. (“FIGI”)) and the Burke Group, Inc. (formerly 100% owned) (“BGI”), collectively referred to as the “Financial Services Group” (“FSG”). FSIS is a brokerage subsidiary that commenced operations as a start-up company in March 2000. BGI, an employee benefits and compensation consulting firm, was acquired by the Company in October 2001. During 2005, the Company sold the stock of BGI and its results have been reported separately as a discontinued operation in the consolidated statements of income. Since the sale of BGI occurred during 2005, there are no assets or liabilities associated with the discontinued operation recorded at December 31, 2006 or 2005. BGI’s cash flows are shown in the consolidated statements of cash flows by activity (operating, investing and financing) consistent with the applicable source of cash flow.
During 2003, FII terminated its financial holding company status and now operates as a bank holding company. The change in status did not affect the non-financial subsidiaries or activities being conducted by the Company, although future acquisitions or expansions of non-financial activities may require prior Federal Reserve Board (“FRB”) approval and will be limited to those that are permissible for bank holding companies.
In February 2001, the Company formed FISI Statutory Trust I (100% owned) (the “Trust”) and capitalized the entity with a $502,000 investment in the Trust’s common securities. The Trust was formed to facilitate the private placement of $16.2 million in capital securities (“trust preferred securities”). In accordanceFII capitalized the Trust with a $502 thousand investment in the provisions ofTrust’s common securities. The Trust is a variable interest entity as defined by Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities,” and, as such, the Trust is not included inaccounted for as an unconsolidated subsidiary. Therefore, the Company’s consolidation; insteadconsolidated statements of financial position reflect the $16.7 million in junior subordinated debentures are recorded as a liability and a $502,000the $502 thousand investment in the trust recordedTrust’s common securities is included in other assetsassets.
During the second quarter of 2008, the Company received Federal Reserve approval for an election to reinstate its status as a financial holding company under the Gramm-Leach-Bliley Act, which permits the Company to engage in the Company’s consolidated statements ofbusiness activities that are financial condition.in nature or incidental to financial activity.
Available InformationOTHER INFORMATION
This annual report, including the exhibits and schedules filed as part of the annual report, may be inspected at the public reference facility maintained by the SEC at its public reference room at 100 F. Street, N.E., Room 1580, Washington, DC 20549 and copies of all or any part thereof may be obtained from that office upon payment of the prescribed fees. You may call the SEC at 1-800-SEC-0330 for further information on the operation of the public reference room and you can request copies of the documents upon payment of a duplicating fee, by writing to the SEC. In addition, the SEC maintains a website that contains reports, proxy and information statements and other information regarding registrants, including us, that file electronically with the SEC which can be accessed at www.sec.gov.
The Company also makes available, free of charge through its website atwww.fiiwarsaw.com, all reports filed with the SEC, including our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K, as well as any amendments to those reports, as soon as reasonably practicable after those

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documents are filed with, or furnished to, the SEC. Information available on our website is not a part of, and is not incorporated into, this annual report on Form 10-K.
Executive Officers and Other Significant Employees of the Registrant
The following table sets forth current information regarding executive officers and other significant employees (ages are as of December 31, 2006).
           
Name Age Starting In Positions/Offices
Peter G. Humphrey  52   1983  President and Chief Executive Officer.
           
James T. Rudgers  57   2004  Executive Vice President and Chief of Community Banking. From 2002 – 2004 was Executive Vice President of Retail Banking at Hudson United Bank Corporation. From 1997 – 2002 was Senior Vice President and Principal of Manchester Humphreys, Inc.
           
Ronald A. Miller  58   1996  Executive Vice President, Chief Financial Officer and Corporate Secretary.
           
George D. Hagi  54   2006  Executive Vice President and Chief Risk Officer. From 1997 – 2005 was Senior Vice President and Director of Risk Management at First National Bankshares of Florida and FNB Corp.
           
John J. Witkowski  45   2005  Senior Vice President and Regional President/Retail Banking Executive. From 1993 – 2005 was Senior Vice President and Director of Sales for Business Banking/Client Development Group at Bank of America.
           
Martin K. Birmingham  41   2005  Senior Vice President and Regional President/Commercial Market Executive. From 1989 – 2005 was Senior Team Leader and Regional President of the Rochester Market at Bank of America.
           
Kevin B. Klotzbach  53   2001  Senior Vice President and Treasurer. From 1999 – 2001 was Chief Investment Officer at Greater Buffalo Savings Bank.
           
Bruce H. Nagle  58   2006  Senior Vice President and Director of Human Resources. From 2000 – 2006 was Vice President of Human Resources at University of Pittsburgh Medical Center.
           
Richard J. Harrison  62   2003  Senior Vice President and Senior Retail Lending Administrator. From 2000 – 2003 was Executive Vice President and Chief Credit Officer at Savings Bank of the Fingerlakes.
Market Area and CompetitionMARKET AREAS AND COMPETITION
The Company provides a wide range of consumer and commercial banking and financial services to individuals, municipalities and businesses through a network of 50 branches52 offices and over 70 ATMs in fifteenfourteen contiguous counties of Western and Central New York State: Allegany, Cattaraugus, Cayuga, Chautauqua, Chemung, Erie, Genesee, Livingston, Monroe, Ontario, Schuyler, Seneca, Steuben, Wyoming and Yates Counties.
The Company’s market area is geographically and economically diversified in that it serves both rural markets and the larger more affluent markets of suburban Rochester and suburban Buffalo. Rochester and Buffalo are the two largest cities in New York State outside of New York City, with combined metropolitan area populations of over two million people. The Company anticipates increasing its presence in the markets around these two cities.cities and opened two branches in the Rochester suburbs during 2008.

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The Company faces significant competition in both making loans and attracting deposits, as Western and Central New York have a high density of financial institutions. The Company’s competition for loans comes principally from commercial banks, savings banks, savings and loan associations, mortgage banking companies, credit unions, insurance companies and other financial service companies. Its most direct competition for deposits has historically come from commercial banks, savings banks and credit unions. The Company faces additional competition for deposits from non-depository competitors such as the mutual fund industry, securities and brokerage firms and insurance companies.

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EmployeesLENDING ACTIVITIES
General
The Company had approximately 640 full-time equivalent employees (“FTEs”) at December 31, 2006.
Operating Segments
The Company’s primary reportable segment is its subsidiary bank, Five Star Bank (“FSB”). During 2005, the Company completed a strategic realignment, which involved the merger of its subsidiary banks into a single state-chartered bank, FSB. The Financial Services Group (“FSG”) was also deemed a reportable segment in prior years, as the Company evaluated the performance of this line of business separately. However, with the sale of BGI during 2005, the FSG segment no longer meets the thresholds included in SFAS No. 131 for separation.
Lending Activities
General.The Bank offers a broad range of loans including commercial and agricultural working capital and revolving lines of credit, commercial and agricultural mortgages, equipment loans, crop and livestock loans, residential mortgage loans and home equity loans and lines of credit, home improvement loans, automobile loans and personal loans. Most newlyNewly originated and refinanced fixed rate residential mortgage loans are either retained in the Company’s portfolio or sold into the secondary market and servicing rights are retained.
Lending Philosophy and Objectives. The BankCompany has thoroughly evaluated and updated its lending policy in recent years. The revisions to the loan policy include a renewed focus on lending philosophy and credit objectives.
The key elements of the Bank’sCompany’s lending philosophy include the following:
To ensure consistent underwriting, all employees must share a common view of the risks inherent in lending activities as well as the standards to be applied in underwriting and managing credit risk;
Pricing of credit products should be risk-based;
The loan portfolio must be diversified to limit the potential impact of negative events; and
Careful, timely exposure monitoring through dynamic use of our risk rating system, is required to provide early warning and assure proactive management of potential problems.
The Bank’s credit objectives are as follows:
Compete effectively and service the legitimate credit needs of our target market;
Enhance our reputation for superior quality and timely delivery of products and services;
Provide pricing that reflects the entire relationship and is commensurate with the risk profiles of our borrowers;
Retain, develop and acquire profitable, multi-product, value added relationships with high quality borrowers;
Focus on government guaranteed lending and establish a specialization in this area to meet the needs of the small businesses in our communities; and
Comply with the relevant laws and regulations.

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Loan Approval Process.The Bank’s loan policy establishes standardized underwriting guidelines, as well as the standards to be applied in underwriting and managing credit risk;
Pricing of credit products should be risk-based;
The loan approval processportfolio must be diversified to limit the potential impact of negative events; and the appropriate committee structures necessary to facilitate and insure the highest possible loan quality decision-making in a
Careful, timely and businesslike manner. The policy establishes requirements for extending credit based on the size,exposure monitoring through dynamic use of our risk rating and type of credit involved. The policy also sets limits on individual loan officer lending authority and various forms of joint lending authority, while designating which loans aresystem is required to be approved at the committee level.provide early warning and assure proactive management of potential problems.
Loan Review Program.Commercial and Agricultural Lending
The Bank’s policy includes loan reviews, under the supervision of the Audit Committee of the Board of Directors and directed by the Chief Risk Officer, to review the Bank’s credit function in order to render an independent and objective evaluation of the Bank’s asset quality and credit administration process.
Risk Assessment Process.Risk ratings are assigned to loans in the commercial, commercial real estate and agricultural portfolios. The risk ratings are specifically used as follows:
Profile the risk and exposure in the loan portfolio and identify developing trends and relative levels of risk;
Identify deteriorating credits; and
Reflect the probability that a given customer may default on its obligations.
Through the loan approval process, loan administration and loan review program, management continuously monitors the credit risk profile of the Bank and assesses the overall quality of the loan portfolio and adequacy of the allowance for loan losses.
Delinquencies and Nonperforming Assets.The Bank has several procedures in place to assist in maintaining the overall quality of its loan portfolio. Delinquent loan reports are monitored by credit administration to identify adverse levels and trends. Loans are generally placed on nonaccruing status and cease accruing interest when the payment of principal or interest is delinquent for 90 days, or earlier in some cases, unless the loan is in the process of collection and the underlying collateral further supports the carrying value of the loan.
Allowance for Loan Losses. The allowance for loan losses is established through charges or credits to earnings in the form of a provision (credit) for loan losses. The allowance reflects management’s estimate of the amount of probable loan losses in the portfolio, based on the following factors:
Specific allocations for individually analyzed credits;
Risk assessment process;
Historical charge-off experience;
Evaluation of the loan portfolio with loan reviews;
Levels and trends in delinquent and nonaccruing loans;
Trends in volume and terms;
Collateral values;
Effects of changes in lending policy;
Experience, ability and depth of management;
National and local economic trends and conditions; and
Concentrations of credit.
Management presents a quarterly review of the adequacy of the allowance for loan losses to the Company’s Board of Directors. In order to determine the adequacy of the allowance for loan losses, the risk rating and delinquency status of loans and other factors are considered, such as collateral value, government guarantees, portfolio composition, trends in economic conditions and the financial strength of borrowers. Specific allocations for individually evaluated loans are established when required. An allowance is also established for groups of loans with similar risk characteristics, based upon average historical charge-off experience taking into account levels

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and trends in delinquencies, loan volumes, economic and industry trends and concentrations of credit. See also the sections titled “Analysis of Allowance for Loan Losses” and “Allocation of Allowance for Loan Losses” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation”.
Commercial.The BankCompany originates commercial loans in its primary market areas and underwrites them based on the borrower’s ability to service the loan from operating income. The BankCompany offers a broad range of commercial lending products, including term loans and lines of credit. Short and medium-term commercial loans, primarily collateralized, are made available to businesses for working capital (including inventory and receivables), business expansion (including acquisition of real estate, expansion and improvements) and the purchase of equipment. As a general practice, where possible, a collateral lien is placed on any available real estate, equipment or other assets owned by the borrower and a personal guarantee of the owner is obtained. AtAs of December 31, 2006, $29.32008, $46.6 million, or 27.7%29.4%, of the aggregate commercial loan portfolio were at fixed rates, while $76.5$111.9 million, or 72.3%70.6%, were at variable rates. The BankCompany utilizes government loan guarantee programs where available and appropriate. See “Government Guarantee Programs” below.
Agricultural loans are offered for short-term crop production, farm equipment and livestock financing and agricultural real estate financing, including term loans and lines of credit. Short and medium-term agricultural loans, primarily collateralized, are made available for working capital (crops and livestock), business expansion (including acquisition of real estate, expansion and improvement) and the purchase of equipment. As of December 31, 2008, $12.6 million, or 28.3%, of the agricultural loan portfolio were at fixed rates, while $32.1 million, or 71.7%, were at variable rates. The Company utilizes government loan guarantee programs where available and appropriate. See “Government Guarantee Programs” below.
Commercial Real Estate. Lending
In addition to commercial loans secured by real estate, the BankCompany makes commercial real estate loans to finance the purchase of real property, which generally consists of real estate with completed structures. Commercial real estate loans are secured by first liens on the real estate and are typically amortized over a 10 to 20 year period. The underwriting analysis includes credit verification, appraisals and a review of the borrower’s financial condition. Atcondition and repayment capacity. As of December 31, 2006, $40.42008, $58.0 million, or 16.6%22.1%, of the aggregate commercial real estate loan portfolio were at fixed rates, while $203.6$204.2 million, or 83.4%77.9%, were at variable rates.
Agricultural.AgriculturalGovernment Guarantee Programs
The Company participates in government loan guarantee programs offered by the SBA, United States Department of Agriculture, Rural Economic and Community Development and Farm Service Agency, among others. As of December 31, 2008, the Company had loans are offered for short-term crop production, farm equipmentwith an aggregate principal balance of $37.6 million that were covered by guarantees under these programs. The guarantees only cover a certain percentage of these loans. By participating in these programs, the Company is able to broaden its base of borrowers while minimizing credit risk.
Consumer Lending
The Company offers a variety of loan products to its consumer customers located in Western and livestock financing and agricultural real estate financing,Central New York, including termhome equity loans and lines of credit. Shortcredit, automobile loans, secured installment loans and medium-term agricultural loans, primarily collateralized, are made available for working capital (cropsvarious other types of secured and livestock), business expansion (including acquisition of real estate, expansion and improvement) and the purchase of equipment.unsecured personal loans. At December 31, 2006, $14.12008, outstanding consumer loan balances were concentrated in indirect automobile loans and home equity products.

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The Company indirectly originates, through dealers, consumer indirect automobile loans. The consumer indirect loan portfolio is primarily comprised of new and used automobile loans with terms that typically range from 36 to 72 months. The Company has expanded its relationships with franchised new car dealers in our general market area and has selectively originated a mix of new and used automobile loans from those dealers. As of December 31, 2008, the consumer indirect portfolio totaled $255.1 million, or 24.9%,nearly all of which were fixed rate automobile loans.
The Company also originates, independently of the agricultural loan portfolio were at fixed rates while $42.7 million, or 75.1%, were at variable rates. The Bank utilizes government loan guarantee programs where available and appropriate. See “Government Guarantee Programs” below.
Residential Real Estate.The Bank originates fixed and variable rate one-to-four family residential mortgages and closed-end home equityindirect loans collateralized by owner-occupied properties located in its market areas. The Bank offers a variety of real estate loan products, which are generally amortized for periods up to 30 years. Loans collateralized by one-to-four family residential real estate generally have been originated in amounts of no more than 80% of appraised value or have mortgage insurance. Mortgage title insurance and hazard insurance are normally required. The Bank sells certain one-to-four family residential mortgages on the secondary mortgage market and typically retains the right to service the mortgages. To assure maximum salability of the residential loan products for possible resale, the Company has formally adopted the underwriting, appraisal, and servicing guidelines of the Federal Home Loan Mortgage Corporation (“FHLMC”) as part of its standard loan policy. At December 31, 2006, the residential mortgage servicing portfolio totaled $355.2 million, the majority of which have been sold to FHLMC. At December 31, 2006, $225.3 million, or 83.9%, of residential real estate loans retained in portfolio were at fixed rates while $43.1 million, or 16.1%, were at variable rates.
Consumer and Home Equity Lines.The Bank originates direct and indirectdescribed above, consumer automobile loans, recreational vehicle loans, boat loans, home improvement loans, closed-end home equity loans, home equity lines of credit, personal loans (collateralized and uncollateralized) and deposit account collateralized loans. The terms of these loans typically range from 12 to 180 months and vary based upon the nature of the collateral and the size of loan. The majority of the consumer lending program is underwritten on a secured basis using the customer’s home or the financed automobile, mobile home, boat or recreational vehicle as collateral. AtAs of December 31, 2006, $153.02008, $134.0 million, or 60.8%60.1%, of consumer and home equity loans were at fixed rates, while $98.5$88.9 million, or 39.2%39.9%, were at variable rates.
Government Guarantee Programs. Residential Mortgage Lending
The Bank participatesCompany originates fixed and variable rate one-to-four family residential mortgages collateralized by owner-occupied properties located in its market areas. The Company offers a variety of real estate loan products, which are generally amortized for periods up to 30 years. Loans collateralized by one-to-four family residential real estate generally have been originated in amounts of no more than 80% of appraised value or have mortgage insurance. Mortgage title insurance and hazard insurance are normally required. The Company sells certain one-to-four family residential mortgages to the secondary mortgage market and typically retains the right to service the mortgages. To assure maximum salability of the residential loan products for possible resale, the Company has formally adopted the underwriting, appraisal, and servicing guidelines of the FHLMC as part of its standard loan policy. As of December 31, 2008, the residential mortgage servicing portfolio totaled $315.7 million, the majority of which have been sold to FHLMC. As of December 31, 2008, $138.8 million, or 78.1%, of residential real estate loans retained in portfolio were at fixed rates, while $38.9 million, or 21.9%, were at variable rates. The Company does not engage in sub-prime or other high-risk residential mortgage lending as a line-of-business.
Credit Administration
The Company’s loan policy establishes standardized underwriting guidelines, as well as the loan approval process and the committee structures necessary to facilitate and insure the highest possible loan quality decision-making in a timely and businesslike manner. The policy establishes requirements for extending credit based on the size, risk rating and type of credit involved. The policy also sets limits on individual loan officer lending authority and various forms of joint lending authority, while designating which loans are required to be approved at the committee level.
The Company’s credit objectives are as follows:
Compete effectively and service the legitimate credit needs of our target market;
Enhance our reputation for superior quality and timely delivery of products and services;
Provide pricing that reflects the entire relationship and is commensurate with the risk profiles of our borrowers;
Retain, develop and acquire profitable, multi-product, value added relationships with high quality borrowers;
Focus on government guaranteed lending and establish a specialization in this area to meet the needs of the small businesses in our communities; and
Comply with the relevant laws and regulations.
The Company’s policy includes loan guarantee programs offeredreviews, under the supervision of the Audit Committee of the Board of Directors and directed by the Small Business Administration (or “SBA”), United States DepartmentChief Risk Officer, in order to render an independent and objective evaluation of Agriculture (or “USDA”), Rural Economicthe Company’s asset quality and Community Development (or “RECD”)credit administration process.
Risk ratings are assigned to loans in the commercial, commercial real estate and Farm Service Agency (or “FSA”), among others. At December 31, 2006,agricultural portfolios. The risk ratings are specifically used as follows:
Profile the Bank had loans with an aggregaterisk and exposure in the loan portfolio and identify developing trends and relative levels of risk;
Identify deteriorating credits; and
Reflect the probability that a given customer may default on its obligations.
Through the loan approval process, loan administration and loan review program, management seeks to continuously monitor the credit risk profile of the Company and assesses the overall quality of the loan portfolio and adequacy of the allowance for loan losses.
The Company has several procedures in place to assist in maintaining the overall quality of its loan portfolio. Delinquent loan reports are monitored by credit administration to identify adverse levels and trends. Loans are generally placed on nonaccruing status and cease accruing interest when the payment of principal balanceor interest is delinquent for 90 days, or earlier in some cases, unless the loan is in the process of $38.7 million that were covered by guarantees under these programs. The guarantees only cover a certain percentagecollection and the underlying collateral further supports the carrying value of these loans. By participating in these programs, the Bank is able to broaden its base of borrowers while minimizing credit risk.loan.

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Investing ActivitiesAllowance for Loan Losses
General.The Bank’sallowance for loan losses is established through charges or credits to earnings in the form of a provision (credit) for loan losses. The allowance reflects management’s estimate of the amount of probable loan losses in the portfolio, based on factors such as:
Specific allocations for individually analyzed credits;
Risk assessment process;
Historical net charge-off experience;
Evaluation of the loan portfolio with loan reviews;
Levels and trends in delinquent and nonaccruing loans;
Trends in volume and terms;
Collateral values;
Effects of changes in lending policy;
Experience, ability and depth of management;
National and local economic trends and conditions; and
Concentrations of credit.
The Company’s methodology in the estimation of the allowance for loan losses includes the following broad areas:
1.Impaired commercial, commercial real estate and agricultural loans, in excess of $50 thousand are reviewed individually and assigned a specific loss allowance, if considered necessary, in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan — an amendment of FASB Statements No. 5 and 15.”
2.The remaining portfolios of commercial, commercial real estate and agricultural loans are segmented by risk rating into the following loan classification categories: uncriticized or pass, special mention and substandard. Uncriticized loans, special mention loans and all substandard loans not assigned a specific loss allowance are assigned allowance allocations based on historical net loan charge-off experience for each of the respective loan categories, supplemented with additional reserve amounts, if considered necessary, based upon qualitative factors. These qualitative factors include the levels and trends in delinquencies, nonaccruing loans, and risk ratings; trends in volume and terms of loans; effects of changes in lending policy; experience, ability, and depth of management; national and local economic conditions; and concentrations of credit, among others.
3.The consumer loan portfolio is segmented into six types of loans: residential real estate, home equity loans, home equity lines of credit, consumer direct, consumer indirect, and overdrafts. Each of those categories is subdivided into categories based on delinquency status, either 90 days and over past due or under 90 days. Allowance allocations on these types of loans are based on the average loss experience over the last three years for each subdivision of delinquency status supplemented with qualitative factors containing the same elements as described above.
Management presents a quarterly review of the adequacy of the allowance for loan losses to the Company’s Board of Directors based on the methodology described above. See also the sections titled “Analysis of Allowance for Loan Losses” and “Allocation of Allowance for Loan Losses” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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INVESTMENT ACTIVITIES
The Company’s investment securities policy is contained within its overall Asset-Liability Management and Investment Policy. This policy dictates that investment decisions will be made based on the safety of the investment, liquidity requirements, potential returns, cash flow targets, need for collateral and desired risk parameters. In pursuing these objectives, the BankCompany considers the ability of an investment to provide earnings consistent with factors of quality, maturity, marketability and risk diversification. The Bank’sCompany’s Treasurer, guided by the ALCO Committee, is responsible for investment portfolio decisions within the established policies.
The Bank’sCompany’s investment securities strategy centers on providing liquidity to meet loan demand and redeeming liabilities, meeting pledging requirements, managing overall interest rate and credit risks and maximizing portfolio yield. The Company’s policy generally limits security purchases to the following:
U.S. treasury securities;
U.S. government agency securities, which are securities issued by official Federal government bodies (e.g. the Government National Mortgage Association (“GNMA”));
U.S. government-sponsored enterprise (“GSE”) securities, which are securities issued by independent organizations that are in part sponsored by the federal government (e.g. the Federal Home Loan Bank (“FHLB”) system, the Federal National Mortgage Association (“FNMA”) and the Federal Home Loan Mortgage Corporation (“FHLMC”));
Mortgage-backed pass-through securities (“MBSs”), collateralized mortgage obligations (“CMOs”) and asset-backed securities (“ABSs”) issued by GNMA, FNMA, FHLMC and the Small Business Associations (“SBA”) and other privately issued investment grade quality securities;
Investment grade municipal securities, including tax, revenue and bond anticipation notes and general obligation bonds;
Certain creditworthy un-rated securities issued by municipalities;
Investment grade corporate debt, certificates of deposit and qualified preferred stock.
Investments in corporate bonds are limited to no more than 10% of total investments and to bonds rated as Baa or better by Moody’s Investor Services, Inc. or BBB or better by Standard & Poor’s Ratings Services at the time of purchase.
U.S. treasury securities;
U.S. government agency securities, which are securities issued by official Federal government bodies (e.g. the Government National Mortgage Association (“GNMA”)) and U.S. government-sponsored enterprise (“GSE”) securities, which are securities issued by independent organizations that are in part sponsored by the federal government (e.g. the Federal Home Loan Bank (“FHLB”) system, the Federal National Mortgage Association (“FNMA”), the Federal Home Loan Mortgage Corporation (“FHLMC”) and the Small Business Administration (“SBA”));
Mortgage-backed securities (“MBS”) include mortgage-backed pass-through securities (“pass-throughs”) and collateralized mortgage obligations (“CMO”) issued by GNMA, FNMA and FHLMC and privately issued whole loan CMOs that contain some exposure to sub-prime loans. See also the section titled “Investing Activities” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations;”
Other asset-backed securities (“ABS”) and other privately issued investment grade quality securities;
Investment grade municipal securities, including tax, revenue and bond anticipation notes and general obligation bonds;
Certain creditworthy un-rated securities issued by municipalities;
Investment grade corporate debt, certificates of deposit and qualified preferred equity securities issued by U.S. government-sponsored enterprises (such as FNMA or FHLMC) rated A+ or better;
Equity securities at the holding company level; and
Limited partnership investments in Small Business Investment Companies (“SBIC”).
Funding ActivitiesSOURCES OF FUNDS
General.Deposits and borrowed funds are theThe Company’s primary sources of the Company’s funds for use in lending, investingare deposits, borrowed funds and for other general purposes. In addition, repayments onrepurchase agreements, scheduled amortization and prepayments of principal from loans and mortgage-backed securities, proceeds from salesmaturities and calls of loans andinvestment securities and cash flows from operations provide additional sources of funds.funds provided by operations.
Deposits.The BankCompany offers a variety of deposit account products with a range of interest rates and terms. The deposit accounts consist of noninterest-bearing demand, interest-bearing demand, savings, money market, club accounts and certificates of deposit. The BankCompany also offers certificates of deposit with balances in excess of $100,000 to local municipalities, businesses, and individuals as well as Individual Retirement Accounts (“IRAs”) and other qualified plan accounts. To enhance its deposit product offerings, the Company provides commercial checking accounts for small to moderately sized commercial businesses, as well as a low-cost checking account service for low-income customers. The flow of deposits is influenced significantly by general economic conditions, changes in money market rates, prevailing interest rates and competition. The Bank’sCompany’s deposits are obtained predominantly from the areas in which its branch offices are located. The BankCompany relies primarily on competitive pricing of its deposit products, customer service and long-standing relationships with customers to attract and retain these deposits. On a secondary basis,In the past, the Company utilizeshas also utilized certificate of deposit sales in the national brokered market (“brokered deposits”) as a wholesale funding source.
Borrowed Funds.Borrowings The Company had no brokered deposits at December 31, 2008. The Company’s borrowings consist mainly of advances entered into with the Federal Home Loan Bank (“FHLB”),FHLB, federal funds purchased and securities sold under repurchase agreements.
OPERATING SEGMENTS
The Company formerly had a term debt agreement with another commercialCompany’s primary operating segment is its subsidiary bank, that was prepaid during 2006.FSB. The Company’s brokerage subsidiary, FSIS, is also deemed an operating segment; however it does not meet the thresholds included in SFAS No. 131 for separation.

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Junior Subordinated Debentures IssuedSUPERVISION AND REGULATION
General
FII and FSB are subject to Unconsolidated Subsidiary Trust.The Company formed the Trustextensive federal and state laws and regulations that impose restrictions on, and provide for regulatory oversight of, FII’s and FSB’s operations. These laws and regulations are generally intended to protect depositors and not shareholders. Any change in February 2001 to facilitate the private placement of capital securities.
Supervisionany applicable statute or regulation could have a material effect on FII’s and RegulationFSB’s business.
The supervision and regulation of financial and bank holding companies and their subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds regulated by the Federal Deposit Insurance Corporation (“FDIC”)FDIC and the banking system as a whole, and not for the protection of shareholders or creditors of bank holding companies. The various bank regulatory agencies have broad enforcement power over bank holding companies and banks, including the power to impose substantial fines, operational restrictions and other penalties for violations of laws and regulations.
The Company is also affected by various governmental requirements and regulations, general economic conditions, and the fiscal and monetary policies of the federal government and the FRB. The monetary policies of the FRB influence to a significant extent the overall growth of loans, investments, deposits, interest rates charged on loans, and interest rates paid on deposits. The nature and impact of future changes in monetary policies are often not predictable.
The following description summarizes some of the laws to which the Company is subject. References to applicable statutes and regulations are brief summaries and do not claim to be complete. They are qualified in their entirety by reference to such statutes and regulations. Management believes the Company is in compliance in all material respects with these laws and regulations. Changes in the laws, regulations or policies that impact the Company cannot necessarily be predicted, but they may have a material effect on the business and earningsCompany’s consolidated financial position, consolidated results of the Company.operations, or liquidity.
The CompanyRegulation of FII
FII is a bankfinancial holding company registered under the Bank Holding Company Act of 1956, as amended, and is subject to supervision, regulation and examination by the FRB. During 2003, FII terminated its financial holding company status and now operates as a bank holding company. The change in status did not affect any non-financial subsidiaries or activities being conducted by FII, although future acquisitions or expansions of non-financial activities may require prior FRB approval and will be limited to those that are permissible for bank holding companies. The Bank Holding Company Act and other federal laws subject bank holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.
Regulatory Restrictions on Dividends; Source of Strength.It is the policy of the FRB 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 bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its subsidiaries.
Under FRB policy, a bank holding company is expected to act as a source of financial strength to each of its subsidiaries and commit resources to their support. Such support may be required at times when, absent this FRB policy, a holding company may not be inclined to provide it. As discussed below, a bank holding company in certain circumstances could be required to guarantee the capital plan of an undercapitalized banking subsidiary.
Safe and Sound Banking PracticesPractices.. Bank holding companies are not permitted to engage in unsafe and unsound banking practices. The FRB’s Regulation Y, for example, generally requires a holding company to give the FRB prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company’s consolidated net worth. The FRB may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. Depending upon the circumstances, the FRB could take the position that paying a dividend would constitute an unsafe or unsound banking practice.
The FRB has broad authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1,000,000 for each day the activity continues.

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Anti-Tying RestrictionsRestrictions.. 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. In 2002, the FRB adopted Regulation W, a comprehensive synthesis of prior opinions and interpretations under Sections 23A and 23B of the Federal Reserve Act. Regulation W contains an extensive discussion of tying arrangements, which could impact the way banks and bank holding companies transact business with affiliates.

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Capital Adequacy RequirementsRequirements.. The FRB has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies. Under the guidelines, specific categories of assets are assigned different risk weights, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a “risk-weighted” asset base. The guidelines require a minimum total risk-based capital ratio of 8.0% (of which at least 4.0% is required to consist of Tier 1 capital elements). Total capital is the sum of Tier 1 and Tier 2 capital. As of December 31, 2006,2008, the Company’s ratio of Tier 1 capital to total risk-weighted assets was 15.85%11.83% and the ratio of total capital to total risk-weighted assets was 17.10%13.08%. See also the section titled “Capital Resources” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation”Operations” and Note 1610, Regulatory Matters, of the notes to consolidated financial statements.
In addition to the risk-based capital guidelines, the FRB uses a leverage ratio as an additional tool to evaluate the capital adequacy of bank holding companies. The leverage ratio is a company’s Tier 1 capital divided by quarterly average consolidated assets. Certain highly rated bank holding companies may maintain a minimum leverage ratio of 3.0%, but other bank holding companies may be required to maintain a leverage ratio of up to 200 basis points above the regulatory minimum. As of December 31, 2006,2008, the Company’s leverage ratio was 8.91%8.05%.
The federal banking agencies’ risk-based and leverage ratios are minimum supervisory ratios generally applicable to banking organizations that meet certain specified criteria, assuming that they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. FRB guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets.
Imposition of Liability for Undercapitalized SubsidiariesSubsidiaries.. Bank regulators are required to take “prompt corrective action” to resolve problems associated with insured depository institutions whose capital declines below certain levels. In the event an institution becomes “undercapitalized,” it must submit a capital restoration plan. The capital restoration plan will not be accepted by the regulators unless each company having control of the undercapitalized institution guarantees the subsidiary’s compliance with the capital restoration plan up to a certain specified amount. Any such guarantee from a depository institutionsinstitution holding company is entitled to a priority of payment in bankruptcy.
The aggregate liability of the holding company of an undercapitalized bank is limited to the lesser of 5% of the institution’s assets at the time it became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior FRB approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.
Acquisitions by Bank Holding CompaniesCompanies.. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the FRB 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 voting shares of such bank. In approving bank acquisitions by bank holding companies, the FRB is required to consider the financial and managerial resources and future prospects of the bank holding company and the banks concerned,involved, the convenience and needs of the communities to be served, and various competitive factors.

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Control AcquisitionsAcquisitions.. The Change in Bank Control Act prohibits a person or group of persons from acquiring “control” of a bank holding company unless the FRB has been notified and has not objected to the transaction. Under a rebuttable presumption established by the FRB, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, would, under the circumstances set forth in the presumption, constitute acquisition of control of the Company.
In addition, any entity is required to obtain the approval of the FRB 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 the Company’s outstanding common stock, or otherwise obtaining control or a “controlling influence” over the Company.

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The BankRegulation of FSB
Five Star Bank (“FSB“or the “Bank”) is a New York State-chartered bank and a member of the Federal Reserve System. The FDIC, through the Bank Insurance Fund, insures deposits of the Bank. The supervision and regulation of FSB subjects the Bank to special restrictions, requirements, potential enforcement actions and periodic examination by the FDIC, the FRB and the New York State Banking Department. Because the FRB regulates the holding company parent, the FRB also has supervisory authority that directly affects FSB.
Restrictions on Transactions with Affiliates and InsidersInsiders.. Transactions between the holding company and its subsidiaries, including the Bank, are subject to Section 23A of the Federal Reserve Act, and to the requirements of Regulation W. In general, Section 23A imposes limits on the amount of such transactions, and also requires certain levels of collateral for loans to affiliated parties. It also limits the amount of advances to third parties, which are collateralized by the securities, or obligations of FII or its subsidiaries.
Affiliate transactions are also subject to Section 23B of the Federal Reserve Act, and to the requirements of Regulation W which generally requires that certain transactions between the holding company and its affiliates be on terms substantially the same, or at least as favorable to the Bank, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to herein as “insiders”) contained in the Federal Reserve Act and Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution’s total unimpaired capital and surplus, and the FDIC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.
Restrictions on Distribution of Subsidiary Bank Dividends and Assets.Dividends paid by the Bank provide a substantial part of FII’s operating funds and, for the foreseeable future, it is anticipated that dividends paid by the Bank will continue to be its principal source of operating funds. Capital adequacy requirements serve to limit the amount of dividends that may be paid by the subsidiaries. Under federal law, the subsidiaries cannot pay a dividend if, after paying the dividend, a particular subsidiary will be “undercapitalized.” The FDIC may declare a dividend payment to be unsafe and unsound even though the bank would continue to meet its capital requirements after the dividend.
During September 2006, FII requested approval from the NYS Banking Department to pay a $25.0 million cash dividend from FSB to FII. Regulatory approval was necessary as the requested dividend amount exceeded the amount allowable under regulations. During October 2006, FSB received regulatory approval and paid the $25.0 million dividend to FII. FSB will be required to obtain approval from the NYS Banking Department for any future dividend that exceeds the sum of the current year’s net income plus the retained profits for the preceding two years.
Because FII is a legal entity separate and distinct from its subsidiaries, FII’s right to participate in the distribution of assets of any subsidiary upon the subsidiary’s liquidation or reorganization will be subject to the prior claims of the subsidiary’s creditors. In the event of a liquidation or other resolution of an insured depository institution, the

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claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of any obligation of the institution to its shareholders, including any depository bank holding company (such as FII) or any shareholder or creditor thereof.
Examinations.The New York State Banking Department, the FRB and the FDIC periodically examine and evaluate the Bank. Based upon such examinations, the appropriate regulator may revalue the assets of the institution and require that it establish specific reserves to compensate for the difference between what the regulator determines the value to be and the book value of such assets.
Audit Reports.Insured institutions with total assets of $500 million or more at the beginning of a fiscal year must submit annual audit reports prepared by independent auditors to federal and state regulators. In some instances, the audit report of the institution’s holding company can be used to satisfy this requirement. Auditors must receive examination reports, supervisory agreements and reports of enforcement actions. In addition, financial statements prepared in accordance with U.S. generally accepted accounting principles, management’s certifications concerning responsibility for the financial statements, internal controls and compliance with legal requirements designated by the FDIC, and if total assets exceed $1.0 billion, an attestation by the auditor regarding the statements of management relating to the internal controls must be submitted. The FDIC Improvement Act of 1991 requires that independent audit committees be formed, consisting of outside directors only. The committees of institutions with assets of more than $3.0 billion must include members with experience in banking or financial management must have access to outside counsel and must not include representatives of large customers.
Capital Adequacy Requirements.The FDIC has adopted regulations establishing minimum requirements for the capital adequacy of insured institutions. The FDIC may establish higher minimum requirements if, for example, a bank has previously received special attention or has a high susceptibility to interest rate risk. The most recent notification from the FDIC categorized the Bank as well-capitalizedwell capitalized under the regulatory framework for prompt corrective action.
The FDIC’s risk-based capital guidelines generally require banks to have a minimum ratio of Tier 1 capital to total risk-weighted assets of 4.0% and a ratio of total capital to total risk-weighted assets of 8.0%. The capital categories have the same definitions for the Company. As of December 31, 2006,2008, the ratio of Tier 1 capital to total risk-weighted assets for the Bank was 14.35%9.52% and the ratio of total capital to total risk-weighted assets was 15.61%10.77%. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” and Note 16 of the notes to consolidated financial statements.
The FDIC’s leverage guidelines require banks to maintain Tier 1 capital of no less than 4.0% of average total assets, except in the case of certain highly rated banks for which the requirement is 3.0% of average total assets. As of December 31, 2006,2008, the ratio of Tier 1 capital to quarterly average total assets (leverage ratio) was 8.06%6.46% for FSB. See the section captioned “Liquidity and Capital Resources” included in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources”Operations” and Note 1610, Regulatory Matters, of the notes to consolidated financial statements.

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Corrective Measures for Capital Deficiencies. The federal banking regulators are required to take “prompt corrective action” with respect to capital-deficient institutions. Agency regulations define, for each capital category, the levels at which institutions are “well-capitalized,” “adequately capitalized,” “undercapitalized,” “significantly undercapitalized” and “critically undercapitalized.” A “well-capitalized” bank has a total risk-based capital ratio of 10.0% or higher; a Tier 1 risk-based capital ratio of 6.0% or higher; a leverage ratio of 5.0% or higher; and is not subject to any written agreement, order or directive requiring it to maintain a specific capital level for any capital measure. An “adequately capitalized” bank has a total risk-based capital ratio of 8.0% or higher; a Tier 1 risk-based capital ratio of 4.0% or higher; a leverage ratio of 4.0% or higher (3.0% or higher if the bank was rated a composite 1 in its most recent examination report and is not experiencing significant growth); and does not meet the criteria for a well-capitalized bank. A bank is “undercapitalized” if it fails to meet any one of the “adequately capitalized” ratios.
In addition to requiring undercapitalized institutions to submit a capital restoration plan, agency regulations contain broad restrictions on certain activities of undercapitalized institutions including asset growth, acquisitions, branch establishment and expansion into new lines of business. With certain exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying

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management fees to control persons if the institution would be undercapitalized after any such distribution or payment.
As an institution’s capital decreases, the FDIC’s enforcement powers become more severe. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management and other restrictions. The FDIC has only very limited discretion in dealing with a critically undercapitalized institution and is virtually required to appoint a receiver or conservator.
Banks with risk-based capital and leverage ratios below the required minimums may also be subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital.
Deposit Insurance Assessments.The Bank must pay assessments to the FDIC for federal deposit insurance protection that was impacted by legislation enacted during 2006. The Federal Deposit Insurance Reform Act of 2005 and the Federal Deposit Insurance Reform Conforming Amendment Act of 2005 were signed into law in 2006 (collectively the “Reform Act”) providing the following changes:
Merged the Bank Insurance Fund (“BIF”) and the Savings Association Insurance Fund (“SAIF”) into a new fund, the Deposit Insurance Fund (“DIF”).
Increased the coverage limit for retirement accounts to $250,000.
Indexed the coverage limit for deposit insurance for inflation.
Establishing a range of 1.15 percent to 1.50 percent within which the FDIC may set the Designated Reserve Ratio (“DRR”).
Eliminating the restrictions on premium rates based on the DRR and granting the FDIC the discretion to price deposit insurance according to risk for all insured institutions regardless of the level of the reserve ratio.
Granting a one-time initial assessment credit to recognize institutions’ past contributions to the fund.
Merged the Bank Insurance Fund (“BIF”) and the Savings Association Insurance Fund (“SAIF”) into a new fund, the Deposit Insurance Fund (“DIF”).
Increased the coverage limit for retirement accounts to $250,000.
Indexed the coverage limit for deposit insurance for inflation.
Establishing a range of 1.15 percent to 1.50 percent within which the FDIC may set the Designated Reserve Ratio (“DRR”).
Eliminating the restrictions on premium rates based on the DRR and granting the FDIC the discretion to price deposit insurance according to risk for all insured institutions regardless of the level of the reserve ratio.
Granting a one-time initial assessment credit to recognize institutions’ past contributions to the fund.
The Deposit Insurance Fund Act of 1996 contained a comprehensive approach to recapitalizing the Savings Association Insurance Fund and to assuring the payment of the Financing Corporation’s (“FICO”) bond obligations. Under this law, banks insured under the Bank Insurance Fund are required to pay a portion of the interest due on bonds that were issued by FICO in 1987 to help shore up the ailing Federal Savings and Loan Insurance Corporation. The FDIC bills and collects this assessment on behalf of FICO.
Prior to the Company’s restructuring in December 2005, the Company’s former bank subsidiaries NBG and BNB were operating under formal agreements with the Office of the Comptroller of the Currency (“OCC”), which resulted in a higher FDIC risk classification and the Company experienced an increase in FDIC insurance premiums in 2005. As a result of the merger of the Company’s subsidiary banks and the lower risk classification for FSB, the FDIC insurance premiums decreased in 2006. As a result of the Reform Act previously described, effective for the FDIC billing period that commenced January 1, 2007, the Company hashad a $1.3 million assessment credit available to offset future FDIC premium assessments, but not the FICO assessment. Therefore,The $442 thousand in assessment credits that remained as of December 31, 2007 were fully utilized in 2008, contributing to a $385 increase in the FDIC expense over 2007.
The Reform Act also requires that the FDIC Board of Directors adopt a restoration plan when the DIF reserve ratio falls or is expected to fall below certain minimum levels. The bank failures that occurred in 2008 adversely impacted the deposit insurance fund’s loss provisions, resulting in a decline in the reserve ratio. As part of the restoration plan, the FDIC has increased the insurance assessment rates by seven basis points uniformly for the quarter beginning January 1, 2009. In addition, on February 27, 2009 the FDIC Board adopted an interim rule imposing a 20 basis point emergency special assessment on the industry on June 30, 2009. The assessment is to be collected on September 30, 2009. The interim rule would also permit the Board to impose an emergency special assessment after June 30, 2009, of up to 10 basis points if necessary to maintain public confidence in federal deposit insurance. The Company estimates the combined impact of the seven basis point increase and 20 basis point emergency special assessment to be an approximate increase of $4.6 million in its FDIC deposit insurance assessments for 2009. Subsequently, on March 5, 2009 the Chairman of the FDIC announced that it may cut the 20 basis point emergency special assessment to 10 basis points if legislation passes to expand the FDIC’s existing line of credit with the U.S. Treasury Department.

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Enforcement Powers.The FDIC, the New York State Banking Department and the FRB have broad enforcement powers, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties and appoint a conservator or receiver. Failure to comply with applicable laws, regulations and supervisory agreements could subject the Company expectsor the Reform ActBank, as well as the officers, directors and other institution-affiliated parties of these organizations, to have minimal impact on its 2007 consolidated results of operations.administrative sanctions and potentially substantial civil money penalties.
Federal Home Loan Bank System.FSB is a member of the FHLB System, which consists of 12 regional Federal Home Loan Banks. The FHLB System provides a central credit facility primarily for member institutions. As members of the FHLB of New York, the Bank is required to acquire and hold shares of capital stock in the FHLB. The minimum investment requirement is determined by a “membership” investment component and an “activity-based” investment component. Under the “membership” component, a certain minimum investment in capital stock is required to be maintained as long as the institution remains a member of the FHLB. Under the “activity-based” component, members are required to purchase capital stock in proportion to the volume of certain transactions with the FLHB. As of December 31, 2006,2008, FSB complied with these requirements.
Enforcement Powers. The FDIC, the New York State Banking Department and the FRB have broad enforcement powers, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal

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penalties and appoint a conservator or receiver. Failure to comply with applicable laws, regulations and supervisory agreements could subject the Company or the Bank, as well as the officers, directors and other institution-affiliated parties of these organizations, to administrative sanctions and potentially substantial civil money penalties.
Brokered Deposit Restrictions.Adequately capitalized institutions cannot accept, renew or roll over brokered deposits except with a waiver from the FDIC, and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew or roll over brokered deposits. As of December 31, 2008, FSB was considered well-capitalized and subject to the brokered deposit restrictions.
Cross-Guarantee Provisions.The Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) contains a “cross-guarantee” provision which generally makes commonly controlled insured depository institutions liable to the FDIC for any losses incurred in connection with the failure of a commonly controlled depository institution.
Community Reinvestment Act.The Community Reinvestment Act of 1977 (“CRA”) and the regulations issued hereunder are intended to encourage banks to help meet the credit needs of their service area, including low and moderate income neighborhoods, consistent with the safe and sound operations of the banks. These regulations also provide 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. FIRREA requires federal banking agencies to make public a rating of a bank’s performance under the CRA. 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. Five Star Bank received a rating of “outstanding” as of its most recent CRA performance evaluation.
Consumer Laws and RegulationsRegulations.. In addition to the laws and regulations discussed herein, the Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include, among others, the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, 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 disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers. The Bank must comply with the applicable provisions of these consumer protection laws and regulations as part of their ongoing customer relations. The Check Clearing for the 21st Century Act (“Check 21 Act” or “the Act”), which became effective on October 28, 2004, creates a new negotiable instrument, called a “substitute check”, which banks are required to accept as the legal equivalent of a paper check if it meets the requirements of the Act. The Act is designed to facilitate check truncation, to foster innovation in the check payment system, and to improve the payment system by shortening processing times and reducing the volume of paper checks.
Changing Regulatory Structure
Gramm-Leach-Bliley Act
The Gramm-Leach-Bliley Act (“Gramm-Leach”) was signed into law on November 12, 1999. Gramm-Leach permits, subject to certain conditions, combinations among banks, securities firms and insurance companies. Under Gramm-Leach, bank holding companies are permitted to offer their customers virtually any type of financial service including banking, securities underwriting, insurance (both underwriting and agency), and merchant banking. In order to engage in these additional financial activities, a bank holding company must qualify and register with the Board of Governors of the Federal Reserve System as a “financial holding company” by demonstrating that each of its subsidiaries is “well capitalized,” “well managed,” and has at least a “satisfactory” rating under the CRA. On May 12, 2000,During the second quarter of 2008, FII received FRB approval from the Federal Reserve Bank of New Yorkfor an election to becomere-instate its status as a financial holding company, resulting inwhich the eventual formation of Five Star Investment Services, Inc. (“FSIS”) (formerly known as The FI Group, Inc. (“FIGI”)). During 2003, FIICompany terminated its financial holding company status and now operates as a bank holding company.during 2003. The change in status did not affect the non-financial subsidiaries or activities being conducted by the Company although future acquisitions or expansions of non-financial activities may require prior FRB approval and will be limited to those that are

15


permissible for bank holding companies.its subsidiaries. Gramm-Leach establishes that the federal banking agencies will regulate the banking activities of financial holding companies and banks’ financial subsidiaries, the SEC will regulate their securities activities and state insurance regulators will regulate their insurance activities. Gramm-Leach also provides new protections against the transfer and use by financial institutions of consumers’ nonpublic, personal information.

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The major provisions of Gramm-Leach are:include:
Financial Holding Companies and Financial ActivitiesActivities.. Title I establishes a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the Bank Holding Company Act framework to permit a holding company system to engage in a full range of financial activities through qualification as a new entity known as a financial holding company. A bank holding company that qualifies as a financial holding company can expand into a wide variety of services that are financial in nature, if its subsidiary depository institutions are “well-managed”, “well-capitalized” and have received at least a “satisfactory” rating on their last CRA examination. Services that have been deemed to be financial in nature include securities underwriting, dealing and market making, sponsoring mutual funds and investment companies, insurance underwriting and agency activities and merchant banking.
Securities ActivitiesActivities.. Title II narrows the exemptions from the securities laws previously enjoyed by banks, requires the FRB and the SEC to work together to draft rules governing certain securities activities of banks and creates a new, voluntary investment bank holding company.
Insurance ActivitiesActivities.. Title III restates the proposition that the states are the functional regulators for all insurance activities, including the insurance activities of federally chartered banks, and bars the states from prohibiting insurance activities by depository institutions. The law encourages the states to develop uniform or reciprocal rules for the licensing of insurance agents.
PrivacyPrivacy.. Under Title V, federal banking regulators were required to adopt rules that have limited the ability of banks and other financial institutions to disclose non-public information about consumers to nonaffiliated third parties. These limitations require disclosure of privacy policies to consumers and, in some circumstances, allow consumers to prevent disclosure of certain personal information to a nonaffiliated third party. Federal banking regulators issued final rules on May 10, 2000 to implement the privacy provisions of Title V. Under the rules, financial institutions must provide:
Initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates;
Annual notices of their privacy policies to current customers; and
A reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.
Initial notices to customers about their privacy policies, describing the conditions under which they may disclose nonpublic personal information to nonaffiliated third parties and affiliates;
Compliance with the rules is mandatory after July 1, 2001.
Annual notices of their privacy policies to current customers; and
A reasonable method for customers to “opt out” of disclosures to nonaffiliated third parties.
The Bank wasis in full compliance with the rules as of or prior to the respective effective dates.rules.
Safeguarding Confidential Customer InformationInformation.. Under Title V, federal banking regulators are required to adopt rules requiring financial institutions to implement a program to protect confidential customer information. In January 2000, the federal banking agencies adopted guidelines requiring financial institutions to establish an information security program to:
Identify and assess the risks that may threaten customer information;
Develop a written plan containing policies and procedures to manage and control these risks;
Implement and test the plan; and
Adjust the plan on a continuing basis to account for changes in technology, the sensitivity of customer information and internal or external threats to information security.
Identify and assess the risks that may threaten customer information;
Develop a written plan containing policies and procedures to manage and control these risks;
Implement and test the plan; and
Adjust the plan on a continuing basis to account for changes in technology, the sensitivity of customer information and internal or external threats to information security.
The Bank approved security programs appropriate to its size and complexity and the nature and scope of its operations prior to the July 1, 2001 effective date of the regulatory guidelines. The implementation of the programs is an ongoing process.

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Community Reinvestment Act Sunshine RequirementsRequirements.. In February 2001, the federal banking agencies adopted final regulations implementing Section 711 of Title VII, the CRA Sunshine Requirements. The regulations require nongovernmental entities or persons and insured depository institutions and affiliates that are parties to written agreements made in connection with the fulfillment of the institution’s CRA obligations to make available to the public and the federal banking agencies a copy of each agreement. The regulations impose annual reporting requirements concerning the disbursement, receipt and use of funds or other resources under these agreements. The effective date of the regulations was April 1, 2001. Neither FII nor the Bank is a party to any agreement that would be the subject of reporting pursuant to the CRA Sunshine Requirements.
USA Patriot Act
As part of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (“USA Patriot Act”), signed into law on October 26, 2001, Congress adopted the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (“IMLAFATA”AML”). IMLAFATAAML authorizes the Secretary of the Treasury, in consultation with the heads of other government agencies, to adopt special measures applicable to banks, bank holding companies or other financial institutions. During 2002, the Department of Treasury issued a number of regulations relating to enhanced recordkeeping and reporting requirements for certain financial transactions that are of primary money laundering concern, due diligence requirements concerning the beneficial ownership of certain types of accounts, and restrictions or prohibitions on certain types of accounts with foreign financial institutions. Covered financial institutions also are barred from dealing with foreign “shell” banks. In addition, IMLAFATAAML expands the circumstances under which funds in a bank account may be forfeited and requires covered financial institutions to respond under certain circumstances to requests for information from federal banking agencies within 120 hours.

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Regulations were also adopted during 2002 to implement minimum standards to verify customer identity, to encourage cooperation among financial institutions, federal banking agencies, and law enforcement authorities regarding possible money laundering or terrorist activities, to prohibit the anonymous use of “concentration accounts,” and to require all covered financial institutions to have in place a Bank Secrecy Act compliance program. IMLAFATAAML also amends the Bank Holding Company Act and the Bank Merger Act to require the federal banking agencies to consider the effectiveness of a financial institution’s anti-money laundering activities when reviewing an application under these acts.
The Bank has in place a Bank Secrecy Act compliance program, and it engages in very few transactions of any kind with foreign financial institutions or foreign persons.
Sarbanes-Oxley Act
On July 30, 2002, the President signed into law the Sarbanes-Oxley Act of 2002 (the “Act”) implementing legislative reforms intended to address corporate and accounting fraud. In addition to the establishment of a new accounting oversight board that enforces auditing, quality control and independence standards and is funded by fees from all publicly traded companies, the law restricts accounting firms from providing both auditing and consulting services to the same client. To ensure auditor independence, any non-audit services being provided to an audit client requires pre-approval by the issuer’s audit committee members. In addition, the audit partners must be rotated. The Act requires chief executive officers and chief financial officers, or their equivalent, to certify to 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 the Act, 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 its chief executive officer or its chief legal 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.
Longer prison terms and increased penalties are also applied to corporate executives who violate federal securities laws, the period during which certain types of suits can be brought against a company or its officers has been extended, and bonuses issued to top executives prior to restatement of a company’s financial statements are subject to disgorgement if such restatement was due to corporate misconduct. Executives are also prohibited from insider trading during retirement plan “blackout” periods, and loans to company executives are restricted. The

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Act accelerates the time frame for disclosures by public companies, as they must immediately disclose any material changes in their financial condition or operations. Directors and executive officers must also provide information for most changes in ownership in a company’s securities within two business days of the change.
The Act also prohibits any officer or director of a company or any other person acting under their direction from taking any action to fraudulently influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the audit of the company’s financial statements for the purpose of rendering the financial statement’s materially misleading. The Act also requires the SEC to prescribe rules requiring inclusion of an internal control report and assessment by management in the annual report to stockholders. In addition, the Act requires that each financial report required to be prepared in accordance with (or reconciled to) accounting principles generally accepted in the United States of America and filed with the SEC reflect all material correcting adjustments that are identified by a “registered public accounting firm” in accordance with accounting principles generally accepted in the United States of America and the rules and regulations of the SEC.
As directed by Section 302(a) of the Act, the Company’s chief executive officer and chief financial officer are each required to certify that the Company’s quarterly and annual reports do not contain any untrue statement of a material fact. The Act imposes several requirements, including having these officers certify that: they are responsible for establishing, maintaining and regularly evaluating the effectiveness of the Company’s internal controls; they have made certain disclosures to the Company’s auditors and the Audit Committee of the Board of Directors about the Company’s internal controls; and they have included information in the Company’s quarterly and annual reports about their evaluation and whether there have been significant changes in the Company’s internal controls or in other factors that could significantly affect internal controls during the last quarter.

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Fair Credit Reporting Act and Fair and Accurate Transactions Act
In 1970, the U. S. Congress enacted the Fair Credit Reporting Act (the “FCRA”) in order to ensure the confidentiality, accuracy, relevancy and proper utilization of consumer credit report information. Under the framework of the FCRA, the United States has developed a highly advanced and efficient credit reporting system. The information contained in that broad system is used by financial institutions, retailers and other creditors of every size in making a wide variety of decisions regarding financial transactions. Employers and law enforcement agencies have also made wide use of the information collected and maintained in databases made possible by the FCRA. The FCRA affirmatively preempts state law in a number of areas, including the ability of entities affiliated by common ownership to share and exchange information freely, the requirements on credit bureaus to reinvestigate the contents of reports in response to consumer complaints, among others. By its terms, the preemption provisions of the FCRA were to terminate as of December 31, 2003. With the enactment of the Fair and Accurate Transactions Act (the “FACT Act”) in late 2003, the preemption provisions of FCRA were extended, although the FACT Act imposes additional requirements on entities that gather and share consumer credit information. The FACT Act required the FRB and the Federal Trade Commission (“FTC”) to issue final regulations within nine months of the effective date of the Act. A series of regulations and announcements have been promulgated, including a joint FTC/FRB announcement of effective dates for FCRA amendments, the FTC’s “Free Credit Report” rule, revisions to the FTC’s FACT Act Rules, the FTC’s final rules on identity theft and proof of identity, the FTC’s final regulation on consumer information and records disposal, the FTC’s final summaries and the final rule on prescreen notices.
Emergency Economic Stabilization Act of 2008
On October 3, 2008, EESA was signed into law as part of a broad initiative to stabilize U.S. financial markets and provide liquidity. EESA enables the federal government, under terms and conditions to be developed by the Secretary of the Treasury, to insure troubled assets, including mortgage-backed securities, and collect premiums from participating financial institutions. EESA includes, among other provisions: (a) the $700 billion TARP, under which the Secretary of the Treasury is authorized to purchase, insure, hold, and sell a wide variety of financial instruments, particularly those that are based on or related to residential or commercial mortgages originated or issued on or before March 14, 2008; and (b) an increase in the amount of deposit insurance provided by the FDIC.
Troubled Assets Relief Program

Under the TARP, the Department of Treasury authorized a voluntary capital purchase program (CPP) to purchase up to $250 billion of senior preferred shares of qualifying financial institutions that elected to participate by November 14, 2008. Participating companies must adopt certain standards for executive compensation, including (a) prohibiting “golden parachute” payments as defined in EESA to senior Executive Officers; (b) requiring recovery of any compensation paid to senior Executive Officers based on criteria that is later proven to be materially inaccurate; and (c) prohibiting incentive compensation that encourages unnecessary and excessive risks that threaten the value of the financial institution. The terms of the CPP also limit certain uses of capital by the issuer, including repurchases of company stock, and increases in dividends.
Federal Deposit Insurance Corporation Insurance Limit Increases

EESA temporarily raised the limit on federal deposit insurance coverage from $100,000 to $250,000 per depositor. Separate from EESA, in October 2008, the FDIC also announced the TLGP. Under one component of this program, the FDIC temporarily provides unlimited coverage for noninterest bearing transaction deposit accounts through December 31, 2009. The limits are scheduled to return to $100,000 on January 1, 2010.
Change in Tax Treatment of Fannie Mae and Freddie Mac Preferred Stock

Section 301 of the EESA changes the tax treatment of gains or losses from the sale or exchange of FNMA or FHLMC preferred stock by an “applicable financial institution,” such as FSB, by stating that a gain or loss on Fannie Mae or Freddie Mac preferred stock shall be treated as ordinary gain or loss instead of capital gain or loss, as was previously the case. This change, which was enacted in the 2008 fourth quarter, provides tax relief to banking organizations that have suffered losses on certain direct and indirect investments in Fannie Mae and Freddie Mac preferred stock. As a result, the Company was able to recognize the tax effects of the other-than-temporary-impairment (“OTTI”) charge on its investment in auction rate preferred equity securities, which are collateralized by FNMA and FHLMC preferred stock, as an ordinary loss in the consolidated financial statements for the year ended December 31, 2008.
Financial Stability Plan
On February 10, 2009, the Financial Stability Plan was announced by the U.S. Treasury Department. The Financial Stability Plan is a comprehensive set of measures intended to shore up the financial system. The core elements of the plan include making bank capital injections, creating a public-private investment fund to buy troubled assets, establishing guidelines for loan modification programs and expanding the Federal Reserve lending program. The U.S. Treasury Department has indicated more details regarding the Financial Stability Plan are to be announced on a newly created government website, www.FinancialStability.gov, in the next several weeks.

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FRB Final Rule on Trust Preferred SecuritiesAmerican Recovery and Reinvestment Act of 2009
On March 1, 2005,February 17, 2009, the FRB issuedARRA was enacted. ARRA is intended to provide a final rule that allowsstimulus to the continued inclusion of trust preferred securitiesU.S. economy in the Tier 1 capitalwake of bank holding companies. Trust preferred securities, however,the economic downturn brought about by the subprime mortgage crisis and the resulting credit crunch. The bill includes federal tax cuts, expansion of unemployment benefits and other social welfare provisions, and domestic spending in education, healthcare, and infrastructure. The new law also includes numerous non-economic recovery related items, including a limitation on executive compensation in federally-aided banks.
Under ARRA, an institution will be subject to stricter quantitative limits. Key components of the final rule are:following restrictions and standards throughout the period in which any obligation arising from financial assistance provided under TARP remains outstanding:
  Trust preferred securities, together with other “restricted core capital elements”, can be included in a bank holding company’s Tier 1 capital up to 25% of the sum of core capital elements, including “restricted core capital elements”;Limits on compensation incentives for risk-taking by senior executive officers.
 
  Restricted core capital elements are defined to include:
Qualifying trust preferred securities;Requirement of recovery of any compensation paid based on inaccurate financial information.
 
  Qualifying cumulative perpetual preferred stock (and related surplus);Prohibition on “Golden Parachute Payments”.
 
  Minority interest relatedProhibition on compensation plans that would encourage manipulation of reported earnings to qualifying cumulative perpetual preferred stock directly issued by a consolidated U.S. depository institution or foreign bank subsidiary; andenhance the compensation of employees.
 
  Minority interest related to qualifying common or qualifying perpetual preferred stock issued byPublicly registered TARP recipients must establish a consolidated subsidiary that is neither a U.S. depository institution nor a foreign bank subsidiary.
The sumboard compensation committee comprised entirely of core capital elements will be calculated netindependent directors, for the purpose of goodwill, less any associated deferred tax liability;reviewing employee compensation plans.
 
  Internationally active bank holding companiesProhibition on bonus, retention award, or incentive compensation, except for payments of long term restricted stock.
Limitation on luxury expenditures.
TARP recipients are further limited, and must limit restricted core capital elementsrequired to 15%permit a separate non-binding shareholder vote to approve the compensation of the sum of core capital elements, including restricted core capital elements, net of goodwill, although they may include qualifying mandatory convertible preferred securities upexecutives, as disclosed pursuant to the 25% limit;SEC’s compensation disclosure rules.
The chief executive officer and chief financial officer of each TARP recipient will be required to provide a written certification of compliance with these standards to the SEC.
Notwithstanding the foregoing, the ARRA provides that the Secretary of the Treasury shall permit a TARP recipient, subject to consultation with the recipient’s appropriate Federal banking agency, to repay such assistance without regard to whether the recipient has replaced such funds from any other source or to any waiting period. ARRA further provides that when the recipient repays such assistance, the Secretary of the Treasury shall liquidate the warrants associated with the assistance at the current market price. While Treasury has not yet issued implementing regulations, it appears that ARRA will permit the Company, if it so elects and following consultation with the FRB, to redeem the Series A Preferred Stock at any time without restriction.
Homeowner Affordability and Stability Plan
On February 18, 2009, the Homeowner Affordability and Stability Plan (“HASP”) was announced by the President of the United States. HASP is intended to support a recovery in the housing market and ensure that workers can continue to pay off their mortgages through the following elements:
Provide access to low-cost refinancing for responsible homeowners suffering from falling home prices.
 
  A five year transition period for application of quantitative limits, ending March 31, 2009.$75 billion homeowner stability initiative to prevent foreclosure and help responsible families stay in their homes.
Support low mortgage rates by strengthening confidence in Fannie Mae and Freddie Mac.
Expanding Enforcement AuthorityImpact of Inflation and Enforcement MattersChanging Prices
The FRB,Company’s financial statements included herein have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”). GAAP requires the New York State SuperintendentCompany to measure financial position and operating results principally using historic dollars. Changes in the relative value of Banksmoney due to inflation or recession are generally not considered. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. In the Company’s view, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are generally influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude. Interest rates are sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, general and local economic conditions and the FDIC possess extensive authority to police unsafe or unsound practicesmonetary and violationsfiscal policies of applicable lawsthe United States government, its agencies and regulations by depository institutionsvarious other governmental regulatory authorities.

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Regulatory and their holding companies. For example, the FDIC may terminate the deposit insurance of any institution that it determines has engaged in an unsafe or unsound practice. The agencies can also assess civil money penalties, issue cease and desist or removal orders, seek injunctions, and publicly disclose such actions.
Effect On Economic EnvironmentPolicies
The Company’s business and earnings are affected by general and local economic conditions and by the monetary and fiscal policies of the U.S. government, its agencies and various other governmental regulatory authorities, includingauthorities. The FRB regulates the supply of money in order to influence general economic conditions. Among the instruments of monetary policy of the FRB, have a significant effect on the operating results of bank holding companies and their subsidiaries. Among the means available to the FRB to affect the money supply are (i) conducting open market operations in U.S. Government securities, changes ingovernment obligations, (ii) changing the discount rate on member bankfinancial institution borrowings, and changes in(iii) imposing or changing reserve requirements against member bank deposits.financial institution deposits, and (iv) restricting certain borrowings and imposing or changing reserve requirements against certain borrowings by financial institutions and their affiliates. These meansmethods are used in varying degrees and combinations to influence overall growth and distributiondirectly affect the availability of bank loans investments and deposits, and their use may affectas well as the interest rates charged on loans orand paid foron deposits. For that reason, the policies of the FRB monetary policiescould have materially affecteda material effect on the operating resultsearnings of commercial banks in the pastCompany.
EMPLOYEES
At December 31, 2008, the Company had 532 full-time and 133 part-time employees.
EXECUTIVE OFFICERS OF REGISTRANT
The following table sets forth current information regarding executive officers and other significant employees (ages are expected to continue to do so inas of the future.2009 Annual Meeting).
           
      Starting  
Name Age In Positions/Offices
 
Peter G. Humphrey  54   1977  President and Chief Executive Officer of FII and Five Star Bank.
           
Ronald A. Miller  60   1996  Executive Vice President, Chief Financial Officer and Corporate Secretary of FII and Five Star Bank.
           
James T. Rudgers  59   2004  Executive Vice President and Chief of Community Banking Officer of FII and Five Star Bank. Executive Vice President of Retail Banking at Hudson United Bank Corporation from 2002 to 2004.
           
John J. Witkowski  46   2005  Senior Vice President and Regional President / Retail Banking Executive Officer of Five Star Bank. Senior Vice President and Director of Sales for Business Banking / Client Development Group at Bank of America from 1993 to 2005.
           
Martin K. Birmingham  42   2005  Senior Vice President and Regional President / Commercial Banking Executive Officer of Five Star Bank. Senior Team Leader and Regional President of the Rochester Market at Bank of America (formally Fleet Boston Financial) from 2000 to 2005.
           
George D. Hagi  56   2006  Executive Vice President and Chief Risk Officer of FII and Five Star Bank. Senior Vice President and Director of Risk Management at First National Bankshares of Florida and FNB Corp from 1997 to 2005.
           
Kevin B. Klotzbach  56   2001  Senior Vice President and Treasurer of Five Star Bank.
           
Bruce H. Nagle  60   2006  Senior Vice President and Director of Human Resources of FII and Five Star Bank. Vice President of Human Resources at University of Pittsburgh Medical Center from 2000 to 2006.
           
Richard J. Harrison  63   2003  Senior Vice President and Senior Retail Lending Administrator of Five Star Bank. Executive Vice President and Chief Credit Officer at Savings Bank of the Fingerlakes from 2000 to 2003.

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ItemITEM 1A. Risk FactorsRISK FACTORS
Our financial results are subject to a number of risks.Making or continuing an investment in securities issued by the Company, including its common stock, involves certain risks that you should carefully consider. The factors discussedrisks and uncertainties described below are intended to highlightnot the only risks that management believes are most relevant to our current operating environment. This listing is not intended to capture all risks associated with our business.may have a material adverse effect on the Company. Additional risks including those generally affectingand uncertainties also could adversely affect the industry in which we operate,Company’s business, financial condition and results of operations. If any of the following risks that we currently deem immaterial and risks generally applicable to companies that have recently undertaken similar transactions, may also negatively impact our consolidatedactually occur, the Company’s business, financial position, consolidatedcondition or results of operations could be negatively affected, the market price for your securities could decline, and you could lose all or a part of your investment. Further, to the extent that any of the information contained in this Annual Report on Form 10-K constitutes forward-looking statements, the risk factors set forth below also are cautionary statements identifying important factors that could cause the Company’s actual results to differ materially from those expressed in any forward-looking statements made by or on behalf of the Company.
The Company’s business may be adversely impacted by adverse conditions in the financial markets and economic conditions generally.
The capital and credit markets have been experiencing unprecedented levels of volatility and disruption for more than a year. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. As a consequence of the recession that the United States now finds itself in, business activity across a wide range of industries face serious difficulties due to the lack of consumer spending and the extreme lack of liquidity in the global credit markets. Unemployment has also increased significantly.
A sustained weakness or weakening in business and economic conditions generally or specifically in the principal markets in which the Company does business could have one or more of the following material adverse impacts on the Company’s business, financial condition and results of operations:
A decrease in the demand for loans and other products and services offered by the Company;
A decrease in the value of our loans held for sale or other assets secured by consumer or commercial real estate;
An impairment of certain intangible assets, such as goodwill;
An increase in the number of clients and counterparties who become delinquent, file for protection under bankruptcy laws or default on their loans or other obligations to the Company. An increase in the number of delinquencies, bankruptcies or defaults could result in a higher level of non-performing assets, net charge-offs, provision for loan losses, and valuation adjustments on loans held for sale.
Current market developments may adversely impact the Company’s industry and business.
Dramatic declines in the housing market during the prior year, with falling home prices and increasing foreclosures and unemployment, have resulted in, and may continue to result in, significant write-downs of asset values by the Company and other financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers including financial institutions.
This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting lack of available credit, lack of confidence in the financial sector, increased volatility in the financial markets and reduced business activity could have a material adverse impact on the Company’s business, financial condition or results of operations.
Further negative market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provisions for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on the financial services industry and could have a material adverse impact on the Company’s business, financial condition or results of operations.
The Company is subject to liquidity risks.
The Company maintains liquidity primarily through customer deposits and other funding sources. If economic influences change so that we do not have access to short-term credit, or our depositors withdraw a substantial amount of their funds for other uses, Five Star Bank might experience liquidity issues. Our efforts to monitor and manage liquidity risk may not be successful or sufficient to deal with dramatic or unanticipated reductions in our liquidity. In such events, our cost of funds may increase, thereby reducing our net interest revenue, or we may need to sell a portion of our investment portfolio, which, depending upon market conditions, could result in our realizing a loss.

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Asset Quality.A significant sourceThe soundness of riskother financial institutions, including Federal Home Loan Bank, could adversely impact the Company.
The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of counterparty relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial services industry. The most important counterparty for the Company, arises from the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loans. Most loans originated byliquidity, is the Federal Home Loan Bank of New York (“FHLBNY”). The Company uses FHLBNY as its primary source of long-term wholesale funding. At December 31, 2008, the Company had a total of $30.7 million in borrowed funds with FHLBNY.
There are secured, but loanstwelve branches of the Federal Home Loan Bank (“FHLB”), including New York. Several members have warned that they have either breached risk-based capital requirements or that they are close to breaching those requirements. To conserve capital, some FHLB branches are suspending dividends, cutting dividend payments, and not buying back excess FHLB stock that members hold. FHLBNY has stated that they expect to be able to continue to pay dividends, redeem excess capital stock, and provide competitively priced advances in the future. The most severe problems in the FHLB system have been at some of the other FHLB branches. Nonetheless, the twelve FHLB branches are jointly liable for the consolidated obligations of the FHLB system. To the extent that one FHLB branch cannot meet its obligations to pay its share of debt, other FHLB branches may be unsecured depending oncalled upon to make the naturepayment.
As a member of the loan. With respectFHLB System, the Company is required to secured loans,hold stock in FHLBNY. The carrying value and fair value of the collateral securingCompany’s FHLBNY common stock as of December 31, 2008 was $3.2 million based on its par value. In an extreme situation, it is possible that the repaymentcapitalization of these loans includesan FHLB, including FHLBNY, could be substantially diminished or reduced to zero. Consequently, given that there is no market for the Company’s FHLBNY common stock, there is a wide variety of diverse real and personal propertyrisk that maythe investment could be affected by changes in prevailing economic, environmental and other conditions, including declinesdetermined to be impaired in the valuefuture.
Deterioration in the soundness of real estate, changes in interest rates, changes in monetary and fiscal policies ofFHLBNY or the federal government, wide-spread disease, terrorist activity, environmental contamination and other external events.
The Company has adopted loan policies with well-defined risk tolerance limits including individual loan officer and committee approval processes. Policies and procedures outline underwriting standards, appraisal requirements, collateral valuations, financial information reviews, and ongoing quality monitoring processes that management believes are appropriate to mitigate the risk of loss within the loan portfolio. Such policies and procedures, however, may not prevent unexpected losses thatFHLB System could have a material adverse effectimpact on the Company’s business, financial condition, results of operations or liquidity.
Interest Rate RiskThe value of certain securities in the Company’s investment securities portfolio may be negatively affected by disruptions in the market for these securities.
In addition to interest rate risk typically associated with an investment portfolio, the market for certain investment securities held within the Company’s investment portfolio has, over the past year, become much less liquid. This coupled with uncertainly surrounding the credit risk associated with the underlying collateral has caused material discrepancies in valuation estimates obtained from third parties. The Company values some of its investments using internally developed cash flow and valuation models, which include certain subjective estimates which are believed to reflect the estimates a purchaser of such securities would use if such a transaction were to occur. The volatile market may affect the value of these securities, such as through reduced valuations due to the perception of heightened credit and liquidity risks, in addition to interest rate risk typically associated with these securities. There can be no assurance that the declines in market value associated with these disruptions will not result in impairments of these assets, which could have a material adverse impact on the Company’s business, financial condition, results of operations or liquidity.
.FDIC insurance premiums may increase materially.
The FDIC insures deposits at FDIC insured financial institutions, including FSB. The FDIC charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at a certain level. Current economic conditions have increased bank failures and expectations for further failures, in which case the FDIC ensures payments of deposits up to insured limits from the Deposit Insurance Fund. In December 2008 and again in February 2009, the FDIC adopted rules that will increase premiums paid by insured institutions and make other changes to the assessment system. Significant increases in deposit insurance premiums could have a material adverse impact on the Company’s business, financial condition, results of operations or liquidity.
There can be no assurance that the EESA and other recently enacted government programs will help stabilize the U.S. financial system.
On October 3, 2008, the EESA was signed into law by the President. The legislation was the result of a proposal by the Secretary of the Treasury on September 20, 2008 in response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions. The U.S. Treasury and federal banking regulators are implementing a number of programs under this legislation and otherwise to address capital and liquidity issues in the banking system, including the CPP, in which the Company participates. In addition, other regulators have taken steps to attempt to stabilize and add liquidity to the financial markets, such as the FDIC’s TLGP.
On February 10, 2009, the Secretary of the Treasury announced the Financial Stability Plan, which earmarks the second $350 billion originally authorized under the EESA. The Financial Stability Plan is intended to, among other things, make capital available to financial institutions, purchase certain legacy loans and assets from financial institutions, restart securitization markets for loans to consumers and businesses and relieve certain pressures on the housing market, including the reduction of mortgage payments and interest rates.

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In addition, the ARRA, which was signed into law on February 17, 2009, includes, among other things, extensive new restrictions on the compensation arrangements of financial institutions participating in TARP.
There can be no assurance, however, as to the actual impact that the EESA, as supplemented by the Financial Stability Plan, the ARRA and other programs will have on the financial markets, including the extreme levels of volatility and limited credit availability currently being experienced. The failure of the EESA, the ARRA, the Financial Stability Plan and other programs to stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect the Company’s business, financial condition, results of operations, access to credit or the trading price of the Company’s common stock.
The EESA, ARRA and the Financial Stability Plan are relatively new initiatives and, as such, are subject to change and evolving interpretation. There can be no assurances as to the effects that any further changes will have on the effectiveness of the government’s efforts to stabilize the credit markets and economy or on the Company’s business, financial condition, results of operations or liquidity.
The limitations on incentive compensation contained in the ARRA may adversely affect the Company’s ability to retain its highest performing employees.
The Company received CPP funds and the ARRA contains restrictions on bonus and other incentive compensation payable to the five executives named in the Company’s proxy statement. Depending upon the limitations placed on incentive compensation by the final regulations issued under the ARRA, it is possible that the Company may be unable to create a compensation structure that permits it to retain its highest performing employees. If this were to occur, it could have a material adverse impact on the Company’s business, financial condition, results of operations or liquidity.
Participants in the CPP are subject to certain restrictions on dividends, repurchases of common stock and executive compensation.
The Company is subject to restrictions on dividends, repurchases of common stock, and executive compensation. Compliance with these restrictions and other restrictions may increase the Company’s costs and limit its ability to pursue business opportunities. Additionally, any reduction of, or the elimination of, the Company’s common stock dividend in the future could adversely affect the market price of the Company’s common stock. The current restrictions, as well as any possible future restrictions, associated with participation in the CPP could have a material adverse impact on the Company’s business, financial condition, results of operations.
The Company may need to raise additional capital in the future and such capital may not be available when needed or at all.
The Company may need to raise additional capital in the future to provide sufficient capital resources and liquidity to meet the Company’s commitments and business needs. The Company’s ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, which are outside of the Company’s control, and its financial performance. The ongoing liquidity crisis and the loss of confidence in financial institutions may increase the Company’s cost of funding and limit its access to some of its customary sources of capital.
The Company cannot assure that such capital will be available to it on acceptable terms or at all. Any occurrence that may limit the Company’s access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of Five Star Bank or counterparties participating in the capital markets, or a downgrade of the Company’s debt rating, may adversely affect the Company’s capital costs and ability to raise capital and, in turn, its liquidity. An inability to raise additional capital on acceptable terms when needed could have a material adverse impact on the Company’s business, financial condition, results of operations or liquidity.
FII is a holding company and is dependent on its banking subsidiary for dividends, distributions and other payments.
The parent company, FII, is a legal entity separate and distinct from its banking and other subsidiaries. FII’s principal source of cash flow, including cash flow to pay dividends to its shareholders and principal and interest on its outstanding debt, is dividends from Five Star Bank. There are statutory and regulatory limitations on the payment of dividends by FSB to the parent company, as well as by FII to its shareholders. Regulations of both the Federal Reserve and the State of New York affect the ability of FSB to pay dividends and other distributions, as well as make loans to FII. Given the loss recorded at FSB during the year ended December 31, 2008, under New York State Banking Department rules, FSB does not expect to be able to pay dividends to FII in the near term without first obtaining regulatory approval. If FSB is unable to make dividend payments to FII and sufficient capital is not otherwise available, FII may not be able to make dividend payments to its common shareholders or principal and interest payments on its outstanding debt. See also the section titled “Supervision and Regulation—Restrictions on Distribution of Subsidiary Bank Dividends and Assets” of this Annual Report on Form 10-K.

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The Company may not pay dividends on its common stock.
Shareholders of the Company’s common stock are only entitled to receive such dividends as the Company’s Board of Directors may declare out of funds legally available for such payments. Although the Company has historically declared cash dividends on its common stock, it is not required to do so and may reduce or eliminate its common stock dividend in the future. This could adversely affect the market price of the Company’s common stock. Also, participation in the CPP limits our ability to increase our dividend or to repurchase our common stock, for so long as any securities issued under such program remain outstanding, as discussed in greater detail below.
If the Company experiences greater credit losses than anticipated, earnings may be adversely impacted.
As a lender, the Company is exposed to the risk that its customers will be unable to repay their loans according to their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse impact on the Company’s results of operations.
The Company makes various assumptions and judgments about the collectibility of its loan portfolio, including the creditworthiness of its borrowers and the value of the real estate and other assets serving as collateral, and provides an allowance for estimated loan losses based on a number of factors. The Company believes that the allowance for loan losses is adequate. However, if the Company’s assumptions or judgments are wrong, its allowance for loan losses may not be sufficient to cover its actual credit losses. The Company may have to increase the allowance in the future in response to the request of one of its primary banking regulators, to adjust for changing conditions and assumptions, or as a result of any deterioration in the quality of its loan portfolio. The actual amount of future provisions for credit losses may vary from the amount of past provisions.
Geographic concentration in one market may unfavorably impact the Company’s operations.
Substantially all of the Company’s business and operations are concentrated in the Western and Central New York region. As a result of this geographic concentration, the Company’s results depend largely on economic conditions in these and surrounding areas. Deterioration in economic conditions in this market could:
increase loan delinquencies;
increase problem assets and foreclosures;
increase claims and lawsuits;
decrease the demand for our products and services; and
decrease the value of collateral for loans, especially real estate, in turn reducing customers’ borrowing power, the value of assets associated with non-performing loans and collateral coverage.
Generally, the Company makes loans to small to mid-sized businesses whose success depends on the regional economy. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. Adverse economic and business conditions in these market areas could reduce the Company’s growth rate, affect our borrowers’ ability to repay their loans and, consequently, adversely affect the Company’s business, financial condition and performance. For example, the Company places substantial reliance on real estate as collateral for its loan portfolio. A sharp downturn in real estate values in our market area could leave many of these loans inadequately collateralized. If the Company is required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, the impact on the Company’s results of operations could be materially adverse. See also the section titled “Market Area and Competition” of this Annual Report on Form 10-K.
The market price of shares of the Company’s common stock may fluctuate.
The market price of the Company’s common stock could be subject to significant fluctuations due to a change in sentiment in the market regarding the Company’s operations or business prospects. Such risks may be affected by:
Operating results that vary from the expectations of management, securities analysts and investors;
Developments in the Company’s business or in the financial sector generally;
Regulatory changes affecting the financial services industry generally or the Company’s business and operations;
The operating and securities price performance of companies that investors consider to be comparable to the Company;
Announcements of strategic developments, acquisitions and other material events by the Company or its competitors;
Changes in the credit, mortgage and real estate markets, including the markets for mortgage-related securities; and
Changes in global financial markets and global economies and general market conditions, such as interest or foreign exchange rates, stock, commodity, credit or asset valuations or volatility.

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Stock markets in general and the Company’s common stock in particular have, over the past year, and continue to be experiencing significant price and volume volatility. As a result, the market price of the Company’s common stock may continue to be subject to similar market fluctuations that may be unrelated to its operating performance or prospects. Increased volatility could result in a decline in the market price of the Company’s common stock and may make it more difficult for shareholders to liquidate the common stock.
Future issuances of additional securities could result in dilution of your ownership.
The Company may determine from time to time to issue additional securities to raise additional capital, support growth, or to make acquisitions. Further, the Company may issue stock options or other stock grants to retain and motivate its employees. These issuances of the Company’s securities may dilute the ownership interests of existing shareholders.
The Company’s market value could result in an impairment of goodwill.
The Company’s goodwill is evaluated for impairment on an annual basis at September 30, or when triggering events or circumstances indicate impairment may exist. During the fourth quarter of 2008, the Company experienced a decline in its market capitalization, therefore the Company evaluated its goodwill as of December 31, 2008 and concluded that there was no impairment. In the first quarter of 2009, the Company has experienced further declines in its market capitalization as its common stock has been trading at a price significantly below its book value. Significant and sustained declines in the Company’s stock price and market capitalization, significant declines in the Company’s expected future cash flows, significant adverse changes in the business climate or slower growth rates could result in impairment of goodwill. If impairment of goodwill was determined to exist, the Company would be required to write down its goodwill as a charge to earnings, which could have a material adverse impact on the Company’s results of operations or financial condition. For further discussion, see Note 1, Summary of Significant Accounting Policies, and Note 6, Goodwill and Other Intangible Assets, to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K.
Changes in interest rates could adversely impact the Company’s results of operations and financial condition.
The banking industry’s earnings depend largely on the relationship between the yield on earning assets, primarily loans and investments, and the cost of funds, primarily deposits and borrowings. This relationship, known as the interest rate spread, is subject to fluctuation and is affected by economic and competitive factors which influence interest rates, the volume and mix of interest-earning assets and interest-bearing liabilities and the level of non-performing assets. Fluctuations in interest rates affect the demand of customers for the Company’s products and services. The Bank is subject to interest rate risk to the degree that interest-bearing liabilities re-price or mature more slowly or more rapidly or on a different basis than interest-earning assets. Significant fluctuations in interest rates could have a material adverse effectimpact on the Company’s business, financial condition, results of operations or liquidity. For additional information regarding interest rate risk, see Part II, Item 7A, “Quantitative and Qualitative Disclosures About Market Risk.”Risk” of this Annual Report on Form 10-K.
ChangesIndustry competition may have an adverse impact on the Company’s success.
The Company’s profitability depends on its ability to compete successfully. The Company operates in a highly competitive environment where certain of its competitors are larger and have more resources. In the Company’s market areas, it faces competition from commercial banks, savings and loan associations, credit unions, internet banks, finance companies, insurance companies, brokerage and investment banking firms, and other financial intermediaries that offer similar services. Some of the Company’s non-bank competitors are not subject to the same extensive regulations that govern FII or FSB and may have greater flexibility in competing for business. The Company expects competition to intensify among financial services companies due to the recent consolidation of certain competing financial institutions and the conversion of certain investment banks to bank holding companies. Should competition in the Valuefinancial services industry intensify, the Company’s ability to market its products and services may be adversely impacted.
The Company’s deferred tax assets may not ultimately be realized or its tax positions may be subject to challenge by the IRS.
The Company’s deferred tax assets may provide significant future tax savings to the Company. The Company’s use of Goodwill and Other Intangible Assets.Under accounting standards,these deferred tax benefits may depend on a number of factors including the ability of the Company is not required to amortize goodwill but rather must evaluate goodwill for impairment at least annually. If deemed impaired at any pointgenerate significant taxable income; the absence of a future ownership change of the Company that could limit or eliminate the tax benefits; the acceptance by the taxing authorities of the positions taken on the Company’s tax returns as to the amount and timing of its income and expenses; and future changes in laws or regulations relating to tax deductions and net operating losses.
The Company assesses the future, an impairment charge representing all or a portion of goodwilllikelihood that deferred tax assets will be recordedrealizable based on future taxable income and, if necessary, establishes a valuation allowance for those deferred tax assets determined to current earningsnot likely be realizable. Management judgment is required in determining the periodappropriate recognition of deferred tax assets and liabilities, including projections of future taxable income. There can be no absolute assurance, however, that the net deferred assets will ultimately be realized.

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The Company’s information systems may experience an interruption or breach in which the impairment occurred. The capitalized value of other intangible assets is amortized to earnings over their estimated lives. Other intangible assets are also subject to periodic impairment reviews. If these assets are deemed impaired at any point in the future, an impairment charge will be recorded to current earnings in the period in which the impairment occurred. See also Note 7 of the notes to consolidated financial statements.security.
Breach of Information Security and Technology Dependence.The Company depends upon data processing, software, communication and information exchange on a variety of computing platforms and networks and over the internet. Despite instituted safeguards, the Company cannot be certain that all of its systems are entirely free from vulnerability to attack or other technological difficulties or failures. The Company relies on the services of a variety of vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted and the Company could be exposed to claims from customers. Any of these results could have a material adverse effectimpact on the Company’s business, financial condition, results of operations or liquidity.
Economic Conditions, Limited Geographic Diversification.The Company’s banking operations are located in Western and Central New York State. Because of the geographic concentration of its operations, the Company’s results depend largely upon economic conditions in this area, which include volatility in wholesale milk prices, losses of manufacturing jobs in Rochester and Buffalo, and minimal population growth throughout the region. Further deterioration in economic conditions could adversely affect the quality of the Company’s loan portfolio and the demand for its products and services, and accordingly, could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. See also the section titled “Market Area and Competition”.

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Ability of the Company to Execute Its Business Strategy.The financial performance and profitability of the Company will depend on its ability to execute its strategic plan and manage its future growth. Failure to execute these plans could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. Moreover, the Company’s future performance is subject to a number of factors beyond its control, including pending and future federal and state banking legislation, regulatory changes, unforeseen litigation outcomes, inflation, lending and deposit rate changes, interest rate fluctuations, increased competition and economic conditions. Accordingly, these issues could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity.
Dependence on Key Personnel.The Company’s success depends to a significant extent on the management skills of its existing executive officers and directors, many of whom have held officer and director positions with the Company for many years. The loss or unavailability of any of its key personnel, including Erland E. Kailbourne, Chairman of the Board of Directors, Peter G. Humphrey, President and Chief Executive Officer, James T. Rudgers, Executive Vice President and Chief of Community Banking, Ronald A. Miller, Executive Vice President and Chief Financial Officer, George D. Hagi, Executive Vice President and Chief Risk Officer, John J. Witkowski, Senior Vice President and Regional President/Retail Banking Executive, Martin K. Birmingham, Senior Vice President and Regional President/Commercial Market Executive, Kevin B. Klotzbach, Senior Vice President and Treasurer, Bruce H. Nagle, Senior Vice President and Director of Human Resources and Richard J. Harrison, Senior Vice President and Senior Retail Lending Administrator, could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. See also Part III, Item 10, “Directors, Executive Officers and Corporate Governance.”
Competition.National competitors are much larger in total assets and capitalization, have greater access to capital markets and offer a broader array of financial services than the Company. There can be no assurance that the Company will be able to compete effectively in its markets. Furthermore, developments increasing the nature or level of competition, together with changes in our strategic plan and stricter loan underwriting standards, could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. See also the sections titled “Market Area and Competition” and “Supervision and Regulation.”
Government Regulation and Monetary Policy.The Company and the banking industry are subject to extensive regulation and supervision under federal and state laws and regulations. The restrictions imposed by such laws and regulations limit the manner in which the Company conducts its banking business, undertakes new investments and activities and obtains financing. These regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit holders of the Company’s securities. Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation in the future, none of which is in the control of the Company. Significant new laws or changes in, or repeals of, existing laws could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. Further, federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company, and any unfavorable change in these conditions could have a material adverse effect on the Company’s business, financial condition, results of operations or liquidity. See also “Supervision and Regulation”.
ItemITEM 1B. Unresolved Staff CommentsUNRESOLVED STAFF COMMENTS
None.Not applicable.

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ItemITEM 2. PropertiesPROPERTIES
The Company believes that its properties have been adequately maintained, are in good operating condition and are suitable for its business as presently conducted. The Company conducts banking operations at the following locations.
       
Location TYPE OFType LEASED OROwned or Leased EXPIRATION
LOCATIONFACILITYOWNEDOF LEASELease Expiration
Allegany Branch Owned 
Amherst Branch Leased February 2020
Attica Branch Owned 
Auburn Branch Owned 
Avoca Branch Owned 
Batavia Branch Leased December 2016
Batavia (In-Store) Branch Leased July 2009
Bath Branch Owned 
Bath Drive-up Branch Owned 
Caledonia Branch Leased January 2007July 2012
Canandaigua Branch Owned 
Cuba Branch Owned 
Dansville Branch Ground Leased March 2014
Dundee Branch Owned 
East Aurora Branch Leased January 2013
East RochesterBranchLeasedSeptember 2009
Ellicottville Branch Owned 
Elmira Branch Owned 
Elmira Heights Branch Leased August 2009
Erwin Branch Leased July 2007October 2010
Geneseo Branch Owned 
Geneva Branch Owned 
Geneva Drive-up Branch Owned 
GreeceBranchLeasedJune 2023
Geneva (Plaza) Branch Ground Leased January 2016
Hammondsport Branch Owned 
HenriettaBranchLeasedJune 2023
Honeoye Falls Branch Leased September 2017
Hornell Branch Owned 
Horseheads Branch Leased OctoberSeptember 2012
Lakeville Branch Owned 
Lakewood Branch Owned 
Leroy Branch Owned 
Mount Morris Branch Owned 
Naples Branch Owned 
North Chili Branch Owned 
North Java Branch Owned 
North Warsaw Branch Owned 
Olean Branch Owned 
Olean Drive-up Branch Owned 
Orchard Park Branch Ground Leased January 2019
Ovid Branch Owned 
Pavilion Branch Owned 
Penn Yan Branch Owned 
PittsfordAdministrative OfficesLeasedApril 2017
Salamanca Branch Owned 
Strykersville Branch Owned 
Victor Branch Owned 
Warsaw (220 Liberty Street) Headquarters Owned 
Warsaw (31(29 North Main Street) Administrative Offices Owned 
Warsaw (55 North Main Street) Main OfficeBranch Owned 
Waterloo Branch Owned 
Wayland Branch Owned 
Williamsville Branch Leased August 20072009
Wyoming Branch Leased June 2007March 2009
Yorkshire Branch Ground Leased November 20072012

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ItemITEM 3. Legal ProceedingsLEGAL PROCEEDINGS
From time to time the Company is a party to or otherwise involved in legal proceedings arising in the normal course of business. Management does not believe that there is any pending or threatened proceeding against the Company, which, if determined adversely, would have a material adverse effect on the Company’s business, results of operations or financial condition.
ItemITEM 4. Submission of Matters to a Vote of Security HoldersSUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the fourth quarter of the year ended December 31, 2006.Not applicable.

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PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Market and Dividend Information
ITEM 5.
MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED SHAREHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
The Company’s common stock of FII is traded on the NASDAQ Global Select Market under the ticker symbol “FISI.” At December 31, 2008, 10,798,019 shares of “FISI”.the Company’s stock were outstanding by approximately 1,100 shareholders of record. During 2008, the high sales price of our common stock was $22.50 and the low sales price was $10.06. The following chart lists pricesclosing price per share of actual sales transactionscommon stock on December 31, 2008, the last trading day of the Company’s fiscal year, was $14.35. The Company declared dividends of $0.54 per common share during the year ended December 31, 2008. See additional information regarding the market price and dividends paid filed herewith in Part II, Item 6, “Selected Financial Data.”
Equity Compensation Plan Information
The following table sets forth, as reportedof December 31, 2008, information about our equity compensation plans that have been approved by NASDAQ, as well asour shareholders, including the cash dividends declared.number of shares of our common stock exercisable under all outstanding options, warrants and rights, the weighted average exercise price of all outstanding options, warrants and rights and the number of shares available for future issuance under our equity compensation plans. We have no equity compensation plans that have not been approved by our shareholders.
                 
              Cash
              Dividends
  Sales Price Per Share Per Share
  High Low Close Declared
   
2006
                
First Quarter $21.17  $18.16  $18.89  $0.08 
Second Quarter  20.86   17.43   20.86   0.08 
Third Quarter  25.38   19.15   23.36   0.09 
Fourth Quarter  24.25   22.07   23.05   0.09 
                 
2005
                
First Quarter $24.93  $18.93  $19.81  $0.16 
Second Quarter  20.21   17.05   18.02   0.08 
Third Quarter  20.76   15.86   18.41   0.08 
Fourth Quarter  21.98   15.52   19.62   0.08 
             
          Number of securities 
      Weighted average  remaining for future 
  Number of securities to  exercise price  issuance under equity 
  be issued upon exercise  of outstanding  compensation plans 
  of outstanding options,  options, warrants  (excluding securities 
Plan Category warrants and rights  and rights  reflected in column (a)) 
             
Equity compensation plans approved by shareholders  582,885  $19.14   763,378 
             
Equity compensation plans not approved by shareholders    $    
FII paysThe Company has paid regular quarterly cash dividends on its common stock and its Board of Directors presently intends to continue the payment of regular quarterly cash dividends,this practice, 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 fromby the Bank, future dividends will depend uponCompany is subject to continued compliance with minimum regulatory capital requirements and CPP restrictions. See the earnings ofdiscussions in the Bank, its financial conditionsection captioned “Supervision and need for funds. Furthermore, there are a number of federal banking policies and regulations that restrict both FII’s and the Bank’s ability to pay dividends. For further discussion on dividend restrictions, refer to theRegulation” included in Part I, Item 1, sections titled “Supervision“Business”, in the section captioned “Liquidity and Regulation”Capital Resources” included in Part II, Item 7, in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in Note 10, Regulatory Matters, in the accompanying financial statements included in Part II, Item 8, “Financial Statements and Supplementary Data”, “The Company”all of which are included elsewhere in this report and “The Bank”, as these restrictions may have the effect of reducing the amount of dividends that FII can declare to its shareholders.

23


Shareholders
At March 2, 2007, the Company had approximately 1,950 common shareholders and 11,336,730 shares of common stock outstanding (exclusive of treasury shares).
Recent Sales of Unregistered Securities
None.
Purchases of Equity Securitiesincorporated herein by the Issuer and Affiliated Purchasesreference thereto.
The table below sets forth the information with respect to purchases made by the Company or any “affiliated purchaser” (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of FIIour common stock during the three months ended December 31, 2006:2008:
                 
              Approximate Dollar
          Total Number of Value of Shares that
  Total     Shares Purchased as May Yet Be
  Number of Average Part of Publicly Purchased Under
  Shares Price Paid Announced Plans or the Plans or
Period Purchased per Share Programs Programs (1)
 
10/01/06 – 10/31/06    $     $5,000,000 
11/01/06 – 11/30/06  4,351   22.48   4,351   4,902,000 
12/01/06 – 12/31/06  1,000 (2)  14.81      4,902,000 
   
                 
Total  5,351  $21.05   4,351  $4,902,000 
   
                 
          Total number  Approximate 
          of shares  dollar value 
          purchased as  of shares that 
  Total number  Average  part of publicly  may yet be 
  of shares  price paid  announced  purchased 
Period purchased  per share  repurchase plans  under the plans 
                 
10/01/08 – 10/31/08  8,444  $14.60   8,444  $2,661,113 
11/01/08 – 11/30/08           2,661,113 
12/01/08 – 12/31/08           (1)
             
                 
Total  8,444  $14.60   8,444  $ 
             
(1)On October 25, 2006, the Company’s Board of Directors approved a one-year, $5.0 million common stock repurchase program. Under the program, stock repurchases may be made either in the open market or through privately negotiated transactions in amounts and at times and prices as determined by the Company.
(2)Shares were purchased in a private transaction pursuant to an agreement that priced the shares at the Company’s book value at the previous year-end.

24


Performance Graph
The Stock Performance Graph compares the cumulative total return on FII’s common stock against the cumulative total return of the NASDAQ Composite of U.S. Stocks and the SNL Financial LC (“SNL”) $1 Billion — $5 Billion Bank Index, for the period of December 31, 2001 through December 31, 2006. The graph assumes that $100 was invested on December 31, 2001 in our common stock and the comparison groups and reinvestment of all cash dividends prior to any tax effect.
                                 
 
    Period Ending 
 Index  12/31/01  12/31/02  12/31/03  12/31/04  12/31/05  12/31/06 
 
 Financial Institutions, Inc.   100.00    127.95    126.40    107.04    92.23    110.10  
 NASDAQ Composite   100.00    68.76    103.67    113.16    115.57    127.58  
 SNL $1B-$5B Bank Index   100.00    115.44    156.98    193.74    190.43    220.36  
 
   
Source : SNL Financial LC, Charlottesville, VA(1) (434) 977-1600
© 2007www.snl.comThe $5 million stock repurchase plan approved by the Company’s Board of Directors during the second quarter of 2008 was terminated in December 2008 and future stock repurchase plans are limited as a result of the Company’s participation in the CPP.

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Stock Performance Graph
The stock performance graph below compares (a) the cumulative total return on the Company’s common stock for the period beginning December 31, 2003 as reported by the NASDAQ Global Market, through December 31, 2008, (b) the cumulative total return on stocks included in the NASDAQ Composite Index over the same period, and (c) the cumulative total return, as compiled by SNL Financial L.C., of Major Exchange (NYSE, AMEX and NASDAQ) Banks with $1 billion to $5 billion in assets over the same period. Cumulative return assumes the reinvestment of dividends. The graph was prepared by SNL Financial, L.C. and is expressed in dollars based on an assumed investment of $100.
                         
  Period Ending 
Index 12/31/03  12/31/04  12/31/05  12/31/06  12/31/07  12/31/08 
Financial Institutions, Inc.  100.00   84.68   72.97   87.10   68.96   57.35 
NASDAQ Composite  100.00   108.59   110.08   120.56   132.39   78.72 
SNL Bank $1B-$5B  100.00   123.42   121.31   140.38   102.26   84.81 

25

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ItemITEM 6. Selected Financial DataSELECTED FINANCIAL DATA
                     
  At December 31: 
(Dollars in thousands) 2006  2005  2004  2003  2002 
 
Selected Financial Condition Data
                    
                     
Total assets $1,907,552  $2,022,392  $2,156,329  $2,173,732  $2,105,034 
Loans  926,482   992,321   1,252,405   1,340,436   1,314,921 
Allowance for loan losses  17,048   20,231   39,186   29,064   21,660 
Securities available for sale  735,148   790,855   727,198   604,964   596,862 
Securities held to maturity  40,388   42,593   39,317   47,131   47,125 
Total liabilities  1,725,164   1,850,635   1,972,042   1,990,629   1,926,740 
Deposits  1,617,695   1,717,261   1,818,949   1,818,889   1,708,518 
Borrowed funds (1)  87,199   115,199   132,614   154,223   195,441 
Total shareholders’ equity  182,388   171,757   184,287   183,103   178,294 
                     
  For the years ended December 31: 
(Dollars in thousands) 2006  2005  2004  2003  2002 
 
Selected Results of Operations Data
                    
                     
Interest income $103,070  $103,887  $106,175  $111,450  $118,439 
Interest expense  43,604   36,395   30,768   35,947   42,577 
   
                     
Net interest income  59,466   67,492   75,407   75,503   75,862 
                     
(Credit) provision for loan losses  (1,842)  28,532   19,676   22,526   6,119 
   
                     
Net interest income after (credit) provision for loan losses  61,308   38,960   55,731   52,977   69,743 
                     
Noninterest income  21,911   29,384   22,149   22,570   18,680 
Noninterest expense  59,612   65,492   61,767   57,283   49,749 
   
                     
Income from continuing operations before income taxes  23,607   2,852   16,113   18,264   38,674 
                     
Income tax expense (benefit) from continuing operations  6,245   (1,766)  3,170   3,923   12,248 
   
                     
Income from continuing operations  17,362   4,618   12,943   14,341   26,426 
                     
Gain (loss) on discontinued operations, net of tax     (2,452)  (450)  (94)  30 
   
                     
Net income $17,362  $2,166  $12,493  $14,247  $26,456 
   
                     
  At or for the year ended December 31, 
(Dollars in thousands, except per share data) 2008  2007  2006  2005  2004 
                     
Selected financial condition data:
                    
Total assets $1,916,919  $1,857,876  $1,907,552  $2,022,392  $2,156,329 
Loans, net  1,102,330   948,652   909,434   972,090   1,213,219 
Investment securities  606,038   754,720   775,536   833,448   766,515 
Deposits  1,633,263   1,575,971   1,617,695   1,717,261   1,818,949 
Borrowings  70,820   68,210   87,199   115,199   132,614 
Shareholders’ equity  190,300   195,322   182,388   171,757   184,287 
Common shareholders’ equity(1)
  137,226   177,741   164,765   154,123   166,565 
Tangible common shareholders’ equity(2)
  99,577   139,786   126,502   115,440   127,452 
                     
Selected operations data:
                    
Interest income $98,948  $105,212  $103,070  $103,887  $106,175 
Interest expense  33,617   47,139   43,604   36,395   30,768 
                
Net interest income  65,331   58,073   59,466   67,492   75,407 
Provision (credit) for loan losses  6,551   116   (1,842)  28,532   19,676 
                
Net interest income after provision (credit) for loan losses  58,780   57,957   61,308   38,960   55,731 
Noninterest (loss) income(3)
  (48,778)  20,680   21,911   29,384   22,149 
Noninterest expense  57,461   57,428   59,612   65,492   61,767 
                
(Loss) income from continuing operations before income taxes  (47,459)  21,209   23,607   2,852   16,113 
Income tax (benefit) expense from continuing operations  (21,301)  4,800   6,245   (1,766)  3,170 
                
(Loss) Income from continuing operations  (26,158)  16,409   17,362   4,618   12,943 
Loss on discontinued operations, net of tax           2,452   450 
                
Net (loss) income $(26,158) $16,409  $17,362  $2,166  $12,493 
                
Preferred stock dividends and accretion  1,538   1,483   1,486   1,488   1,495 
                
Net (loss) income applicable to common shareholders $(27,696) $14,926  $15,876  $678  $10,998 
                
                     
Stock and related per share data:
                    
(Loss) earnings from continuing operations per common share:                    
Basic $(2.56) $1.34  $1.40  $0.28  $1.02 
Diluted  (2.56)  1.33   1.40   0.28   1.02 
(Loss) earnings per common share:                    
Basic  (2.56)  1.34   1.40   0.06   0.98 
Diluted  (2.56)  1.33   1.40   0.06   0.98 
Cash dividends declared on common stock  0.54   0.46   0.34   0.40   0.64 
Common book value per share(1)
  12.71   16.14   14.53   13.60   14.81 
Tangible common book value per share(2)
  9.22   12.69   11.15   10.19   11.31 
Market price (NASDAQ: FISI):                    
High  22.50   23.71   25.38   24.93   29.03 
Low  10.06   16.18   17.43   15.52   20.52 
Close  14.35   17.82   23.05   19.62   23.25 
 
(1) Borrowed funds include junior subordinated debentures.
(1)Excludes preferred shareholders’ equity.
(2)Excludes preferred shareholders’ equity, goodwill and other intangible assets.
(3)The 2008 figure includes OTTI charges of $68.2 million. There were no OTTI charges in the other years presented.

26

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Item 6. Selected Financial Data (Continued)
                     
  At or for the years ended December 31: 
  2006  2005  2004  2003  2002 
 
Per Common Share Data
                    
                     
Basic:                    
Income from continuing operations $1.40  $0.28  $1.02  $1.15  $2.25 
Net income  1.40   0.06   0.98   1.14   2.26 
Diluted:                    
Income from continuing operations $1.40  $0.28  $1.02  $1.14  $2.22 
Net income  1.40   0.06   0.98   1.13   2.23 
Cash dividends declared on common stock  0.34   0.40   0.64   0.64   0.58 
Book value  14.53   13.60   14.81   14.81   14.46 
Tangible book value  11.15   10.19   11.31   11.22   10.74 
Market value  23.05   19.62   23.25   28.23   29.36 
                     
Selected Financial Ratios
                    
                     
Performance Ratios:                    
Return on average common equity  10.02%  0.43%  6.55%  7.65%  17.01%
Return on average tangible common equity  13.23   0.56   8.57   10.12   23.29 
Return on average assets  0.90   0.10   0.57   0.66   1.35 
Common dividend payout (2)  24.29   666.67   65.31   56.14   25.66 
Net interest margin (3)  3.55   3.65   3.90   3.99   4.40 
Efficiency ratio (4)  69.45   70.18   60.41   54.26   49.18 
                     
Asset Quality Ratios:                    
Nonperforming loans to total loans (5)  1.71%  1.82%  4.31%  3.84%  2.82%
Nonperforming loans and other real estate to total loans and other real estate (5)  1.84   1.93   4.40   3.89   2.91 
Nonperforming assets to total assets (5)  0.89   0.97   2.56   2.40   1.82 
Allowance for loan losses to total loans (5)  1.84   2.04   3.13   2.17   1.65 
Allowance for loan losses to nonperforming loans (5)  108   112   73   56   58 
Net charge-offs to average total loans (5)  0.14   4.27   0.74   1.11   0.30 
                     
Capital ratios:                    
Period end common equity to total assets  8.64%  7.62%  7.72%  7.61%  7.63%
Average common equity to average assets  8.17   7.54   7.67   7.74   7.47 
Period end tangible common equity to total tangible assets  6.77   5.82   6.01   5.87   5.78 
Average tangible common equity to average tangible assets  6.32   5.80   5.97   5.96   5.56 
Tier 1 leverage capital  8.91   7.60   7.13   7.03   6.96 
Tier 1 risk-based capital  15.85   13.75   11.27   10.18   9.82 
Total risk-based capital  17.10   15.01   12.54   11.44   11.08 
                     
  At or for the year ended December 31, 
(Dollars in thousands, except per share data) 2008  2007  2006  2005  2004 
Selected financial ratios and other data:
                    
Performance ratios:
                    
Net (loss) income (returns on):                    
Average assets  -1.37%  0.86%  0.90%  0.10%  0.57%
Average equity  -14.30   8.84   9.86   1.22   6.73 
Average common equity(1)
  -16.84   8.89   10.02   0.43   6.55 
Average tangible common equity(2)
  -21.87   11.50   13.23   0.56   8.57 
Common dividend payout ratio(3)
 NA   34.33   24.29   666.67   65.31 
Net interest margin (fully tax-equivalent)  3.93   3.53   3.55   3.65   3.90 
Efficiency ratio(4)
  64.07%  68.77%  69.78%  70.18%  60.41%
                     
Capital ratios:
                    
Leverage ratio  8.05%  9.35%  8.91%  7.60%  7.13%
Tier 1 risk-based capital  11.83   15.74   15.85   13.75   11.27 
Total risk-based capital  13.08   16.99   17.10   15.01   12.54 
Equity to assets(5)
  9.60   9.73   9.08   8.37   8.48 
Common equity to assets(1) (5)
  8.63   8.81   8.17   7.54   7.67 
Tangible common equity to tangible assets(2)(5)
  6.78%  6.95%  6.32%  5.80%  5.97%
                     
Asset quality(6):
                    
Non-accruing loans $8,189  $8,075  $15,837  $17,761  $51,946 
Other non-performing assets  56   2   3   276   2,018 
Allowance for loan losses  18,749   15,521   17,048   20,231   39,186 
Net loan charge-offs $3,323  $1,643  $1,341  $47,487  $9,554 
Total non-performing loans to total loans  0.73%  0.84%  1.71%  1.82%  4.31%
Total non-performing assets to total assets  0.48   0.51   0.89   0.97   2.56 
Net charge-offs to average loans  0.32   0.18   0.14   4.27   0.74 
Allowance for loan losses to total loans  1.67   1.61   1.84   2.04   3.13 
Allowance for loan losses to non-performing loans  229%  192%  108%  112%  73%
                     
Other data:
                    
Number of branches  52   50   50   50   50 
Full time equivalent employees  600   621   640   700   765 
 
(2) Cash dividends declared on common stock divided by basic net income per common share.
(1)Excludes preferred shareholders’ equity.
 
(3)(2) Represents net interest income divided by average interest-earningExcludes preferred shareholders’ equity, goodwill and other intangible assets. The interest earned from tax-exempt securities includes a tax-equivalent adjustment.
 
(4)(3) The efficiencyCommon dividend payout ratio representsequals dividends declared during the year divided by earnings per share for the year. There is no ratio shown for years where the Company both declared a dividend and incurred a loss because the ratio would result in a negative payout since the dividend declared (paid out) will always be greater than 100% of earnings.
(4)Efficiency ratio equals noninterest expense less other real estate expense and amortization of intangibles (all from continuing operations) divided byintangible assets as a percentage of net revenue, defined as the sum of tax-equivalent net interest income (tax-equivalent) plus otherand noninterest income less gainbefore net gains and impairment charges on sale ofinvestment securities, gain on sale of credit card portfolio, gain on sale of trust relationshipsproceeds from company owned life insurance included in income, and net gain on salegains from the sales of commercial-related loans held for sale and trust relationships (all from continuing operations).
 
(5)Ratios calculated using average balances for the periods shown.
(6) Ratios exclude nonaccruingnon-accruing commercial-related loans held for sale (which amounted to $577,000 at December 31,($577 thousand for 2005 and zero for all other years presented) from nonperformingnon-performing loans and exclude loans held for sale from total loans.

27

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SELECTED QUARTERLY DATA
                 
  2008 
  Fourth  Third  Second  First 
(Dollars in thousands, except per share data) Quarter  Quarter  Quarter  Quarter 
Interest income $24,582  $24,558  $24,536  $25,272 
Interest expense  7,269   7,812   8,349   10,187 
             
Net interest income  17,313   16,746   16,187   15,085 
Provision for loan losses  2,586   1,891   1,358   716 
             
Net interest income, after provision for loan losses  14,727   14,855   14,829   14,369 
Noninterest (loss) income  (25,106)  (29,348)  932   4,744 
Noninterest expense  15,394   13,409   14,385   14,273 
             
(Loss) income before income taxes  (25,773)  (27,902)  1,376   4,840 
Income tax (benefit) expense  (22,631)  524   (255)  1,061 
             
Net (loss) income $(3,142) $(28,426) $1,631  $3,779 
             
Preferred stock dividends  426   371   370   371 
             
Net (loss) income applicable to common shareholders $(3,568) $(28,797) $1,261  $3,408 
             
                 
(loss) earnings per common share(1):
                
Basic $(0.33) $(2.68) $0.12  $0.31 
Diluted  (0.33)  (2.68)  0.12   0.31 
Market price (NASDAQ: FISI):                
High $20.27  $22.50  $20.00  $20.78 
Low  10.06   14.82   15.25   15.10 
Close  14.35   20.01   16.06   18.95 
Dividends declared $0.10  $0.15  $0.15  $0.14 
                 
  2007 
  Fourth  Third  Second  First 
(Dollars in thousands, except per share data) Quarter  Quarter  Quarter  Quarter 
Interest income $26,397  $26,553  $26,458  $25,806 
Interest expense  11,192   11,692   12,406   11,850 
             
Net interest income  15,205   14,861   14,052   13,956 
Provision (credit) for loan losses  351   (82)  (153)   
             
Net interest income, after provision (credit) for loan losses  14,854   14,943   14,205   13,956 
Noninterest income  5,002   6,334   4,606   4,738 
Noninterest expense  14,543   14,609   14,348   13,928 
             
Income before income taxes  5,313   6,668   4,463   4,766 
Income tax expense  1,215   1,414   1,020   1,151 
             
Net income $4,098  $5,254  $3,443  $3,615 
             
Preferred stock dividends  370   371   371   371 
             
Net income applicable to common shareholders $3,728  $4,883  $3,072  $3,244 
             
                 
Earnings per common share(1):
                
Basic $0.34  $0.44  $0.27  $0.29 
Diluted  0.34   0.44   0.27   0.29 
Market price (NASDAQ: FISI):                
High $19.80  $20.46  $20.62  $23.71 
Low  16.42   16.18   18.62   19.30 
Close  17.82   17.94   20.19   20.07 
Dividends declared $0.13  $0.12  $0.11  $0.10 
(1)(Loss) earnings per share data is computed independently for each of the quarters presented. Therefore, the sum of the quarterly earnings or loss per common share amounts may not equal the total for the year.

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Item
ITEM 7. Management’s Discussion and Analysis of Financial Condition and Results of Operation
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
GENERAL
The principal objective of this discussion is to provide an overview of the financial condition and results of operations of the Company during the year ended December 31, 20062008 and the preceding two years. This discussionThe following analysis of financial condition and the tabular presentationsresults of operations should be read in conjunction with the accompanying consolidated financial statements and accompanying notes.related notes filed herewith in Part II, Item 8, “Financial Statements and Supplementary Data” and the description of the business filed herewith in Part I, Item 1, “Business.”
Income.The Company’s results of operations are dependent primarily on net interest income, which is the difference between the income earned on loans and securities and the interest paid on deposits and borrowings. Results of operations are also affected by the (credit) provision for loan losses, service charges on deposits, financial services group fees and commissions, mortgage banking revenues, gain or loss on the sale of securities, gain or loss on sale of loans and other miscellaneous income.
Expenses.The Company’s expenses primarily consist of salaries and employee benefits, occupancy and equipment, supplies and postage, amortization of other intangible assets, computer and data processing, professional fees and services, advertising and promotions and other miscellaneous expense and income tax expense (benefit). Results of operations are also significantly affected by general economic and competitive conditions, particularly changes in consumer and business spending, interest rates, government policies and the actions of regulatory authorities.
RECENT MARKET DEVELOPMENTS
The global and U.S. economies are experiencing significantly reduced business activity as a result of, among other factors, disruptions in the financial system during the past year. Dramatic declines in the housing market during the past year, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of residential-related loans and mortgage-backed securities, but spreading to credit default swaps and other derivative securities, have caused many financial institutions to seek additional capital, to merge with larger and stronger institutions and, in some cases, to fail.
Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced, and in some cases, ceased to provide funding to borrowers, including other financial institutions. The availability of credit, confidence in the financial sector, and level of volatility in the financial markets have been significantly adversely affected as a result. In recent months, volatility and disruption in the capital and credit markets have reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit capacity for certain issuers without regard to those issuers’ underlying financial strength.
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, EESA was signed into law on October 3, 2008. The EESA authorizes the Treasury to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. The EESA also provided a temporary increase in deposit insurance coverage from $100,000 to $250,000 per insured account until December 31, 2009.
On October 14, 2008, the Secretary of the Treasury, after consulting with the Federal Reserve and the FDIC, announced that the Treasury will purchase equity stakes in certain banks and thrifts. Under this program, known as the CPP, the Treasury will make $250 billion of capital available to U.S. financial institutions in the form of preferred stock (from the $700 billion authorized by the EESA). In conjunction with the purchase of preferred stock, the Treasury will receive warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions will be required to adopt the Treasury’s standards for executive compensation and corporate governance for the period during which the Treasury holds equity issued under the CPP.
Also on October 14, 2008, after receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, the Secretary of the Treasury signed the systemic risk exception to the FDIC Act, enabling the FDIC to temporarily provide a 100% guarantee of the senior unsecured debt of all FDIC-insured institutions and their holding companies, as well as deposits in noninterest-bearing transaction deposit accounts under the TLGP through December 31, 2009. All insured depository institutions automatically participated in the TLGP for 30 days following the announcement of the program without charge (subsequently extended to December 5, 2008) and thereafter, unless an institution opted out, at a cost of 75 basis points per annum for senior unsecured debt and 10 basis points per annum for noninterest-bearing transaction deposits.

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The Company elected to participate in the CPP, and on December 23, 2008 received $37.5 million in additional capital through the program. In exchange, the Treasury received a like amount of the FII preferred stock that pays an annual dividend of 5% for the first five years, and an annual dividend of 9% in any years thereafter. The Company may redeem the preferred shares issued to Treasury in full during the first three years following issuance only with the proceeds of a qualifying equity offering. Thereafter, the preferred shares may be redeemed in full or in part at any time. The Company also issued a warrant to the Treasury to purchase 378,175 shares of FII common stock, which, upon issuance, would represent approximately 3.4% of our outstanding common shares, based upon current information. The warrant is exercisable at any time during the ten-year period following issuance at an exercise price of $14.88.
Notwithstanding the foregoing, the ARRA, which was signed into law by President Obama on February 17, 2009, provides that the Secretary of the Treasury shall permit a recipient of funds under the TARP, subject to consultation with the recipient’s appropriate Federal banking agency, to repay such assistance without regard to whether the recipient has replaced such funds from any other source or to any waiting period. ARRA further provides that when the recipient repays such assistance, the Secretary of the Treasury shall liquidate the warrants associated with the assistance at the current market price. While Treasury has not yet issued implementing regulations, it appears that ARRA will permit the Company, if it so elects and following consultation with the FRB, to redeem the Series A Preferred Stock at any time without restriction.
The FDIC Act also requires that the FDIC Board of Directors adopt a restoration plan when the Deposit Insurance Fund reserve ratio falls or is expected to fall below certain minimum levels. The bank failures that resulted in 2008 adversely impacted the deposit insurance funds loss provisions, resulting in a decline in the reserve ratio. As part of the restoration plan, the FDIC has increased the insurance assessment rates by seven basis points uniformly for the quarter beginning January 1, 2009. In addition, on February 27, 2009 the FDIC Board adopted an interim rule imposing a 20 basis point emergency special assessment on the industry on June 30, 2009. The assessment is to be collected on September 30, 2009. The interim rule would also permit the Board to impose an emergency special assessment after June 30, 2009, of up to 10 basis points if necessary to maintain public confidence in federal deposit insurance. The Company estimates the combined impact of the seven basis point increase and 20 basis point emergency special assessment to be an approximate increase of $4.6 million in its FDIC deposit insurance assessments for 2009. Subsequently, on March 5, 2009 the Chairman of the FDIC announced that it may cut the 20 basis point emergency special assessment to 10 basis points if legislation passes to expand the FDIC’s existing line of credit with the U.S. Treasury Department.
Additionally, the Company opted to continue to participate in the Transaction Account Guarantee portion of the TLGP following the expiration of the initial opt-out period. Participation includes the full guarantee of noninterest bearing deposit transaction accounts and eligible, low interest-earning demand accounts (interest rate equal to or less than 0.50%) regardless of dollar amount.
It is not clear at this time what impact the EESA, the CPP, the TLGP, or other liquidity and funding initiatives will have on the financial markets and the other difficulties described above, including the high levels of volatility and limited credit availability currently being experienced, or on the U.S. banking and financial industries and the broader U.S. global economies. Further adverse effects could have an adverse effect on our business.
OVERVIEW
Net income was $17.4 million, $2.2 million and $12.5 million for 2006, 2005 and 2004, respectively. Diluted earnings per share forFor the year ended December 31, 2006 was $1.40, compared to $0.06 in 20052008, the Company’s net loss totaled $26.2 million (or $2.56 loss per share), which included a pre-tax non-cash charge of $68.2 million for OTTI on certain investment securities. The Company reported net income of $16.4 million ($1.33 per diluted share) and $0.98 in 2004. The return on average common equity in 2006 was 10.02%, compared to 0.43% in 2005 and 6.55% in 2004. The return on average assets in 2006 was 0.90%, compared to 0.10% in 2005 and 0.57% in 2004.
The primary factor$17.4 million ($1.40 per diluted share) for the improvedyears ended December 31, 2007 and 2006, results was a $1.8 million credit for loan losses in 2006 compared with a $28.5 million and $19.7 million provision for loan losses in 2005 and 2004, respectively. The Company also reduced noninterest expense by $5.9 million in 2006 compared with 2005. The improved risk profile of the Company’s loan portfolio contributed to the credit for loan losses. Lower noninterest expense resulted from improved operating efficiencies from the consolidation of the Company’s subsidiary banks in December 2005, coupled with a reduction in costs associated with asset quality issues and regulatory matters.
Net interest income, the principal source of the Company’s earnings, was $65.3 million in 2008, up from $58.1 million in 2007 and $59.5 million in 2006 down from $67.5 million in 2005 and $75.4 million in 2004.2006. Net interest margin was 3.55%, 3.65% and 3.90%improved substantially to 3.93% for the yearsyear ended December 31, 2006, 20052008, compared with 3.53% and 2004, respectively.3.55% for the two prior years. The decline inimproved net interest incomemargin resulted principally from lower earning asset levels alongfunding costs and the benefits associated with a narrowedhigher percentage of earning assets being deployed in higher yielding loan assets. Total loans increased $156.9 million, or 16%, to $1.121 billion for the one year period ended December 31, 2008. Indirect auto loans increased $120.1 million or 89%, and commercial-related increased $35.5 million or 8% during that same one year period.
The Company recorded a provision for loan losses of $6.6 million for the year ended December 31, 2008, compared with $116 thousand in 2007. The increase in the provision for loan losses is primarily due to growth in the loan portfolio and the changing mix of the loan portfolio together with higher net interest margin.charge offs. For the year ended December 31, 2008, net charge-offs were $3.3 million, or 32 basis points of average loans, compared with $1.6 million, or 18 basis points of average loans, for the year ended December 31, 2007. The allowance for loan losses was $18.7 million at December 31, 2008, compared with $15.5 million at December 31, 2007. Non-performing loans were $8.2 million at December 31, 2008, compared with $8.1 million at December 31, 2007. The ratio of allowance for loan losses to non-performing loans improved to 229% at December 31, 2008 versus 192% at December 31, 2007.
EffectiveFor the year ended December 3, 2005,31, 2008, noninterest income (loss) was $(48.8) million, compared with $20.7 million for the Company merged its subsidiary banks intosame period in 2007. The loss reflects OTTI charges on investment securities totaling $68.2 million for the New York State-chartered First Tier Bank & Trust (“FTB”), whichyear ended December 31, 2008. Exclusive of OTTI charges, noninterest income was then renamed Five Star Bank (“FSB”). The consolidation activities have improved operational efficiencies and have contributed$19.4 million for the year, compared with $20.7 million in 2007. Aside from the impact of the OTTI charges in 2007, most of the remaining decrease in noninterest income was due to lowerthe receipt of $1.1 million in proceeds from company owned life insurance.

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For the year ended December 31, 2008, noninterest expense in 2006 whenwas $57.5 million compared with 2005$57.4 million for the same period in 2007. Total salaries and 2004. benefits cost declined $1.7 million for the year ended December 31, 2008 compared with 2007, and was offset by a $599 thousand increase in occupancy and equipment expense, a $385 thousand increase in FDIC insurance, and a $557 thousand prepayment charge on borrowed funds.
The Company retained its “well-capitalized” equity position with total equity capital of $190.3 million, which includes $37.5 million in preferred equity issued in December 2008 under the U.S. Treasury Department’s CPP. As of December, 31, 2008, the leverage capital ratio was 8.05% and total risk-based capital ratio was 13.08%.
The Company also sold the Burke Group, Inc (“BGI”) subsidiary during 2005 to focus onexpanded its core community banking business. The results of BGI have been reported separately as a discontinued operationbranch network in the consolidated statementsmetro-Rochester area of incomeNew York State, adding de novo branches in Henrietta and Greece during the loss on discontinued operation totaled $2.5 millionthird and $450,000 for 2005 and 2004,fourth quarters of 2008, respectively. In addition, the Company sold its trust relationships during 2006 and recognized a $1.4 million gain on the sale.
CRITICAL ACCOUNTING POLICIESESTIMATES
The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States and are consistent with predominant practices in the financial services industry. Application of critical accounting policies, which are those policies that management believes are the most important to the Company’s financial position and results, requires management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes and are based on information available as of the date of the financial statements. Future changes in information

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may affect these estimates, assumptions and judgments, which, in turn, may affect amounts reported in the financial statements.
The Company has numerous accounting policies, of which the most significant are presented in Note 1, Summary of Significant Accounting Policies, of the notes to consolidated financial statements. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets, liabilities, revenues and expenses are reported in the consolidated financial statements and how those reported amounts are determined. Based on the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies with respect to the allowance for loan losses, valuation of goodwill and goodwilldeferred tax assets, the valuation of securities and determination of OTTI, and accounting for defined benefit plans require particularly subjective or complex judgments important to the Company’s financial position and results of operations, and, as such, are considered to be critical accounting policies as discussed below. These estimates and assumptions are based on management’s best estimates and judgment and are evaluated on an ongoing basis using historical experience and other factors, including the current economic environment. The Company adjusts these estimates and assumptions when facts and circumstances dictate. Illiquid credit markets and volatile equity have combined with declines in consumer spending to increase the uncertainty inherent in these estimates and assumptions. As future events cannot be determined with precision, actual results could differ significantly from the Company’s estimates.
Adequacy of the Allowance for Loan Losses
The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of subjective measurements including management’s assessment of the internal risk classifications of loans, changes in the nature of the loan portfolio, industry concentrations and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.
A commercial-related loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts of principal and interest under the original terms of the agreement and all loans restructured in a troubled debt restructuring. Accordingly, the Company evaluates impaired commercial-related loans individually, primarily based on the net realizable value of the collateral, as the majority of the Company’s impaired loans are collateral dependent.
Loans, including impaired loans, are generally classified as nonaccruing if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-collateralized and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccruing if repayment in full of principal and/or interest is uncertain.
For additional discussion related to the Company’s accounting policies for the allowance for loan losses, see the sections titled “Analysis of Allowance for Loan Losses” and “Allocation of Allowance for Loan Losses” in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operation”Operations” and Note 1, Summary of Significant Accounting Policies, of the notes to consolidated financial statements.

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Valuation of Goodwill
Statement of Financial Accounting Standards (SFAS)(“SFAS”) No. 142, “Goodwill and Other Intangible Assets” prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets are subject to at least an annual impairment review and more frequently if certain impairment indicators are in evidence. Goodwill impairment testing is performed at the segment (or “reporting unit”) level. Currently, the Company’s goodwill is evaluated at the entity level as there is only one reporting unit. Goodwill is assigned to reporting units at the date it is initially recorded. Once goodwill has been assigned to reporting units, it no longer retains its association with a particular acquisition, and all of the activities within a reporting unit, whether acquired or organically grown, are available to support the value of the goodwill. Changes in the estimates and assumptions used to evaluate impairmentare reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity. During 2006, 2005 and 2004, the Company evaluated goodwill for impairment using a discounted cash flow analysis and determined no impairment existed. For additional discussion related to the Company’s accounting policy for goodwill and other intangible assets, see Note 1, Summary of Significant Accounting Policies, of the notes to consolidated financial statements.
Valuation of Deferred Tax Assets
The determination of deferred tax expense or benefit is based on changes in the carrying amounts of assets and liabilities that generate temporary differences. The carrying value of the Company’s net deferred tax assets assumes that the Company will be able to generate sufficient future taxable income based on estimates and assumptions (after consideration of historical taxable income as well as tax planning strategies). If these estimates and related assumptions change, the Company may be required to record valuation allowances against its deferred tax assets resulting in additional income tax expense in the consolidated statements of operations. Management evaluates its deferred tax assets on a quarterly basis and assesses the need for a valuation allowance, if any. A valuation allowance is established when management believes that it is more likely than not that some portion of its deferred tax assets will not be realized. Changes in valuation allowance from period to period are included in the Company’s tax provision in the period of change. For additional discussion related to the Company’s accounting policy for income taxes see Note 14, Income Taxes, of the notes to consolidated financial statements.
Valuation and Other Than Temporary Impairment of Securities
The Company records all of its securities that are classified as available for sale at fair value. The fair value of equity securities are determined using public quotations, when available. Where quoted market prices are not available, fair values are estimated based on dealer quotes, pricing models, discounted cash flow methodologies, or similar techniques for which the determination of fair value may require significant judgment or estimation. Fair values of public bonds and those private securities that are actively traded in the secondary market have been determined through the use of third-party pricing services using market observable inputs. Private placement securities and other corporate fixed maturities where the Company does not receive a public quotation are valued by discounting the expected cash flows. Market rates used are applicable to the yield, credit quality and average maturity of each security. Private equity securities may also utilize internal valuation methodologies appropriate for the specific asset. Fair values might also be determined using broker quotes or through the use of internal models or analysis.
Securities are evaluated quarterly to determine whether a decline in their fair value is other than temporary. Management utilizes criteria such as, the magnitude and duration of the decline and, when appropriate, consideration of adverse changes in cash flows, in addition to the reasons underlying the decline, including creditworthiness, capital adequacy and near term prospects of issuers, the level of credit subordination, estimated loss severity, prepayments and future delinquencies, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable. Once a decline in fair value is determined to be other than temporary the cost basis of the security is reduced through a charge to earnings.
Defined Benefit Pension Plan
Management is required to make various assumptions in valuing its defined benefit pension plan assets and liabilities. These assumptions include, but are not limited to, the expected long-term rate of return on plan assets, the weighted average discount rate used to value certain liabilities and the rate of compensation increase. The Company uses a third-party specialist to assist in making these estimates and assumptions. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

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ANALYSIS OF FINANCIAL CONDITION
Overview
At December 31, 20062008, the Company had total assets of $1.908$1.917 billion, a decreasean increase of 6%3% from $2.022$1.858 billion atas of December 31, 2005.2007, primarily a result of growth of its core business of loans and deposits. Loans attotaled $1.121 billion as of December 31, 2006 were $926.5 million, down $65.82008, up $156.9 million, or 6.6%16%, when compared to $992.3$964.2 million atas of December 31, 2005.2007. The declineincrease in loans was primarily attributed to loan payments outpacing new loan originations and the consequencesexpansion of the 2005indirect lending program and commercial business development efforts. Nonperforming assets totaled $9.3 million as of December 31, 2008, down $246 thousand from a year ago despite the increase the loan sale.portfolio. For the year ended December 31, 2008, net charge-offs were $3.3 million, or 32 basis points of average loans, compared with $1.6 million, or 18 basis points of average loans, for the year ended December 31, 2007. The Company’s strategy isincrease in net charge-offs in 2008 related principally to rebuild a balanced qualitythe commercial mortgage and consumer indirect loan portfolio, and loan originations slowed due to more stringent underwriting requirements, firm pricing disciplines and a highly competitive marketplace for quality loans.portfolios. Total deposits amounted to $1.618$1.633 billion and $1.717$1.576 billion atas of December 31, 20062008 and 2005,2007, respectively. ContributingThe increase in deposits was due in part to the declineCompany’s successfully expansion of its branch network in depositsthe metro-Rochester area, where de novo branches were fewer certificatesadded in Henrietta and Greece during the third and fourth quarters of deposit, including brokered certificates2008, respectively. As of deposit,December 31, 2008, total borrowed funds were $70.8 million, comparable to $68.2 million as of December 31, 2007. While the outstanding balance of borrowed funds is up slightly, the average cost of the borrowed funds is down considerably as the Company actively managed to lowertook advantage of the levellow interest rate environment and prepaid a portion of theseits higher cost deposits. Other deposit categories declined from deposit outflows associated withlong term debt in the effectsfourth quarter of the 2005 loan sale and from higher-rate competitor products. At December 31, 2006, total borrowed funds and junior subordinated debentures were $87.2 million compared to $115.2 million at December 31, 2005. The Company funded the reduction in borrowings with cash available from the decline in loans experienced in 2006.2008. Book value per common share was $14.53$12.71 and $13.60 at December 31,

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2006 and 2005, respectively. At$16.14 as of December 31, 20062008 and 2007, respectively. As of December 31, 2008 the Company’s total shareholders’ equity was $182.4$190.3 million compared to $171.8$195.3 million a year earlier.
Goodwill
At December 31, 2008, the carrying amount of our goodwill totaled $37.4 million. On September 30, 2008, the Company performed the annual goodwill impairment test and determined the estimated fair value of our reporting unit to be in excess of its carrying amount. Accordingly, as of the Company’s annual impairment test date, there was no indication of goodwill impairment. The Company tests its goodwill for impairment between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of our reporting unit below its carrying amount. Accordingly, an evaluation of the goodwill for impairment was performed as of December 31, 2008 due to the market’s continued contraction. The estimated fair value of the Company’s reporting unit was in excess of its carrying amount at December 31, 2008. No assurance can be given that the Company will not record an impairment loss on goodwill in 2009. However, the Company’s tangible capital ratio and Bank’s regulatory capital ratios would not be affected by this potential non-cash expense since goodwill is not included in these calculations.
Subsequent to December 31, 2008, the Company’s stock price significantly declined as was the case for the financial services sector as a whole. The Company considers this to be primarily a financial services industry issue and not related specifically to the Company. If this decline does not reverse by March 31, 2009, there may be a triggering event requiring a goodwill impairment analysis under SFAS No. 142 that may result in an impairment charge.
Investing Activities
The following table summarizes the composition of the available for sale and held to maturity security portfolios (in thousands).
                         
  At December 31, 
  2008  2007  2006 
  Adjusted                
  Amortized  Fair  Amortized  Fair  Amortized  Fair 
  Cost  Value  Cost  Value  Cost  Value 
Securities available for sale:
                        
U.S. Government agency and government-sponsored enterprise securities $67,871  $68,173  $158,920  $158,940  $235,863  $231,936 
Mortgage-backed securities:  339,574   342,552   297,798   295,872   304,833   296,738 
Other asset-backed securities  3,918   3,918   34,115   33,198   7,082   7,077 
State and municipal obligations  129,572   131,711   171,294   172,601   198,428   198,310 
Equity securities  923   1,152   33,930   34,630   80   1,087 
                   
Total available for sale securities  541,858   547,506   696,057   695,241   746,286   735,148 
                   
Securities held to maturity:
                        
State and municipal obligations Total held to maturity securities  58,532   59,147   59,479   59,902   40,388   40,421 
                   
Total investment securities $600,390  $606,653  $755,536  $755,143  $786,674  $775,569 
                   

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The deteriorating credit quality of assets linked to the sub-prime mortgage market has led to a lack of liquidity and downgrades to certain whole-loan mortgage-backed securities, trust preferred and auction rate securities. This, in turn, has contributed to a broad-based liquidity shortfall in the financial system. The subsequent increase in risk aversion has contributed to a decline in credit availability in the financial and capital markets. The U.S. Government has attempted to stabilize the financial and capital markets through an injection of liquidity and capital, but it is unclear if and how long it may take for those efforts to be successful.
For the year ended December 31, 2008, the Company recorded OTTI non-cash charges on certain equity, mortgage-backed and other asset-backed investment securities totaling $68.2 million. There were no such charges in prior years. Further deterioration in credit quality and/or a continuation of the current imbalances in liquidity that exist in the marketplace may adversely effect the fair values of the Company’s investment portfolio and increase the potential that certain unrealized losses may be designated as “other than temporary” in future periods and that the Company may incur additional write-downs in the future that could be material.
U.S. Government Agency and U.S. Government-Sponsored Enterprise (“GSE”) Obligations
The U.S. government agency and GSE obligations portfolio, all of which was classified as available for sale, was comprised of debt obligations issued directly by the U.S. government agencies or GSEs and totaled $68.2 million and $158.9 million as of December 31, 2008 and December 31, 2007, respectively. At December 31, 2008, the portfolio consisted of approximately $20.2 million, or 30%, callable securities. As of December 31, 2008, this category of investment securities also included $7.2 million of structured notes, the majority of which were step-callable debt issues that step-up in rate at specified intervals and are periodically callable by the issuer. As of December 31, 2008, the structured notes had a current average coupon rate of 4.21% that adjust on average to 6.00% within five years. However, under current market conditions these notes are likely to be called at the time of the rate adjustment.
Mortgage-Backed Securities (“MBS”)
The MBS portfolio totaled $342.6 million as of December 31, 2008, which was comprised of $239.5 million of mortgage-backed pass-through securities (“pass-through”) and $103.1 million of collateralized mortgage obligations (“CMO”). As of December 31, 2007, the available for sale MBS portfolio totaled $295.9 million, which consisted of $160.0 million of pass-throughs and $135.9 million of CMOs.
The pass-throughs were predominately issued by FNMA, FHLMC or GNMA. The majority of the pass-through portfolio was in fixed rate securities that were most frequently formed with mortgages having an original balloon payment of five or seven years and 15, 20 and 30 year seasoned mortgages. The remainder of the pass-through portfolio was principally adjustable rate securities indexed to the one-year Treasury bill.
The CMO portfolio consisted of two principal groups, with balances as of December 31, 2008 as follows: (1) $63.6 million of fixed and variable rate CMOs issued by FNMA, FHLMC or GNMA that carried a full guaranty by the issuing agency of both principal and interest, and (2) $39.5 million of privately issued whole loan CMOs.
The following table details, by credit rating, the privately issued whole loan CMOs as of December 31, 2008 (dollars in thousands):
           
  Moody’s S&P Fitch Fair 
Number of Securities Rating Rating Rating Value 
Five(1)
 Aaa AAA  $11,408 
Two Aaa  AAA  6,240 
Four  AAA AAA  6,261 
One   AAA  5,651 
Two(2)
 Aa1 AAA AAA  4,698 
One Baa3  AAA  2,467 
One  BB AAA  1,518 
          
Total whole loan CMOs with prime and Alt-A collateral (at least 90% prime collateral)        38,243 
          
One(3)
 A3 AAA   426 
One  BBB- AAA  657 
One A3 BB   124 
          
Total whole loan CMOs with a high level of sub-prime collateral (more than 35% sub-prime collateral)        1,207 
          
           
Total privately issued whole loan CMOs
       $39,450 
          
In February 2009, the Moody’s credit ratings on certain securities have been changed as follows:
(1)One $5.6 million security was changed to Baa3 and one $2.0 million security was changed to Caa.
(2)One $1.3 million security was changed to Ba1 and one $ 3.4 million security was changed to Ca.
(3)This security was changed to Ca.

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The securities in the privately issued whole loan CMO portoflio carry varying levels of credit enhancement. These securities were purchased based on the underlying loan characteristics such as loan to value ratio, credit scores, property type and location. Current chacteristics of each security such as delinquency and foreclosures levels, loss severity levels, credit enhancement, and coverage ratios are reviewed regularly by management. When the level of credit loss coverage for an individual security deteriorates below a specified level, analysis of the security is expanded. Projected credit losses are compared to the current level of credit enhancement to estimate whether the security is expected to experience losses in the future. The amount of OTTI recognized during the year ended December 31, 2008 on the privately issued whole loan CMOs totaled $6.5 million, of which, $4.6 million related to three securities with a high level (more than 35%) of sub-prime collateral. As the current market disruption continues, more securities may be downgraded and/or devalued, which may resut in additional impairment charges in future periods.
Other Asset-Backed Securities (“ABS”)
The ABS portfolio totaled $3.9 million and $33.2 million as of December 31, 2008 and December 31, 2007, respectively. As of December 31, 2008, the ABS portfolio consists principally of positions in 14 different pooled trust preferred securities and one Student Loan Marketing Association (“SLMA”) security. The following table summarizes changes to amortized cost for the portfolio of ABS in 2008 and the fair value of the portfolio at December 31, 2008 (in thousands).
                         
  Trust Preferred  SLMA  Total ABS 
  Adjusted      Adjusted      Adjusted    
  Amortized  Fair  Amortized  Fair  Amortized  Fair 
  Cost  Value  Cost  Value  Cost  Value 
                         
Balance December 31, 2007 $33,307  $32,390  $808  $808  $34,115  $33,198 
Net change to cost basis before OTTI  (106)      (662)      (768)    
OTTI non-cash charge  (29,429)             (29,429)    
                      
Balance December 31, 2008 $3,772  $3,772  $146  $146  $3,918  $3,918 
                   
All of the pooled trust preferred securities are collateralized by preferred debt issued primarily by financial institutions and, to a lesser extent, insurance companies. The financial services industry is experiencing conditions that have, in some individual companies, resulted in lowered earnings and strained capital positions. Each of the pooled trust preferred securities owned by the Company has some individual companies backing that specific security that have either defaulted or are deferring dividend payments. The class level that the Company owns in each security has at least one subordinate class below the class owned by the Company and as a result, to date, the Company has received scheduled dividend payments on all but one of the securities in accordance with the terms of the security. These securities fall under a class of securities referred to as a collateralized debt obligation (“CDO”). The market for CDOs has very low demand due principally to imbalances in liquidity that exist in the marketplace. The resulting impact from this inactive market, as well as the increased credit risk profile of the banking sector in general and certain of the companies collateralizing the securities has created adverse changes to expected cash flows and to the fair value of the securities. For the year ended December 31, 2008, the Company recorded $29.4 million in OTTI charges of ABS. Further deterioration in credit quality of the companies collateralizing the securities and/or a continuation of the current imbalances in liquidity that exist in the marketplace may further effect the fair value of these securities and increase the potential that certain unrealized losses may be designated as other than temporary in future periods and that the Company may incur additional write downs.
State and Municipal Obligations
At December 31, 2008, the portfolio of state and municipal obligations totaled $190.2 million, of which $131.7 million was classified as available for sale. As of that date, $58.5 million was classified as held to maturity, with a fair value of $59.1 million. As of December 31, 2007 the portfolio of state and municipal obligations totaled $232.1 million, of which $172.6 million was classified as available for sale. As of that date, $59.5 million was classified as held to maturity, with a fair value of $59.9 million.

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Equity Securities
As of December 31, 2008, the Company had $1.2 million in equity securities including $528 thousand of auction rate preferred equity securities collateralized by FNMA and FHLMC preferred stock and $624 thousand of common equity securities. As of December 31, 2007, the Company had $34.6 million in equity securities, including $33.8 million of auction rate preferred equity securities collateralized by FNMA and FHLMC preferred stock and $780 thousand of common equity securities.
The auction rate preferred equity securities consist of positions collateralized by FNMA and FHLMC preferred stock. The auction rate preferred equity securities were structured to be tendered at par, at the option of the investor, at auctions occurring about every 90 days. The auctions were unsuccessful beginning in April 2008, primarily as a result of the financial and capital market crisis. The FNMA and FHLMC preferred stock fair values deteriorated significantly during the third quarter of 2008. On July 30, 2008, the Housing and Economic Recovery Act of 2008 (the “Act”) was signed into law. The Act established the Federal Housing Finance Agency (“FHFA”) as the federal regulator of FNMA and FHLMC, and provided the FHFA the power to oversee the operations, activities, corporate governance, safety and soundness, and missions of FNMA and FHLMC. On September 7, 2008, the FHFA announced that FNMA and FHLMC were being placed into conservatorship, which significantly reduced the value of existing equity positions in FNMA and FHLMC. As a result, impairment write-downs on the auction rate preferred equity securities totaling $32.3 million were recorded during the year ended December 31, 2008. The EESA changed the tax treatment of gains or losses from the sale or exchange of FNMA or FHLMC preferred stock by stating that a gain or loss on Fannie Mae or Freddie Mac preferred stock will be treated as ordinary gain or loss instead of capital gain or loss, as was previously the case. As a result, the Company was able to recognize the tax effects of the OTTI charge on its investment in auction rate preferred equity securities as an ordinary loss in the consolidated financial statements for the year ended December 31, 2008.
The dividend income related to both the common and auction rate preferred equity securities qualifies for the Federal income tax dividend received deduction. For the year ended December 31, 2008, dividend income of $1.4 million was earned on these securities. FHFA has suspended the payment of preferred dividends for FNMA and FHLMC and the Company will receive no future dividend income while the suspension is in place. The Company does not expect to receive further dividends on FNMA or FHLMC preferred securities.
Lending Activities
Loan Portfolio Composition
Loans outstanding,The composition of the Company’s loan portfolio, excluding loans held for sale and including net unearned income and net deferred fees and costs, areis summarized as follows at December 31:(in thousands):
                                                            
(Dollars in thousands) 2006 2005 2004 2003 2002 
 Loan Portfolio Composition 
 At December 31, 
 2008 2007 2006 2005 2004 
 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent 
Commercial $105,806 $116,444 $203,178 $248,313 $262,630  $158,543  14.1% $136,780  14.2% $105,806  11.4% $116,444  11.7% $203,178  16.2%
Commercial real estate 243,966 264,727 343,532 369,712 332,134  262,234 23.4 245,797 25.5 243,966 26.4 264,727 26.7 343,532 27.4 
Agricultural 56,808 75,018 195,185 235,199 233,769  44,706 4.0 47,367 4.9 56,808 6.1 75,018 7.5 195,185 15.6 
Residential real estate 268,446 274,487 259,055 246,621 244,927  177,683 15.8 166,863 17.3 163,243 17.6 168,498 17.0 178,282 14.2 
Consumer and home equity 251,456 261,645 251,455 240,591 241,461 
           
Consumer indirect 255,054 22.8 134,977 14.0 106,443 11.5 85,237 8.6 67,993 5.5 
Consumer direct and home equity 222,859 19.9 232,389 24.1 250,216 27.0 282,397 28.5 264,235 21.1 
                      
Total loans 926,482 992,321 1,252,405 1,340,436 1,314,921  1,121,079  100.0% 964,173  100.0% 926,482  100.0% 992,321  100.0% 1,252,405  100.0%
 
Allowance for loan losses  (17,048)  (20,231)  (39,186)  (29,064)  (21,660)  (18,749)  (15,521)  (17,048)  (20,231)  (39,186) 
           
            
Total loans, net $909,434 $972,090 $1,213,219 $1,311,372 $1,293,261  $1,102,330 $948,652 $909,434 $972,090 $1,213,219 
                      
Total loans declined 6.6%increased 16%, or $65.8$156.9 million, to $926.5 million at$1.121 billion as of December 31, 20062008 from $992.3$964.2 million atas of December 31, 2005. The decline in loans was2007, primarily attributed to loan payments outpacing new loan originationsthe expansion of the indirect lending program and commercial business development efforts, offset by a reduction in agricultural loans and the consequences of the 2005 loan sale. The Company’s strategy is to rebuild a balanced quality loan portfolio,consumer direct and loan originations slowed due to more stringent underwriting requirements, firm pricing disciplines and a highly competitive marketplace for quality loans.home equity category.
Commercial loans decreased $10.6 million or 9.1%, while commercial real estate loans decreased by $20.8 million or 7.8%. At December 31, 2006, commercial loans totaled $105.8 million, representing 11.4% of total loans and commercial real estate loans totaled $244.0increased $38.2 million representing 26.4% of total loans. At December 31, 2006, agricultural loans, which include agricultural real estate loans, totaled $56.8to $420.8 million or 6.1% of the total loan portfolio, down $18.2 million from 2005. Collectively, commercial-related loans comprised $49.6 million or 75.3% of the decline in total loans.
Asas of December 31, 2006, residential real estate loans totaled $268.42008 from $382.6 million a $6.1 million or 2.2% decrease from $274.5 million atas of December 31, 2005. 2007, a result of the Company’s focused commercial business development programs. Agricultural loans decreased $2.7 million, to $44.7 million as of December 31, 2008 from $47.4 million as of December 31, 2007. Competition and adherence to strict credit standards has led to payments outpacing new loan originations in the agricultural portfolio.
Residential real estate loans represented 29.0%increased $10.8 million to $177.7 million as of December 31, 2008 in comparison to $166.9 million as of December 31, 2007. The increase resulted from management’s decision to add certain newly originated or refinanced residential mortgages, namely 15 year FHLMC conforming mortgages, to its portfolio rather than selling to the total loan portfolio at the end of 2006 compared to 27.7% at the end of 2005.secondary market. The Company’sCompany does not engage in sub-prime or other high-risk residential mortgage volume slowedlending as a result of the rising interest rate environment and the increasingly competitive marketplace for mortgage loans.line-of-business.

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The Company also offers a broad rangeconsumer indirect portfolio increased 89% to $255.1 million as of consumer loan products. Consumer and home equity lines of credit totaled $251.5 and $261.6 million at December 31, 2006 and 2005, respectively. Consumer and home equity lines2008 from $135.0 million as of credit represented 27.1% of the total loan portfolio at year-end 2006. The mix in the Company’s consumer portfolio changed during 2006 as the Company focused on expanding its indirect automobile lending program. At December 31, 2006, the Company’s indirect consumer loans were $106.4 million, an increase of $21.2 million or 24.9% from $85.2 million at December 31, 2005. While the2007. The Company increased its indirect consumer loan portfolio declinesby managing existing and developing new relationships with over 250 franchised auto dealers in consumer directWestern and home equity lines of credit resulted from an increasingly competitive marketplace and more than offset the increase in indirect consumer loans.
Loans Held for Sale and Commercial-Related Loan Sale Results
Central New York State. During the year ended December 31, 2005,2008 the Company transferred $169.0originated $180.9 million in commercial-relatedindirect auto loans to held for sale, at an estimated fair value less costs to sellwith a mix of $132.3 million. As a result, $36.7approximately 38% new auto and 62% used auto. This compares with $76.6 million in commercial-related charge-offs were recorded. Subsequentindirect loan auto originations with a mix of approximately 41% new auto and 59% used auto for the same period in 2007.
The consumer direct and home equity portfolio decreased $9.5 million to the transfer, the Company decided not to proceed with the sale of $613,000 of these commercial-related loans held for sale and returned the loans to portfolio at the lower of cost or fair value. In the second half of 2005, the Company realized a net gain of $9.4 million on the ultimate sale or settlement of commercial-related loans held for sale.

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Loans held for sale (not included in the previous loan portfolio composition table) totaled $992,000 at December 31, 2006, all of which were residential real estate loans. Loans held for sale (not included in the previous loan portfolio composition table) totaled $1.3$222.9 million as of December 31, 2005, comprised2008 in comparison to $232.4 million as of nonaccruing commercial-relatedDecember 31, 2007. The decline in direct consumer and home equity products is reflective of an overall slowing in the economy, as well as the Company’s policy to maintain a firm pricing and underwriting discipline on these products, which has led to slower loan originations in this category.
Parts of the country have experienced a significant decline in real estate values that has led, in some cases, to the debt on the real estate exceeding the value of the real estate. Generally, the Western and Central New York State markets the Company serves have not experienced, to this point, such conditions. Should deterioration in real estate values in the markets we serve occur, the value and liquidity of real estate securing the Company’s loans (includingcould become impaired. While the Company is not engaged in the business of sub-prime lending, a decline in the value of residential or commercial real estate and agricultural loans) of $577,000 and residential real estate loans of $676,000.
The Company also sells certain qualifying newly originated and refinanced residential real estate mortgagescould have a material adverse effect on the secondary market. The sold and serviced residential real estatevalue of property pledged as collateral for our loans. Adverse changes in the economy may have a negative effect on the ability of borrowers to make timely loan portfolio decreased to $355.2 million at December 31, 2006 from $377.6 million at December 31, 2005. The Company’s residential mortgage volume slowed aspayments, which could have a result of the rising interest rate environment and the increasingly competitive marketplace for mortgage loans.
Nonaccruing Loans and Nonperforming Assetsnegative impact on earnings.
The following table sets forth information regarding nonaccruing loans and other nonperformingnon-performing assets at December 31:(in thousands):
                     
(Dollars in thousands) 2006  2005  2004  2003  2002 
 
Nonaccruing loans (1)                    
Commercial $2,205  $4,389  $20,576  $12,983  $12,760 
Commercial real estate  4,661   6,985   15,954   11,745   8,407 
Agricultural  4,836   2,786   13,165   18,870   8,739 
Residential real estate  3,602   3,096   1,733   2,496   1,065 
Consumer and home equity  533   505   518   578   915 
                
                     
Total nonaccruing loans  15,837   17,761   51,946   46,672   31,886 
                     
Restructured loans           3,069   4,129 
                     
Accruing loans 90 days or more delinquent  3   276   2,018   1,709   1,091 
                
                     
Total nonperforming loans  15,840   18,037   53,964   51,450   37,106 
                     
Other real estate owned (“ORE”)  1,203   1,099   1,196   653   1,251 
                
                     
Total nonperforming loans and other real estate owned  17,043   19,136   55,160   52,103   38,357 
                     
Nonaccruing commercial-related loans held for sale     577          
                
                     
Total nonperforming assets $17,043  $19,713  $55,160  $52,103  $38,357 
                
                     
Total nonperforming loans to total loans (2)  1.71%  1.82%  4.31%  3.84%  2.82%
                     
Total nonperforming loans and ORE to total loans and ORE (2)  1.84%  1.93%  4.40%  3.89%  2.91%
                     
Total nonperforming assets to total assets  0.89%  0.97%  2.56%  2.40%  1.82%
(1)Although loans are generally placed on nonaccruing status when they become 90 days or more past due they may be placed on nonaccruing status earlier if they have been identified by the Company as presenting uncertainty with respect to the collectibility of interest or principal. Loans past due 90 days or more may remain on accruing status if they are both well secured and in the process of collection.
(2)Ratios exclude nonaccruing commercial-related loans held for sale from nonperforming loans and exclude loans held for sale from total loans.
Nonperforming loans (excluding nonaccruing commercial-related loans held for sale) decreased to $15.8 million at December 31, 2006 from $18.0 million at December 31, 2005. Nonaccruing commercial-related loans

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decreased in 2006 and totaled $11.7 million and $14.2 million at December 31, 2006 and 2005. The Company also experienced declines in accruing loans 90 days or more delinquent and nonaccruing commercial-related loans held for sale during 2006. Offsetting those declines was a $104,000 increase in ORE to $1.2 million at December 31, 2006 compared to $1.1 million at December 31, 2005.
The following table details nonaccruing commercial-related loan activity for the year ended December 31:
         
(Dollars in thousands) 2006  2005 
Nonaccruing commercial-related loans at beginning of year $14,160  $49,695 
Additions  12,002   27,839 
Payments  (8,783)  (11,708)
Charge-offs  (2,075)  (46,920)
Returned to accruing status  (2,300)  (3,745)
Transferred to other real estate or repossessed assets  (1,302)  (1,001)
       
         
Nonaccruing commercial-related loans at end of year $11,702  $14,160 
       
During 2006, the Company received $8.8 million in payments on nonaccruing commercial-related loans and $2.3 million of nonaccruing commercial-related loans were returned to accruing status. In addition, the Company charged-off $2.1 million in nonaccruing commercial-related loans during 2006.
                     
  Delinquent and Non-performing Assets 
  At December 31, 
  2008  2007  2006  2005  2004 
Non-accruing loans:                    
Commercial $510  $827  $2,205  $4,389  $20,576 
Commercial real estate  2,360   2,825   4,661   6,985   15,954 
Agricultural  310   481   4,836   2,786   13,165 
Residential real estate  3,365   2,987   3,127   2,615   1,473 
Consumer indirect  445   278   166   63   74 
Consumer direct and home equity  1,199   677   842   923   704 
                
Total non-accruing loans  8,189   8,075   15,837   17,761   51,946 
Restructured loans               
Accruing loans contractually past due over 90 days  7   2   3   276   2,018 
                
Total non-performing loans  8,196   8,077   15,840   18,037   53,964 
Foreclosed assets  1,007   1,421   1,203   1,099   1,196 
Non-accruing commercial-related loans held for sale           577    
Non-performing investment securities  49             
                
Total non-performing assets $9,252  $9,498  $17,043  $19,713  $55,160 
                
Non-performing loans to total loans  0.73%  0.84%  1.71%  1.82%  4.31%
Non-performing assets to total assets  0.48%  0.51%  0.89%  0.97%  2.56%
Approximately $8.6$3.2 million, or 54.2%39.3%, of the $15.8$8.2 million in nonaccruing loans atas of December 31, 2006 are2008 were current with respect to payment of principal and interest. Although these loans are current, the Companyinterest, but were classified the loans as nonaccruing because reasonable doubt existsexisted with respect to the future collectibility of principal and interest in accordance with the original contractual terms. During the year endedFor nonaccruing loans outstanding as of December 31, 20062008, the amount of interest income forgone on nonaccruing loans totaled $1.5 million.$546 thousand for the year ended December 31, 2008.
Potential problem loans are loans that are currently performing, but information known about possible credit problems of the borrowers causes management to have concern as to the ability of such borrowers to comply with the present loan payment terms and may result in disclosure of such loans as nonperforming at some time in the future. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and/or personal or government guarantees. Management considers loans classified as substandard, which continue to accrue interest, to be potential problem loans. The Company identified $16.2$20.5 million and $23.2$16.6 million in loans that continued to accrue interest which were classified as substandard as of December 31, 20062008 and 2005,2007, respectively.
The following table summarizes loan delinquencies (excluding past due nonaccruing loans) as of December 31:
                 
  2006  2005 
      Accruing Loans      Accruing Loans 
  60-89  90 Days  60-89  90 Days 
(Dollars in thousands) Days  or More  Days  or More 
 
Commercial $7  $  $1,205  $266 
Commercial real estate  30      560   9 
Agriculture        25    
Residential real estate  29      412    
Consumer and home equity  119   3   201   1 
             
                 
  $185  $3  $2,403  $276 
             

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Analysis of AllowanceLoans Held for Loan LossesSale
The allowanceLoans held for loan losses represents the estimated amount of probable credit losses inherent in the Company’s loan portfolio. The Company performs periodic, systematic reviews of the Bank’s loan portfolio to estimate probable losses in the respective loan portfolios. In addition, the Company regularly evaluates prevailing economic and business conditions, industry concentrations, changes in the size and characteristics of the portfolio and other pertinent factors. The process used by the Company to determine the overall allowance for loan losses is based on this analysis. Based on this analysis the Company believes the allowance for loan losses is adequate at December 31, 2006.
Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon management’s evaluation of the amounts required to meet estimated charge-offssale (not included in the loan portfolio after weighing various factors. composition table) totaled $1.0 million and $906 thousand as of December 31, 2008 and 2007, respectively, all of which were residential real estate loans.
The adequacyCompany sells certain qualifying newly originated and refinanced residential real estate mortgages on the secondary market. The sold and serviced residential real estate loan portfolio decreased to $315.7 million as of December 31, 2008 from $338.1 million as of December 31, 2007. The decrease in the allowance for loan losses is subjectsold and serviced portfolio partially resulted from management’s decision to ongoing management review. While management evaluates currently available information in establishing the allowance for loan losses, future adjustmentsadd certain newly originated or refinanced residential mortgages, namely 15 year FHLMC conforming mortgages, to its portfolio rather than selling to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution’s allowancesecondary market, leading to payments and run-off outpacing new sold and serviced residential loan volumes.
Allowance for loan losses and carrying amounts of other real estate owned. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.Loan Losses
The following table sets forth an analysis ofsummarizes the activity in the allowance for loan losses for the years ended December 31:(in thousands).
                                        
(Dollars in thousands) 2006 2005 2004 2003 2002 
 Loan Loss Analysis 
Allowance for loan losses at beginning of year $20,231 $39,186 $29,064 $21,660 $19,074 
  Year Ended December 31, 
Addition resulting from acquisitions     174 
  2008 2007 2006 2005 2004 
Charge-offs (1): 
Allowance for loan losses, beginning of year $15,521 $17,048 $20,231 $39,186 $29,064 
Charge-offs(1):
 
Commercial 1,195 12,980 4,486 8,891 1,771  675 562 1,195 12,980 4,486 
Commercial real estate 501 15,397 1,779 2,953 944  1,190 439 501 15,397 1,779 
Agricultural 379 18,543 2,519 1,876 106  47 56 379 18,543 2,519 
Residential real estate 335 104 318 215 98  320 319 278 56 227 
Consumer and home equity 1,789 2,262 1,695 2,107 1,499 
Consumer indirect 2,011 988 532 775 759 
Consumer direct and home equity 1,216 1,531 1,314 1,535 1,027 
                      
Total charge-offs 4,199 49,286 10,797 16,042 4,418  5,459 3,895 4,199 49,286 10,797 
 
Recoveries:  
Commercial 1,417 864 598 525 210  664 972 1,417 864 598 
Commercial real estate 132 280 103 35 69  280 216 132 280 103 
Agricultural 389 57 39 3 36  55 168 389 57 39 
Residential real estate 73 11 43 11 67  26 50 71 5 43 
Consumer and home equity 847 587 460 346 329 
Consumer indirect 548 235 224 261 212 
Consumer direct and home equity 563 611 625 332 248 
                      
Total recoveries 2,858 1,799 1,243 920 711  2,136 2,252 2,858 1,799 1,243 
Net charge-offs 3,323 1,643 1,341 47,487 9,554 
Provision (credit) for loan losses 6,551 116  (1,842) 28,532 19,676 
            
Net charge-offs 1,341 47,487 9,554 15,122 3,707 
 
(Credit) provision for loan losses  (1,842) 28,532 19,676 22,526 6,119 
Allowance for loan losses, end of year $18,749 $15,521 $17,048 $20,231 $39,186 
                      
  
Allowance for loan losses at end of year $17,048 $20,231 $39,186 $29,064 $21,660 
           
 
Ratio of net charge-offs to average loans outstanding during the year  0.14%  4.27%  0.74%  1.11%  0.30%
 
Ratio of allowance for loan losses to total loans (2)  1.84%  2.04%  3.13%  2.17%  1.65%
 
Ratio of allowance for loans losses to nonperforming loans (2)  108%  112%  73%  56%  58%
Net charge-offs to average loans  0.32%  0.18%  0.14%  4.27%  0.74%
Allowance to end of period loans  1.67%  1.61%  1.84%  2.04%  3.13%
Allowance to end of period non-performing loans  229%  192%  108%  112%  73%
 
(1) Included
(1)During 2005 the Company transferred $169.0 million in charge-offscommercial-related loans to held for the year ended December 31, 2005 aresale, at an estimated fair value less costs to sell of $132.3 million, resulting in $36.7 million in write-downscommercial-related charge-offs. In the second half of 2005, the Company realized a net gain of $9.4 million on the ultimate sale or settlement of commercial-related loans.
(2)Ratios exclude nonaccruing loans held for sale from nonperforming loans and loans held for sale from total loans.sale.

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At December 31, 2006, the Company’s allowance for loan losses totaled $17.0 million, a decrease of $3.2 million from the previous year-end. The allowance for loan losses represents the estimated probable losses inherent in the loan portfolio based on the Company’s comprehensive assessment. This assessment resulted in a credit for loan losses of $1.8 million for 2006. The allowance for loan losses as a percentage of total loans was 1.84% and 2.04% at December 31, 2006 and 2005, respectively. The ratio of allowance for loan losses to nonperforming loans decreased to 108% at December 31, 2006 versus 112% at December 31, 2005.
Allocation of Allowance for Loan Losses
The following table sets forth the allocation of the allowance for loan losses by loan category atas of the dates indicated. The allocation is made for analytical purposes and is not necessarily indicative of the categories in which actual losses may occur. The total allowance is available to absorb losses from any segment of the loan portfolio.portfolio (in thousands).
                                                                                
 At December 31: Allowance for Loan Losses 
 2006 2005 2004 2003 2002 At December 31, 
 Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent 2008 2007 2006 2005 2004 
 of of Loans of of Loans of of Loans of of Loans of of Loans Percentage Percentage Percentage Percentage Percentage 
 Allowance in Each Allowance in Each Allowance in Each Allowance in Each Allowance in Each Loan of loans by Loan of loans by Loan of loans by Loan of loans by Loan of loans by 
 for Category for Category for Category for Category for Category Loss category to Loss category to Loss category to Loss category to Loss category to 
 Loan to Total Loan to Total Loan to Total Loan to Total Loan to Total Allowance total loans Allowance total loans Allowance total loans Allowance total loans Allowance total loans 
(Dollars in thousands) Losses Loans Losses Loans Losses Loans Losses Loans Losses Loans
  
Commercial $2,443  11.4% $4,098  11.7% $11,420  16.2% $7,739  18.5% $5,321  20.0% $2,871  14.1% $1,878  14.2% $2,443  11.4% $4,098  11.7% $11,420  16.2%
Commercial real estate 4,458 26.4 6,564 26.7 9,297 27.4 5,354 27.6 4,725 25.3  4,052 23.4 3,751 25.5 4,458 26.4 6,564 26.7 9,297 27.4 
Agricultural 1,887 6.1 2,187 7.5 8,197 15.6 6,078 17.6 3,711 17.7  1,012 4.0 1,516 4.9 1,887 6.1 2,187 7.5 8,197 15.6 
Residential real estate 2,818 29.0 2,019 27.7 1,468 20.7 1,447 18.4 1,414 18.6  2,516 15.8 1,763 17.3 1,748 17.6 1,252 17.0 910 14.2 
Consumer and home equity 3,512 27.1 2,769 26.4 2,122 20.1 2,161 17.9 2,007 18.4 
Consumer indirect 5,152 22.8 2,284 14.0 1,749 11.5 1,032 8.6 666 5.5 
Consumer direct and home equity 3,146 19.9 2,667 24.1 2,833 27.0 2,504 28.5 2,014 21.1 
Unallocated 1,930  2,594  6,682  6,285  4,482     1,662  1,930  2,594  6,682  
  
                      
Total $17,048  100.0% $20,231  100.0% $39,186  100.0% $29,064  100.0% $21,660  100.0% $18,749  100.0% $15,521  100.0% $17,048  100.0% $20,231  100.0% $39,186  100.0%
                       
During the first quarter of 2008, management revised estimation techniques related to allocation of the allowance to specific loan segments. The Company’s methodology inresult was the estimationelimination of the unallocated portion of the allowance for loan losses includesand allocation of the following broad areas:entire balance to specific loan segments.
1.Impaired commercial, commercial real estate, agricultural and agricultural real estate loans, in excess of $100,000 are reviewed individually and assigned a specific loss allowance, if considered necessary, in accordance with SFAS No. 114, “Accounting by Creditors for Impairment of a Loan — an amendment of FASB Statements No. 5 and 15”.
2.The remaining portfolios of commercial, commercial real estate, agricultural and agricultural real estate loans are segmented into the following loan classification categories: uncriticized or pass, special mention, and substandard. The substandard category of loans greater than $100,000 is then further divided into two groupings based on an assessment of the individual loan’s collateralization levels (i.e. under collateralized or adequately collateralized). Loans under collateralized by less than 5% of the outstanding loan balance are treated the same as adequately collateralized loans.
3.If applicable, substandard loans where the collateral deficiency is greater than 5% are split into two categories based on outstanding loan balances (i.e.$3.0 million or more and less than $3.0 million). The inherent risk of loss on the loans in each of these groupings is estimated based upon historical net loan charge-off considerations, review of the amount of under collateralization of the loans in the respective groupings, as well as other qualitative factors.
4.Uncriticized loans, special mention loans, adequately collateralized substandard loans and all substandard loans under $100,000 are assigned allowance allocations based on historical net loan charge-off experience for each of the respective loan categories, supplemented with additional reserve amounts, if considered necessary, based upon qualitative factors. These qualitative factors include the levels and trends in delinquencies, nonaccruing loans, and risk ratings; trends in volume and terms of loans; effects of changes in lending policy; experience, ability, and depth of management; national and local economic conditions, and concentrations of credit, among others.

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5.The consumer loan portfolio is segmented into six types of loans: residential real estate, home equity lines of credit, consumer direct, consumer indirect, overdrafts and personal lines of credit. Each of those categories is subdivided into categories based on delinquency status, either 90 days and over past due or under 90 days. Allowance allocations on these types of loans are based on the average loss experience over the last three years for each subdivision of delinquency status supplemented with qualitative factors containing the same elements as described above.
6.A further component of the allowance is the unallocated portion which takes into consideration the inherent risk of loss in the portfolio not identified in the other three categories and includes such elements as risks associated with variances in the rate of historical loss experiences, information risks associated with the dependence upon timely and accurate risk ratings on loans, and risks associated with the dependence on collateral valuation techniques. This category has been reduced from the previous year due to a reduction in these risks primarily resulting from the 2005 problem loan sale discussed previously as well as the positive credit quality trends in 2006.
While management evaluates currently available information in establishingManagement believes that the allowance for loan losses future adjustmentsat December 31, 2008 is adequate to cover probable losses in the loan portfolio at that date. Factors beyond the Company’s control, however, such as general national and local economic conditions, can adversely impact the adequacy of the allowance mayfor loan losses. As a result, no assurance can be necessary ifgiven that adverse economic conditions differ substantially fromor other circumstances will not result in increased losses in the assumptions used in makingportfolio or that the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution’s allowance for loan losses and carrying amounts of other real estate owned. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
Loan Maturity and Repricing Schedule
The following table sets forth certain information regarding the contractual maturity or repricing of loans in the portfolio as of December 31, 2006. Demand loans having no stated schedule of repayment or maturity and overdrafts are reported as due in one year or less. Adjustable and floating-rate loans are included in the period in which interest rates are next scheduled to adjust rather than the period in which they contractually mature, and fixed-rate loans are included in the period in which the final contractual repayment is due.
                 
      One       
  Within  Through  After    
  One  Five  Five    
(Dollars in thousands) Year  Years  Years  Total 
 
Commercial $45,030  $34,131  $26,645  $105,806 
Commercial real estate  3,976   23,382   216,608   243,966 
Agricultural  7,472   17,441   31,895   56,808 
Residential real estate  4,502   16,417   247,527   268,446 
Consumer and home equity  7,673   107,542   136,241   251,456 
             
                 
Total loans $68,653  $198,913  $658,916  $926,482 
             
 
Loans maturing after one year:                
With a predetermined interest rate     $164,586  $285,013     
With a floating or adjustable rate      34,327   373,903     
               
                 
      $198,913  $658,916     
               

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Investing Activities
Investment Portfolio Composition
The Company’s total investment security portfolio decreased $57.9 million to $775.5 million as of December 31, 2006 compared to $833.4 million as of December 31, 2005. Further detail regarding the Company’s investment portfolio follows.
U.S. Government-Sponsored Enterprise (“GSE”) Securities.At December 31, 2006, the available for sale GSE securities portfolio totaled $231.8 million. The portfolio consisted of approximately $129.7 million, or 56%, of callable securities at December 31, 2006. At December 31, 2006 this category of securities also included $99.0 million of structured notes, the majority of which were step callable agency debt issues. The step callable bonds step-up in rate at specified intervals and are periodically callable by the issuer. At December 31, 2006, the current average coupon of the structured notes was 4.13% and adjust on average to 6.56% within five years. However, under current market conditions these notes are likely towill be called. At December 31, 2005, the available for sale GSE securities portfolio totaled $251.9 million.
State and Municipal Obligations. At December 31, 2006, the portfolio of state and municipal obligations totaled $238.7 million, of which $198.3 million was classified as available for sale. At that date, $40.4 million was classified as held to maturity, with a fair value of $40.4 million. At December 31, 2005, the portfolio of state and municipal obligations totaled $262.9 million, of which $220.3 million was classified as available for sale. At that date, $42.6 million was classified as held to maturity, with a fair value of $42.9 million.
Mortgage-Backed Pass-through Securities (“MBS”), Collateralized Mortgage Obligations (“CMO”) and Other Asset-Backed Securities (“ABS”). MBS, CMO and ABS securities, all of which were classified as available for sale, totaled $300.0 million and $317.6 million at December 31, 2006 and 2005, respectively. The portfolio was comprised of $189.4 million of MBS, $107.4 million of CMO and $3.2 million of other ABS securities at December 31, 2006. The MBSs were by U.S. government agencies or GSEs (GNMA, FNMA or FHLMC). Approximately 92% of the MBSs were in fixed rate securities that were most frequently formed with mortgages having an original balloon payment of five or seven years. The adjustable rate agency mortgage-backed securities portfolio is principally indexed to the one-year Treasury bill. The CMO portfolio consisted primarily of fixed and variable rate government issues and fixed rate privately issued AAA rated securities. The ABS securities are primarily Student Loan Marketing Association (“SLMA”) floaters, which are variable rate securities backed by student loans. At December 31, 2005, the portfolio consisted of $234.3 million of MBSs, $77.4 million of CMOs and $5.9 million of other ABS securities.
Corporate Bonds and Other. At December 31, 2006, the Company held $3.9 million in corporate bonds and other securities. At December 31, 2005, the Company held no corporate bonds and other securities. The Company’s investment policy limits investments in corporate bonds to no more than 10% of total investments and to bonds rated as Baa or better by Moody’s Investors Service, Inc. or BBB or better by Standard & Poor’s Ratings Services at the time of purchase.
Equity Securities. At December 31, 2006 and 2005, available for sale equity securities totaled $1.1 million and $1.0 million, respectively.
Security Yields and Maturities Schedule
The following table sets forth certain information regarding the carrying values, weighted average yields and contractual maturities of the Company’s debt securities portfolio as of December 31, 2006. Actual maturities may differ from the contractual maturities presented, because borrowers may have the right to call or prepay certain investments. No tax-equivalent adjustments were made to the weighted average yields.

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          More than One More than Five    
  One Year or Less Year to Five Years Years to Ten Years After Ten Years Total
      Weighted     Weighted     Weighted     Weighted     Weighted
  Amortized Average Amortized Average Amortized Average Amortized Average Amortized Average
(Dollars in thousands) Cost Yield Cost Yield Cost Yield Cost Yield Cost Yield
 
Available for sale:                                        
GSE $55,198   3.67% $78,611   3.94% $31,886   5.71% $70,029   6.04% $235,724   4.74%
MBS, CMO and ABS  923   3.74   128,519   4.29   65,531   4.32   113,168   4.96   308,141   4.54 
State and municipal obligations  41,036   3.39   135,004   3.44   20,146   3.94   2,242   3.52   198,428   3.48 
Corporate and other                    3,913   4.31   3,913    
   
                                         
Total available for sale debt securities $97,157   3.55% $342,134   3.87% $117,563   4.63% $189,352   5.33% $746,206   4.32%
   
                                         
Held to maturity:                                        
State and municipal obligations $30,440   3.92% $6,832   4.29% $2,198   4.92% $918   5.27% $40,388   4.07%
   
                                         
Total held to maturity debt securities $30,440   3.92% $6,832   4.29% $2,198   4.92% $918   5.27% $40,388   4.07%
   
Other-Than-Temporary Impairment
Management evaluates securities for other-than-temporary impairment on a quarterly basis, or as economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for recovery in fair value. The net unrealized losses on securities available for sale amounted to $11.1 million and $10.3 million as of December 31, 2006 and 2005, respectively. The unrealized losses present do not reflect deterioration in the credit worthiness of the issuing securities and resulted primarily from fluctuations in market interest rates. The Company intends to hold these securities until their fair value recovers to their amortized cost, therefore management has determined that the securities that were in an unrealized loss position at December 31, 2006 and 2005 represent only temporary declines in fair value.meet actual loan losses.
Funding Activities
Deposits
The Bankfollowing table summarizes the composition of the Company’s deposits (dollars in thousands).
                         
  At December 31, 
  2008  2007  2006 
  Amount  Percent  Amount  Percent  Amount  Percent 
 
Noninterest-bearing demand $292,586   17.9% $286,362   18.2% $273,783   16.9%
Interest-bearing demand  344,616   21.1   335,314   21.3   352,661   21.8 
Savings and money market  348,594   21.3   346,639   22.0   321,563   19.9 
Certificates of deposit < $100,000  482,863   29.6   453,140   28.7   474,321   29.3 
Certificates of deposit of $100,000 or more  164,604   10.1   154,516   9.8   195,367   12.1 
                   
  $1,633,263   100.0% $1,575,971   100.0% $1,617,695   100.0%
                   
The Company offers a broad arrayvariety of deposit products including noninterest-bearing demand, interest-bearing demand, savingsdesigned to attract and money market accountsretain customers, with the primary focus on building and certificates of deposit.expanding long-term relationships. At December 31, 2006,2008, total deposits were $1.618$1.633 billion, in comparison to $1.717 billion at December 31, 2005. The decline was primarily due to lower nonpublic deposits attributed torepresenting an increase of $57.3 million for the timing of rate campaigns, the loss of deposits associated with the effects of the 2005 commercial-related loan sale, and fewer certificates of deposits, including brokered certificatesyear. Certificates of deposit as the Company actively managed to lower the level of these higher cost deposits. Public deposits increased slightly to $352.6 million at December 31, 2006 from $351.3 million at December 31, 2005.
The Company considers all deposits to be “core” except certificates of deposit over $100,000. Core deposits amounted to $1.422 billion or 87.9%were 39.7% and 38.5% of total deposits at December 31, 20062008 and 2007, respectively.
Nonpublic deposits represent the largest component of the Company’s funding sources and totaled $1.280 billion and $1.251 billion as of December 31, 2008 and 2007, respectively. The Company has managed this segment of funding through a strategy of competitive pricing that minimizes the number of customer relationships that have only a single service high cost deposit account. Nonpublic deposit levels were positively impacted by the expansion of the Company’s branch network in the metro-Rochester area, where de novo branches were added in Henrietta and Greece during the third and fourth quarters of 2008, respectively.

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As an additional source of funding, the Company offers a variety of public deposit products to the many towns, villages, counties and school districts within our market. Public deposits generally range from 20% to 25% of the Company’s total deposits. There is a high degree of seasonality in this component of funding, as the level of deposits varies with the seasonal cash flows for these public customers. The Company maintains the necessary levels of short-term liquid assets to accommodate the seasonality associated with public deposits. As of December 31, 2008, total public deposits were $352.8 million compared to $1.517 billion or 88.4% of total deposits at December 31, 2005. The core deposit base consisted almost exclusively of in-market accounts. Core deposits are supplemented with certificates of deposit over $100,000, which amounted to $195.4 million and $199.8$318.1 million as of December 31, 2006 and 2005, respectively.2007. In general, the number of public relationships remained stable in comparison to prior year. The Company also utilizedcontinued to place less reliance on brokered certificates of deposit as a funding source. Brokered certificates$6.8 million in brokered deposits outstanding at December 31, 2007 were repaid at their scheduled maturity dates in the second quarter of deposit included in certificates2008.
Short-term Borrowings
At December 31, 2008, short-term borrowings consisted of deposit over $100,000 totaled $16.7overnight repurchase agreements of $23.5 million. At December 31, 2007, short-term borrowings consisted of overnight borrowings with the Federal Home Loan Bank (“FHLB”) of $2.8 million and $31.5$22.8 million of overnight repurchase agreements.
Short-term borrowings from the FHLB are used to satisfy funding requirements resulting from daily fluctuations in deposit, loan and investment activities. FHLB borrowings are collateralized by certain investment securities, FHLB stock owned by the Company and certain qualifying loans.
The following table summarizes information relating to the Company’s short-term borrowings (dollars in thousands).
             
  At or for the Year Ended December 31, 
  2008  2007  2006 
             
Year-end balance $23,465  $25,643  $32,310 
Year-end weighted average interest rate  0.48%  2.71%  2.15%
Maximum outstanding at any month-end $56,861  $44,944  $32,353 
Average balance during the year: $38,028  $29,048  $26,157 
Average interest rate for the year:  1.90%  2.97%  2.18%
Long-term Borrowings
Long-term borrowings totaled $47.4 million at December 31, 20062008 and 2005, respectively. The declineconsisted of $30.0 million in brokered certificatesFHLB repurchase agreements entered into during 2008, $653 thousand of deposit resulted fromFHLB amortizing advances and $16.7 million in junior subordinated debentures. During the fourth quarter of 2008, the Company utilizing cash available from the decline in loans to repay the maturing brokered deposits.

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The daily average balances, percentage composition and weighted average rates paid on deposits are presented below for each of the years ended December 31:
                                     
(Dollars in Thousands) 2006 2005 2004
      Percent         Percent         Percent  
      of Total Weighted     of Total Weighted     of Total Weighted
  Average Average Average Average Average Average Average Average Average
  Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
 
Interest-bearing demand $379,434   23.2%  1.77% $390,610   21.7%  1.26% $396,558   21.5%  0.73%
Savings and money market  333,155   20.4   1.30   393,439   21.9   0.95   424,013   22.9   0.66 
Certificates of deposit under $100,000  460,210   28.1   3.80   510,981   28.5   2.84   527,298   28.5   2.45 
Certificates of deposit over $100,000  204,148   12.5   4.39   226,304   12.6   3.13   233,155   12.6   2.57 
Noninterest-bearing demand  258,416   15.8      275,069   15.3      267,721   14.5    
   
                                     
Total deposits $1,635,363   100.0%  2.29% $1,796,403   100.0%  1.68% $1,848,745   100.0%  1.33%
   
The following table indicates the amount of the Company’s certificates of deposit by time remaining until maturity as of December 31, 2006:
                     
  3 Months  Over 3 To  Over 6 To  Over 12    
(Dollars in thousands) Or Less  6 Months  12 Months  Months  Total 
 
Certificates of deposit less than $100,000 $80,566  $84,102  $238,896  $70,757  $474,321 
 
Certificates of deposit of $100,000 or more  111,386   17,126   49,353   17,502   195,367 
                
Total certificates of deposit $191,952  $101,228  $288,249  $88,259  $669,688 
                
Borrowings
Outstanding borrowings are as follows at December 31:
         
      
(Dollars in thousands) 2006  2005 
 
Short-term borrowings:        
Federal funds purchased and securities sold under repurchase agreements $32,310  $20,106 
       
         
Long-term borrowings:        
FHLB advances $38,187  $53,391 
Other     25,000 
       
         
Total long-term borrowings $38,187  $78,391 
       
Total short-term borrowings increased $12.2prepaid a $20.0 million to $32.3 million at December 31, 2006 from $20.1 million at December 31, 2005 due to an increase in securities sold under repurchase agreements. Total long-term borrowings decreased to $38.2 million at December 31, 2006 from $78.4 million at December 31, 2005. The Company funded the reduction in borrowings with cash available from the decline in loans experienced in 2006.
The Company also hasFHLB advance that bore a credit agreement with another commercial bank and pledged the stock of FSB as collateral for the credit facility. The credit agreement included a $25.0 million term loan facility and a $5.0 million revolving loan facility. At June 30, 2005, the Company was in default of an affirmative financial covenant in the credit agreement and reclassified the borrowing from long-term to short-term. The bank waived the event of default at June 30, 2005. As of September 30, 2005, FII and the bank agreed to modify the covenants in the agreement. FII complied with the modified covenants, therefore the term loan was classified as a long-term

38


borrowing at December 31, 2005. In addition, the interest rate and maturity of the term loan facility were modified. The amended and restated term loan required monthly payments of interest only at a variablefixed interest rate of London Interbank Offered Rate (“LIBOR”) plus 2.00% through the third quarter of 2006. During October 2006, FII repaid the $25.0 million term loan. The debt was scheduled for repayment in equal annual installments of $6.25 million beginning in December 2007. The $5.0 million revolving loan was also modified to accrue interest at a rate of LIBOR plus 1.75% and is scheduled to mature April 2007. There were no advances outstanding on the revolving loan during the year ended December 31, 2006 or December 31, 2005.
Junior Subordinated Debentures5.52%.
In February 2001, the Company established FISI Statutory Trust I (the “Trust”), which issued $16.7 million16,200 fixed rate pooled trust preferred securities with a liquidation preference of $1,000 per security. The trust preferred securities represent an interest in the related junior subordinated debentures to a statutoryof the Company, which were purchased by the Trust and have substantially the same payment terms as these trust subsidiary.preferred securities. The junior subordinated debentures havemature in 2031 and are the only assets of the Trust and interest payments from the debentures finance the distributions paid on the trust preferred securities. Distributions on the debentures are payable quarterly at a fixed interest rate equal to 10.20% and mature in 30 years.. The Company incurred $487,000$487 thousand in costs related to the issuance that are being amortized over 20 years using the straight-line method. The statutory trust subsidiary then participated in the issuance of trust preferred securities of similar terms and maturity. As of December 31, 2003, the Company deconsolidated the subsidiary trust, which had issued trust preferred securities, and replaced the presentation of such instruments with the Company’s junior subordinated debentures issued to the subsidiary trust. Such presentation reflects the adoption ofTrust is a variable interest entity as defined by FASB Interpretation No. 46 (“FIN 46 R”),46R, “Consolidation of Variable Interest Entities.Entities, an Interpretation of ARB No. 51, and, as such, the Trust is accounted for as an unconsolidated subsidiary.
Shareholders’ Equity
Shareholders’ equity decreased by $5.0 million in 2008 to $190.3 million at December 31, 2008. Additional repurchases of treasury stock totaling $4.8 million, combined with increases in accumulated other comprehensive loss of $4.7 million, common and preferred dividends of $7.4 million and a net operating loss of $26.2 million for the year ended December 31, 2008 offset the $37.5 million in proceeds from the issuance of the TARP preferred stock and related warrant. For detailed information on shareholders’ equity and details regarding the TARP preferred stock and related warrant, see Note 11, Shareholders’ Equity, of the notes to consolidated financial statements.
The Bank is subject to various regulatory capital requirements administered by the Federal Deposit Insurance Corporation (“FDIC”) and the New York State Banking Department (“NYSBD”). At December 31, 2008, the Bank’s equity as a percentage of total assets exceeded all regulatory requirements. For detailed information on regulatory capital, see Note 10, Regulatory Matters, of the notes to consolidated financial statements.

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RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 20062008 AND 2005DECEMBER 31, 2007
Overview
For the year ended December 31, 2006, income from continuing operations was $17.4 million or $1.40 per diluted share, up from $4.6 million or $0.28 per diluted share from last year. For the year ended December 31, 2006, net income was $17.4 million or $1.40 per diluted share compared with net income of $2.2 million or $0.06 per diluted share for the prior year. The primary factor for the improved 2006 results was a $1.8 million credit for loan losses in 2006 compared with a $28.5 million provision for loan losses in 2005. The Company also reduced noninterest expense by $5.9 million in 2006 compared with 2005. The improved risk profile of the Company’s loan portfolio contributed to the credit for loan losses. Lower noninterest expense resulted from improved operating efficiencies from the consolidation of FII’s subsidiary banks in December 2005, coupled with a reduction in costs associated with asset quality issues and regulatory matters. Net interest income, the principal source of the Company’s earnings, was $59.5 million in 2006 down from $67.5 million in 2005. Net interest margin was 3.55% and 3.65% for the years ended December 31, 2006 and 2005, respectively. The decline in net interest income resulted from lower earning asset levels along with a narrowed net interest margin. Return on average common equity was 10.02% for 2006 compared to 0.43% in 2005.
Average Statements of Financial Condition and Net Interest Analysis
The following table sets forth certain information relating to the Company’s consolidated statements of financial condition and reflects the average yields earned on interest-earning assets, as well as the average rates paid on interest-bearing liabilities for the years indicated. Such yields and rates were derived by dividing interest income or expense by the average balances of interest-earning assets or interest-bearing liabilities, respectively, for the years shown. Tax-equivalent adjustments have been made. All average balances are average daily balances.

39


                                     
  For the years ended December 31:
  2006  2005  2004 
  Average  Interest      Average  Interest      Average  Interest    
  Outstanding  Earned/  Yield/  Outstanding  Earned/  Yield/  Outstanding  Earned/  Yield/ 
(Dollars in thousands) Balance  Paid  Rate  Balance  Paid  Rate  Balance  Paid  Rate 
Interest-earning assets:                                    
Federal funds sold and interest-bearing deposits $36,572  $1,877   5.13% $42,977  $1,476   3.43% $35,245  $448   1.27%
Commercial paper due in less than 90 days  8,285   411   4.97                   
Investment securities (1):                                    
Taxable  559,945   23,897   4.27   545,496   22,200   4.07   475,180   19,343   4.07 
Non-taxable  251,439   13,663   5.43   251,640   13,172   5.23   241,999   12,802   5.29 
                            
Total investment securities  811,384   37,560   4.63   797,136   35,372   4.44   717,179   32,145   4.48 
Loans (2):                                    
Commercial and agricultural  426,408   32,554   7.63   612,987   38,690   6.31   800,133   46,393   5.80 
Residential real estate  271,691   17,090   6.29   264,506   16,808   6.35   248,872   16,555   6.65 
Consumer and home equity  255,081   18,360   7.20   258,459   16,151   6.25   246,327   15,115   6.14 
                            
Total loans  953,180   68,004   7.13   1,135,952   71,649   6.31   1,295,332   78,063   6.03 
Total interest-earning assets  1,809,421   107,852   5.96   1,976,065   108,497   5.49   2,047,756   110,656   5.40 
                                     
Allowance for loan losses  (19,338)          (29,152)          (30,600)        
Other noninterest-earning assets  148,937           169,493           173,193         
                                  
                                     
Total assets $1,939,020          $2,116,406          $2,190,349         
                                  
                                     
Interest-bearing liabilities:                                    
Interest-bearing demand $379,434  $6,705   1.77% $390,610  $4,917   1.26% $396,558  $2,903   0.73%
Savings and money market  333,155   4,320   1.30   393,439   3,733   0.95   424,013   2,812   0.66 
Certificates of deposit  664,358   26,420   3.98   737,285   21,605   2.93   760,453   18,909   2.49 
Short-term borrowings  26,157   571   2.18   24,998   377   1.51   28,237   284   1.01 
Long-term borrowings  67,023   3,860   5.76   82,142   4,035   4.91   95,446   4,132   4.33 
Junior subordinated debentures and trust preferred securities  16,702   1,728   10.35   16,702   1,728   10.35   16,702   1,728   10.35 
                            
Total interest-bearing liabilities  1,486,829   43,604   2.93   1,645,176   36,395   2.21   1,721,409   30,768   1.79 
                            
                                     
Noninterest-bearing demand  258,416           275,069           267,721         
Other noninterest-bearing liabilities  17,638           19,023           15,472         
                                  
Total liabilities  1,762,883           1,939,268           2,004,602         
                                     
Stockholders’ equity (3)  176,137           177,138           185,747         
                                  
                                     
Total liabilities and stockholders’ equity $1,939,020          $2,116,406          $2,190,349         
                                  
                                     
Net interest income – tax-equivalent      64,248           72,102           79,888     
Less: tax-equivalent adjustment      4,782           4,610           4,481     
                                  
Net interest income     $59,466          $67,492          $75,407     
                                  
                                     
Net interest rate spread          3.03%          3.28%          3.61%
                                  
                                     
Net earning assets $322,592          $330,889          $326,347         
                                  
Net interest income as a percentage of average interest-earning assets (“net interest margin”)          3.55%          3.65%          3.90%
                                  
                                     
Ratio of average interest-earning assets to average interest-bearing liabilities          121.70%          120.11%          118.96%
                                  
(1)Amounts shown are amortized cost for both held to maturity and available for sale securities. In order to make resultant yields on tax-exempt securities comparable to those on taxable securities and loans, the interest earned from tax-exempt bonds is presented on a tax-equivalent basis.
(2)Includes the average balance and interest earned on loans held for sale. Includes net unearned income and net deferred loan fees and costs. Loans held for sale and nonaccruing loans are included in the average loan totals and payments on nonaccruing loans have been recognized as disclosed in Note 1 of the notes to consolidated financial statements.
(3)Includes unrealized losses on securities available for sale, net of related taxes.

40


Net Interest Income
Net interest income, the principal source of the Company’s earnings, was $59.5$65.3 million in 2006,2008 compared to $67.5$58.1 million in 2005.2007. Net interest margin was 3.55%3.93% for the year ended December 31, 2006, a drop2008, an increase of 1040 basis points from 3.65%3.53% for the same period last year. The decline40 basis point increase in net interest incomemargin was partially offset by a decline in average interest-earning assets of $9.3 million to $1.772 billion as of December 31, 2008 compared to $1.781 billion for the same period last year, which resulted from a combination of lower earning asset levels, a changed mix of earnings assets and a narrowedin the $7.3 million increase in net interest income. The increase in net interest margin asresulted from the inverted to flat yield curve prevalent for mostaverage cost of 2006 negatively impacted net interest margin.
For the year ended December 31, 2006,funds decreasing 74 basis points while average earning asset yield decreased only 34 basis points. In 2008, earning asset yield benefited from a higher percentage of earning assets were $1.809 billion compared with $1.976 billion for the prior year. being deployed in higher yielding loan assets.
Average total loans for the year ended December 31, 20062008 were $953.2$1.023 billion, up $85.4 million down $182.8 million, or 16.1%, when compared with $1.136 billion$937.8 million for the same period last year. The bulk ofhigher average consumer indirect and commercial portfolios more than offset the declinedrop in the average total loans in 2006 relates to the commercial-related loan sale that occurred during 2005.consumer and home equity portfolio. Average total investment securities (excluding federal funds sold and other interest-bearing deposits and commercial paper due in less than 90 days)deposits) totaled $811.4$721.6 million for the year ended December 31, 2006, a $14.3 million increase compare to $797.12008, down from $811.1 million for the same period last year. A portion of the cash available from the decline in loans was redeployed in investment securities.
The overall mix of the Company’s earning assets changed, with loans, which generally have a higher interest yield than investments, representing a lower percentage of earning assets. For the year ended December 31, 2006, loans comprised 52.7% of average earnings assets compared to 57.5% in 2005.
The Company’s yield on average earning assets was 5.96%5.83% for 2006, up 472008, down 34 basis points from 5.49%6.17% in 2005.2007. The Company’s loan portfolio yield was 7.13%6.61% for 2006, up 822008, down 69 basis points from 2005,2007, and the tax-equivalent investment yield was 4.63%4.84% for 2006, up 192008, down 6 basis points from 2005.2007.
Total average interest-bearing deposits were $1.377$1.335 billion for the year ended December 31, 2006,2008, down 9.5%slightly from $1.521$1.357 billion for the same period in 2005. Contributing to the decline in deposits were fewer2007. Fewer certificates of deposit, including brokered certificates of deposit. Other consumer deposit, categories declined duecontributed to deposit outflows associated with the effects of the 2005 loan sale anddecline. Average short-term borrowings amounted to $38.0 million for 2008, up from higher-rate competitor products. Total average short-term and$29.0 million for 2007. Average long-term borrowings were $93.2totaled $53.7 million for the year ended December 31, 2006, down2008, up slightly from $107.1$51.6 million compared to 2005. The Company actively managed to reduce higher cost borrowings using cash available fromfor the decline in loans.same period last year.
The rate on interest-bearing liabilities for the year ended December 31, 20062008 was 2.93%2.36%, an increasea decrease of 7292 basis points over 2005.from 2007. The increasedecrease primarily resulted from higher deposit interest costs associated with higherlower general market interest rates.rates experienced in 2008 and a favorable shift to lower cost funding sources.

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The following tables present, for the periods indicated, information regarding: (i) the average balance sheet; (ii) the amount of interest income from interest-earning assets and the resulting annualized yields (tax-exempt yields and tax-preferred yields on investment securities that qualify for the Federal dividend received deduction (“DRD”) have been adjusted to a tax-equivalent basis using the applicable Federal tax rate in each year); (iii) the amount of interest expense on interest-bearing liabilities and the resulting annualized rates; (iv) net interest income; (v) net interest rate spread; (vi) net interest income as a percentage of average interest-earning assets (“net interest margin”); and (vii) the ratio of average interest-earning assets to average interest-bearing liabilities. Investment securities are at amortized cost for both held to maturity and available for sale securities. Loans include net unearned income, net deferred loan fees and costs and non-accruing loans. Dollar amounts are shown in thousands.
                                     
  Years ended December 31, 
  2008  2007  2006 
  Average      Average  Average      Average  Average      Average 
  Balance  Interest  Rate  Balance  Interest  Rate  Balance  Interest  Rate 
Interest-earning assets:
                                    
Federal funds sold and other interest-earning deposits $26,568  $619   2.33% $31,756  $1,662   5.23% $44,857  $2,288   5.10%
Investment securities:                                    
Taxable  487,687   21,882   4.49   557,035   25,414   4.56   559,864   23,859   4.26 
Tax-exempt  208,519   11,059   5.30   234,078   12,880   5.50   251,439   13,663   5.43 
Tax-preferred  25,345   2,006   7.91   20,005   1,463   7.31   81   52   63.67 
                            
Total investment securities  721,551   34,947   4.84   811,118   39,757   4.90   811,384   37,574   4.63 
Loans held for sale  821   51   6.23   770   54   6.99   698   42   5.95 
Loans:                                    
Commercial  149,927   9,141   6.10   119,823   9,728   8.12   111,118   8,910   8.02 
Commercial real estate  247,475   17,086   6.90   244,357   18,230   7.46   249,899   18,455   7.39 
Agricultural  45,035   3,126   6.94   53,356   4,351   8.16   64,658   5,189   8.02 
Residential real estate  171,262   10,710   6.25   165,226   10,815   6.55   164,730   10,676   6.48 
Consumer indirect  185,197   13,098   7.07   118,152   8,067   6.83   96,260   6,063   6.30 
Consumer direct and home equity  224,343   14,462   6.45   236,910   17,315   7.31   265,817   18,669   7.02 
                            
Total loans  1,023,239   67,623   6.61   937,824   68,506   7.30   952,482   67,962   7.14 
                            
Total interest-earning assets  1,772,179   103,240   5.83   1,781,468   109,979   6.17   1,809,421   107,866   5.96 
                               
Less: Allowance for loan losses  16,287           16,587           19,338         
Other noninterest-earning assets  149,453           142,156           148,937         
                                  
Total assets $1,905,345          $1,907,037          $1,939,020         
                                  
 
Interest-bearing liabilities:
                                    
Deposits:                                    
Interest-bearing demand $347,702   3,246   0.93  $338,326   5,760   1.70  $379,434   6,705   1.77 
Savings and money market  369,926   3,773   1.02   346,131   5,863   1.69   333,155   4,320   1.30 
Certificates of deposit  617,381   22,330   3.62   672,239   31,091   4.63   664,358   26,420   3.98 
                            
Total interest-bearing deposits  1,335,009   29,349   2.20   1,356,696   42,714   3.15   1,376,947   37,445   2.72 
Short-term borrowings  38,028   721   1.90   29,048   864   2.97   26,157   571   2.18 
Long-term borrowings  53,687   3,547   6.61   51,561   3,561   6.91   83,725   5,588   6.67 
                            
Total interest-bearing liabilities  1,426,724   33,617   2.36   1,437,305   47,139   3.28   1,486,829   43,604   2.93 
                               
Noninterest-bearing deposits  280,467           266,239           258,416         
Other liabilities  15,249           17,966           17,638         
Shareholders’ equity  182,905           185,527           176,137         
                                  
Total liabilities and shareholders’ equity $1,905,345          $1,907,037          $1,939,020         
                                  
Net interest income (tax-equivalent)     $69,623          $62,840          $64,262     
                                  
Interest rate spread          3.47%          2.89%          3.03%
                                  
Net earning assets $345,455          $344,163          $322,592         
                                  
Net interest margin (tax-equivalent)          3.93%          3.53%          3.55%
                                  
Ratio of average interest-earning assets To average interest-bearing liabilities  124.21%          123.95%          121.70%        
                                  

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Rate/VolumeRate /Volume Analysis
The following table presents, on a tax equivalent basis, the extent to whichrelative contribution of changes in interest ratesvolumes and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’srates to changes in net interest income and interest expense duringfor the periods indicated. Information is providedThe change in each category with respect to: (i) changes attributableinterest not solely due to changes in volume (changesor rate has been allocated in volume multiplied by current year rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributableproportion to the combined impactabsolute dollar amounts of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.change in each (in thousands):
                         
  December 31, 2008 vs. 2007  December 31, 2007 vs. 2006 
  Increase/(Decrease)      Increase/(Decrease)    
  Due to Change in  Total Net  Due to Change in  Total Net 
  Average  Average  Increase  Average  Average  Increase 
  Volume  Rate  (Decrease)  Volume  Rate  (Decrease) 
Interest-earning assets:
                        
Federal funds sold and other interest-earning deposits $(238) $(805) $(1,043) $(685) $59  $(626)
Investment securities:                        
Taxable  (3,118)  (414)  (3,532)  (122)  1,677   1,555 
Tax-exempt  (1,368)  (453)  (1,821)  (953)  170   (783)
Tax-preferred  415   128   543   1,498   (87)  1,411 
                       
Total investment securities          (4,810)          2,183 
Loans held for sale  4   (7)  (3)  4   8   12 
Loans:                        
Commercial  2,138   (2,725)  (587)  706   112   818 
Commercial real estate  230   (1,374)  (1,144)  (412)  187   (225)
Agricultural  (627)  (598)  (1,225)  (921)  83   (838)
Residential real estate  387   (492)  (105)  32   107   139 
Consumer indirect  4,732   299   5,031   1,464   540   2,004 
Consumer direct and home equity  (885)  (1,968)  (2,853)  (2,090)  736   (1,354)
                       
Total loans          (883)          544 
                       
Total interest-earning assets          (6,739)          2,113 
                       
                         
Interest-bearing liabilities:
                        
Deposits:                        
Interest-bearing demand  156   (2,670)  (2,514)  (707)  (238)  (945)
Savings and money market  379   (2,469)  (2,090)  174   1,369   1,543 
Certificates of deposit  (2,386)  (6,375)  (8,761)  316   4,355   4,671 
                       
Total interest-bearing deposits          (13,365)          5,269 
Short-term borrowings  222   (365)  (143)  68   225   293 
Long-term borrowings  144   (158)  (14)  (2,215)  188   (2,027)
                       
Total interest-bearing liabilities          (13,522)          3,535 
                       
Change in net interest income          6,783           (1,422)
                       

41

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  For the years ended December 31:
  2006 vs. 2005  2005 vs. 2004 
  Increase/(Decrease)  Total  Increase/(Decrease)  Total 
  Due To:  Increase/  Due To:  Increase/ 
(Dollars in thousands) Volume  Rate  (Decrease)  Volume  Rate  (Decrease) 
Interest-earning assets:                        
Federal funds sold and interest-bearing deposits $(328) $729  $401  $266  $762  $1,028 
Commercial paper due in less than 90 days  411      411          
Investment securities:                        
Taxable  613   1,084   1,697   2,857      2,857 
Non-taxable  (11)  502   491   519   (149)  370 
                   
Total investment securities  602   1,586   2,188   3,376   (149)  3,227 
Loans:                        
Commercial and agricultural  (14,215)  8,079   (6,136)  (11,771)  4,068   (7,703)
Residential real estate  435   (153)  282   1,021   (768)  253 
Consumer and home equity  (243)  2,452   2,209   763   273   1,036 
                   
Total loans  (14,023)  10,378   (3,645)  (9,987)  3,573   (6,414)
                   
                         
Total interest-earning assets $(13,338) $12,693  $(645) $(6,345) $4,186  $(2,159)
                   
                         
Interest-bearing liabilities:                        
Interest-bearing demand $(197) $1,985  $1,788  $(74) $2,088  $2,014 
Savings and money market  (776)  1,363   587   (284)  1,205   921 
Certificates of deposit  (2,887)  7,702   4,815   (686)  3,382   2,696 
Short-term borrowings  25   169   194   (50)  143   93 
Long-term borrowings  (881)  706   (175)  (640)  543   (97)
Junior subordinated debentures and trust preferred securities                  
                   
                         
Total interest-bearing liabilities  (4,716)  11,925   7,209   (1,734)  7,361   5,627 
                   
                         
Net interest income $(8,622) $768  $(7,854) $(4,611) $(3,175) $(7,786)
                   
(Credit) Provision for Loan Losses
The (credit) provision for loan losses represents management’s estimate of the expense necessary to maintain the allowance for loan losses at a level representative of probable credit losses inherent in the portfolio. The credit for loan losses totaled $1.8$6.5 million in 2006, compared to the provision for loan losses of $28.5 million in 2005. Net loan charge-offs were $1.3 million, or 0.14% of average loans, for the year ended December 31, 2006 compared to $47.5 million, or 4.27% of average loans2008, versus $116 thousand for 2005.2007. The 2005 results reflected higherincrease in the provision for is primarily due to growth in the consumer indirect loan lossesportfolio and a $1.7 million increase in net charge-offs as a result of write-downs associated with the decision to sell approximately $169.0 million of commercial-related loans. The credit for loan losses in 2006 was due to overall improving credit quality as well as a decline in the loan portfolio. The ratio of allowance for loan losses to total loans was 1.84% and 2.04% at December 31, 2006 and 2005, respectively. The ratio of the allowance for loan losses to nonperforming loans was 108% at December 31, 2006 versus 112% at December 31, 2005.during 2008. See the “Analysis on Allowance for Loan Losses” and “Allocation of Allowance for Loan Losses” sections for further discussion.

42


Noninterest (Loss) Income
The following table presentssummarizes the major categories ofCompany’s noninterest income for the years ended December 31:
         
(Dollars in thousands) 2006  2005 
 
Service charges on deposits $11,504  $11,586 
ATM and debit card  2,233   1,680 
Financial services group fees and commissions  1,890   2,687 
Mortgage banking revenues  1,194   1,597 
Income from corporate owned life insurance  521   90 
Net gain on sale and call of securities  30   14 
Net gain on sale of student loans held for sale  670   245 
Net gain on sale of commercial-related loans held for sale  82   9,369 
Net loss on sale of premises and equipment  (3)  (321)
Net gain (loss) on sale of other real estate and repossessed assets  90   (9)
Net gain on sale of trust relationships  1,386    
Other  2,314   2,446 
       
         
Total noninterest income $21,911  $29,384 
       
Noninterest(loss) income for the years ended December 31 2006 and 2005 was $21.9 million and $29.4 million, respectively. The majority of the decline was attributed to the net gain of $9.4 million on the sale of commercial-related loans recorded in 2005.(in thousands):
             
  2008  2007  2006 
Service charges on deposits $10,497  $10,932  $11,504 
ATM and debit card  3,313   2,883   2,233 
Broker-dealer fees and commissions  1,458   1,396   1,511 
Loan servicing  664   928   892 
Company owned life insurance  563   1,255   521 
Net gain on sale of loans held for sale  339   779   972 
Net gain on sale of other assets  305   89   169 
Net gain on investment securities  288   207   30 
Net gain on sale of trust relationships     13   1,386 
Impairment charges on investment securities  (68,215)      
Other  2,010   2,198   2,693 
          
Total noninterest (loss) income $(48,778) $20,680  $21,911 
          
Service charges on deposits are down slightlydeclined to $10.5 million for the year ended December 31, 20062008 compared with 2005. The decline results from$10.9 million for the decreasesame period in deposit base, partially offset by2007, a fee increase imposed during 2006.result of fewer customer overdrafts and related service fees.
Automated Teller Machine (“ATM”) and debit card income, which represents fees for foreign ATM usage and income associated with customer debit card purchases,transactions, totaled $2.2$3.3 million and $1.7$2.9 million for the years ended December 31, 20062008 and 2005,2007, respectively. ATM and debit card income has increased from the prior year as a result of an increase inhigher ATM usage fees and more favorable terms on a newan increase in customer utilization of debit card service contract.point-of-sale transactions.
Financial services groupBroker-dealer fees and commissions declined $797,000increased due to slightly higher sales volumes.
Loan servicing income represents fees earned for servicing mortgage loans sold to third parties, net of amortization expense and impairment losses associated with capitalized mortgage servicing assets. Loan servicing income in 2008 was adversely impacted by a $343 thousand impairment charge on capitalized mortgage servicing assets that resulted from an increase in prepayment assumptions used to value capitalized mortgage servicing assets, a direct result of the decline in mortgage interest rates experienced in 2008. The impairment charge recorded in 2007 totaled $18 thousand.
For the year ended December 31, 20062007, company owned life insurance included $1.1 million in income from the receipt of insurance proceeds. The Company invested $20.0 million in company owned life insurance during the third quarter of 2008, which would have resulted in an increase in income compared with theto prior year absent the death benefit proceeds received in 2007.
Net gain on sale of loans held for sale declined compared to prior year due primarily to lower student loan sale volumes, which resulted from increased competition and changing market conditions for student loans as a result of lower volumes primarilythe Company exited the business in the broker-dealer function. Included in financial services group fees and commissions are trust fees of $328,000 and $456,000 for2008. For the years ended December 31, 20062008 and 2005,2007, student loan sale net gains were $104 thousand and $478 thousand, respectively. During 2006, the Bank sold its trust relationships at the end of the third quarter and recorded a gain on sale of $1.4 million.
Mortgage banking revenues, which includes gains and losses from the sale of residential mortgage loans, mortgage servicing income and the amortization and impairment (if any) of mortgage servicing rights, have declined in 2006. The residential mortgage volume has slowed as a result of the rising interest rate environment and the increasingly competitive marketplace for mortgage loans.
Included in noninterest income for year ended December 31, 2006 was $419,000 in income associated with the proceeds from corporate owned life insurance policies received in the second quarter of 2006.
During the third quarter of 2005, the Bank began originating student loans with a forward commitment to sell the student loans to a third-party at a fixed premium on the day of origination. Included in the net gain on sale of student loans held for saleother assets includes gains and losses on premises, equipment, other real estate (“ORE”) and repossessed assets and the increase in 2006 was a $253,000 premium received from the third-party as a result of achieved sales volumes. The Bank anticipates lower future origination volumes and net gain on sale duefor 2008 was favorable in comparison to increased competition and changing market conditions.2007.
The varianceimpairment charges on investment securities totaled $68.2 million in net loss on sale of premises and equipment, when comparing 2006 to 2005, relates primarily to equipment and sign disposals recorded in 2005 as a result of2008. See the Company’s reorganization and consolidation of its subsidiary banks into FSB.“Investing Activities” section for further discussion.

43

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Net gain (loss) on sale of other real estate and repossessed assets increased for the year ended December 31, 2006 compared to 2005, primarily as a result of a $107,000 gain recognized on the sale of a commercial property during the first quarter of 2006.
Noninterest Expense
The following table presentssummarizes the major categories ofCompany’s noninterest expense for the years ended December 31:31 (in thousands):
         
(Dollars in thousands) 2006  2005 
 
Salaries and employee benefits $33,563  $34,763 
Occupancy and equipment  9,465   9,022 
Supplies and postage  1,945   2,173 
Amortization of other intangible assets  420   430 
Computer and data processing  1,903   1,930 
Professional fees and services  2,837   5,074 
Other  9,479   12,100 
       
         
Total noninterest expense $59,612  $65,492 
       
Noninterest expense for the year ended December 31, 2006 decreased $5.9 million, or 9.0% to $59.6 million from $65.5 million for the year ended December 31, 2005. This decline was principally related to operational efficiencies gained from the consolidation of the Company’s subsidiary banks at the end of 2005, the elimination of professional service fees related to last year’s asset quality and regulatory issues, and lower FDIC insurance costs.
             
  2008  2007  2006 
Salaries and employee benefits $31,437  $33,175  $33,563 
Occupancy and equipment  10,502   9,903   9,465 
Computer and data processing  2,433   2,126   1,903 
Professional services  2,141   2,080   2,837 
Supplies and postage  1,800   1,662   1,945 
Advertising and promotions  1,453   1,402   1,974 
Other  7,695   7,080   7,925 
          
Total noninterest expense $57,461  $57,428  $59,612 
          
For the year ended December 31, 2006,2008, salaries and benefits declined $1.2totaled $31.4 million, down $1.7 million from the year ended December 31, 2005. Thisprior year. The factors that contributed to the decline was principally from reduced staffing levelswere as follows: a reduction in annual incentive compensation as certain senior management incentive targets contingent on 2008 financial results were not achieved; an increase in the amount of salaries and lower payroll related taxeswages allocated to deferred direct loan origination costs due to higher loan origination volumes; and benefit costs. lastly, a reduction in full-time equivalent employees (“FTEs”) to 600 as of year-end 2008, a decrease of 21 FTEs compared to prior year-end.
The Company focused on managing staff levelsexperienced a 6% increase in occupancy and filling positions vacated through attrition only when necessary. In addition, salariesequipment expenses in 2008 to $10.5 million, compared to $9.9 million in 2007. The increase was partly a result of the expansion of the branch network in the metro-Rochester area, as de novo branches were added in Henrietta and benefits included $821,000Greece during the third and fourth quarters of management stock compensation expense (excludes director stock compensation expense)2008, respectively. Also contributing to the increase in 2008 were technology upgrades and higher service contract related expenses associated with equipment and computer software.
Supplies and postage increased 8% for the year ended December 31, 2006 as a2008 versus 2007, primarily the result of the adoption of SFAS No. 123(R). Since SFAS No. 123(R) was adopted effective January 1, 2006, there was no such stock compensation expense included in salaries and benefits in 2005.
The Company has experienced a 4.9% increase in occupancy and equipment expenses when comparing 2006 to 2005. The Company has actively managed to reduce costs and lower overhead, but those efforts were more than offset by rising utility and maintenancehigher postage costs.
SuppliesComputer and postage are down 10.5%data processing costs increased 14% in 2008 compared to the prior year, primarily due to higher debit card data transaction processing expense due to increased customer point-of-sale transaction volumes.
Professional fees and services increased 3% for the year ended December 31, 20062008 compared to 2005. This decline results from efficiencies gained through the consolidation2007, primarily due to costs incurred in 2008 associated with valuation of the Company’s banking charters and ongoing efforts to reduce costs.investment securities portfolio.
Computer and data processing costs are down slightly in 2006 versus 2005.
Professional fees and services have declined 44.1%Other expenses increased 9% or $615 thousand for the year ended December 31, 2006 compare2008. Factors that contributed to 2005, primarilythe increase included a result of the resolution of asset quality issues and regulatory matters during 2005.
Other expenses decreased 21.7% for the year ended December 31, 2006. The decline$385 thousand increase in other expenses related primarily to lower FDIC insurance premiums, which declined $1.2 million to $215,000 in 2006 versus $1.4 million in 2005. The Company also experiencedand a reduction in$557 thousand prepayment charge on borrowed funds. Partly offsetting those increases were lower levels of commercial-related loan workout expenses and other operatingreal estate expense (“ORE”) expenses in 2006, as one-time severance and restructuring costs were incurred during 2005 to merge the Company’s subsidiary banks.2008.
The efficiency ratio for the year ended December 31, 20062008 was 69.45%64.07% compared with 70.18%68.77% for 2005.2007. The improved efficiency ratio is reflective of the higher level of net interest income and relatively flat noninterest expense. The efficiency ratio equals noninterest expense less other real estate expense and amortization of intangible assets as a percentage of net revenue, defined as the sum of tax-equivalent net interest income and noninterest income before net gains and impairment charges on investment securities, proceeds from company owned life insurance included in income and net gain on sale of trust relationships.
Income Taxes
The income tax (benefit) expense amounted to $(21.3) million and $4.8 million for the years ended December 31, 2008 and 2007, respectively. The fluctuation in income tax expense corresponded in general with the level of net income before tax. The Company’s effective tax rates were (44.9)% in 2008 and 22.6% in 2007. Effective tax rates are affected by income and expense items that are not subject to Federal or state taxation. The Company’s income tax provision reflects the impact of such items, including tax-exempt interest income from municipal securities, tax-exempt earnings on bank-owned life insurance and the effect of certain state tax credits. The unusual 2008 effective tax benefit rate results from the relationship between the size of the favorable permanent differences and pre-tax loss.

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RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2007 AND DECEMBER 31, 2006
Net Interest Income
Net interest income on a tax-equivalent basis was $58.1 million in 2007, compared to $59.5 million in 2006. The net interest margin was 3.53% for the year ended December 31, 2007, a drop of 2 basis points from 3.55% for the same period in 2006. A $28.0 million decline in average earning assets for the year ended December 31, 2007, together with the decline in the net interest margin, resulted in the $1.4 million drop in net interest income when comparing 2007 to 2006. The decline in average earning assets was affected by average total borrowings declining $29.3 million due to the repayment and maturity of borrowings. The drop in net interest margin resulted from the average cost of funds increasing 23 basis points while average earning asset yield increased only 21 basis points. Net interest margin improved in the second half of 2007, principally the result of a reduction in funding costs, an improved investment security portfolio yield and the benefits associated with a higher percentage of earning assets being deployed in higher yielding loan assets.
Average total loans for the year ended December 31, 2007 were $937.8 million, down $14.7 million, or 1.5%, when compared with $952.5 million for the same period in 2006. The increased average consumer indirect portfolio was more than offset by a drop in the average consumer and home equity portfolio.
The Company’s yield on average earning assets was 6.17% for 2007, up 21 basis points from 5.96% in 2006. The Company’s loan portfolio yield was 7.30% for 2007, up 16 basis points from 2006, and the tax-equivalent investment yield was 4.90% for 2007, up 27 basis points from 2006.
Total average interest-bearing deposits were $1.357 billion for the year ended December 31, 2007, down 1.5% from $1.377 billion for the same period in 2006. Fewer certificates of deposit, including brokered certificates of deposit, contributed to the decline. Average borrowings amounted to $80.6 million for 2007, down from $109.9 million for 2006. The Company’s favorable liquidity position allowed for a managed reduction in higher cost deposits and borrowings.
The rate on interest-bearing liabilities for the year ended December 31, 2007 was 3.28%, an increase of 35 basis points over 2006. The increase primarily resulted from higher interest-bearing deposit and short-term borrowing costs due to the higher general market interest rates experienced in 2007, partially offset by a decrease in the rate of long-term borrowings, which declined as a result of the maturity and repayment of higher cost long-term borrowings.
Provision for Loan Losses
The provision for loan losses totaled $116 thousand in 2007, versus a credit for loan losses of $1.8 million in 2006. The increase in the provision for 2007 is primarily due to growth in the loan portfolio, partially offset by the reduction in non-performing loans. Net loan charge-offs were $1.6 million, or 0.18% of average loans, for the year ended December 31, 2007, compared with $1.3 million, or 0.14% of average loans for 2006.
Noninterest Income
Noninterest income for the year ended December 31, 2007 was $20.7 million, down from $21.9 million in the prior year.
Service charges on deposits declined for the year ended December 31, 2007 compared with 2006, a direct result of fewer customer overdrafts and related service fees.
Automated Teller Machine (“ATM”) and debit card income increased as a result of higher ATM usage fees and an increase in customer utilization of debit card point-of-sale transactions.
Broker-dealer fees and commissions declined due to lower sales volumes. Loan servicing increased slightly in 2007 versus 2006 despite the decrease in the sold and serviced residential mortgage portfolio, a result of a decrease in the amortization of capitalized mortgage servicing assets.
For the years ended December 31, 2007 and 2006, company owned life insurance included $1.1 million and $419 thousand in income, respectively, associated with the proceeds from company owned life insurance policies.
Net gain on sale of loans held for sale declined compared to prior year due primarily to lower student loan sale volumes resulting from increased competition and changing market conditions for student loans. For the years ended December 31, 2007 and 2006, net gains from the sale of student loans were $478 thousand and $670 thousand, respectively.
The net gain on sale or call of securities increased in 2007 as the Company experienced an increase in call activity on investment securities with unamortized discount due to changes in the interest rate environment.
There were no trust fees in 2007, as the Company sold its trust relationships in 2006, as reflected by the $1.4 million net gain on sale of trust relationships included in noninterest income in the third quarter of 2006.

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Noninterest Expense
Noninterest expense for the year ended December 31, 2007 decreased $2.2 million or 3.7% to $57.4 million from $59.6 million for the year ended December 31, 2006. This decline was consistent with management’s continued focus on reduction of costs.
For the year ended December 31, 2007, salaries and benefits totaled $33.2 million, down $388 thousand from the prior year. The Company managed a reduction in full-time equivalent employees (“FTEs”) to 621 as of December 31, 2007, a decrease of 19 FTEs versus the prior year-end. Salaries and wage expense also decreased during 2007 due to an increase in the amount of salaries and wages that were allocated to deferred direct loan origination costs, a direct result of the higher loan origination volumes. The reduction in salaries and wages was partially offset by increases in employee benefits, including stock-based compensation expense, health care costs and the Company’s 401(k) benefit plan match, which in turn, was offset by a reduction in pension expense from plan changes implemented during 2007.
The Company has experienced a 4.6% increase in occupancy and equipment expenses when 2007 is compared to 2006. The increase primarily resulted from a higher service contract related expenses associated with equipment and computer software.
Supplies and postage declined 14.6% for the year ended December 31, 2007 versus 2006. The decline was associated with cost reduction efforts and higher than normal expense incurred in the first quarter of 2006 due to the purchase of branding-related stationery and supplies.
Computer and data processing costs increased in 2007 compared to the prior year. The Bank experienced higher debit card data transaction processing expense due to increased customer point-of-sale transaction volumes.
Professional services declined 26.7% for the year ended December 31, 2007 compared to 2006, primarily due to lower legal and external loan review costs associated with commercial-related problem loans.
Other noninterest expense decreased 10.7% for the year ended December 31, 2007. The Company experienced a reduction in commercial-related loan expenses during 2007, a direct result of the lower level of nonperforming loans, which was partially offset by increased other real estate expense (“ORE”), as the Bank experienced higher ORE write-downs in 2007. In addition, the Company experienced declines in other bank charges, donations and severance expense, all consistent with management’s focus on overall cost reduction. The expense related to the amortization of other intangible assets, which is included in other noninterest expense, also declined in 2007 versus 2006 due to run-off, as certain intangible assets were fully amortized in 2006.
The efficiency ratio for the year ended December 31, 2007 was 68.77% compared with 69.78% for 2006. The improved efficiency ratio is reflective of the lower levels of noninterest expense, partially offset by lower revenues. The efficiency ratio represents noninterest expense less other real estate expense and amortization of intangibles, (all from continuing operations) divided by net interest income (tax-equivalent) plus other noninterest income less net gain on sale or call of securities, income associated with the proceeds from company owned life insurance, net gain on sale of commercial-related loans held for sale and net gain on sale of trust relationships (all from continuing operations).relationships.

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Income Tax Expense (Benefit) From Continuing OperationsTaxes
The income tax expense (benefit) from continuing operations provided for federal and New York State income taxes which amounted to expense of $6.2$4.8 million and a benefit of $1.8$6.2 million for the years ended December 31, 20062007 and 2005,2006, respectively. The fluctuation in income tax expense corresponded in general with taxable income levels for each year. The effective tax rate for 20062007 was 26.5%22.6%, compared to (61.9)%26.5% in 2005.2006. The 2005lower effective tax rate was due to the relationship between the size of the favorable permanent differences and pre-tax income from continuing operations, whichrates resulted, in the unusual effective tax benefit rate.
The current and deferred tax provision was calculated based on estimates and assumptions that could differpart, from the actual results reflected in income tax returns filed during the subsequent year. Adjustments based on filed returns are recorded when identified, which is generally before or during the third quarter of the subsequent year.
The amount of income taxes paid is subject to ongoing audits by federal and state tax authorities, which often result in proposed assessments. Our estimate for the potential outcome for any uncertain tax issue is highly judgmental. We believe we have adequately provided for any reasonably foreseeable outcome related to these matters. However, our future results may include favorable or unfavorable adjustments to our estimated tax liabilities in the period the assessments are made or resolved or when statutes of limitation on potential assessments expire. As a result, our effective tax rate may fluctuate significantly on a quarterly basis.
Discontinued Operation
In 2005, the Company disposed of its BGI subsidiary. The results of BGI have been reported separately as a discontinued operation in the consolidated statements of income for all periods presented. As a result, the Company recorded a loss from operations of the discontinued subsidiary of $340,000, a loss on the sale of BGI of $1.1$1.3 million and $521 thousand in non-taxable corporate owned life insurance income tax expense associated with discontinued operations of $1.0 million for the year ended December 31, 2005. Since the sale occurred during 2005, there are no assets or liabilities associated with the discontinued operation recorded at December 31,in 2007 versus 2006, and 2005 in the consolidated statements of financial condition. Cash flows from BGI are shown in the consolidated statements of cash flows by activity (operating, investing and financing) consistent with the applicable source of the cash flow. See also Note 2 of the notes to consolidated financial statements.
RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2005 AND 2004
Overview
For the year ended December 31, 2005, income from continuing operations was $4.6 million or $0.28 per diluted share, down from $12.9 million or $1.02 per diluted share from the prior year. For the year ended December 31, 2005, net income was $2.2 million or $0.06 per diluted share compared with net income of $12.5 million or $0.98 per diluted share for the prior year. The primary reasons for the decline in net income in 2005 were the $7.9 million decline in net interest income, the $8.9 million increase in the provision for loan losses, and an increase in noninterest expense of $3.7 million. The Company also sold its BGI subsidiary during 2005 and incurred a loss from discontinued operations of $2.5 million in 2005 compared to $450,000 in 2004. Return on average common equity was 0.43% for 2005 compared to 6.55% in 2004. The provision for loan losses in 2005 was $28.5 million, up $8.9 million from the prior year. Noninterest expenses totaled $65.5 million in 2005, an increase of $3.7 million from 2004, which related to a $295,000 increase in salaries and benefits and a $3.4 million increase in other operating expenses. Other operating expenses included $1.4 million of restructuring costs incurred in 2005 to merge the Company’s subsidiary banks.
Net Interest Income
Net interest income, the principal source of the Company’s earnings, was $67.5 million in 2005, compared to $75.4 million in 2004. Net interest margin was 3.65% for the year ended December 31, 2005, a drop of 25 basis points from the 3.90% level for the same period last year. The Company experienced a significant change in the mix of earning assets, with increased levels of investment securities and federal funds sold and lower level of loans. Loan assets generally earn higher yields than investment assets. For 2005, in comparison to 2004, averagerespectively.

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investment securities and federal funds sold increased $87.7 million, while average loans decreased $159.4 million. In addition to the lower loan base that resulted from the Company’s decision to sell $169.0 million in commercial-related loans during 2005, new loan originations slowed and caused an additional drop in total loans.
The Company’s yield on average earning assets was 5.49% for 2005, up 9 basis points from 5.40% in 2004. The Company’s loan portfolio yield was 6.31% for 2005, up 28 basis points from 2004, and tax-equivalent investment yield was 4.44% for 2005, down 4 basis points from 2004. The increased loan portfolio yield in 2005 resulted from the higher general market interest rates and the associated repricing of variable rate loans, as well as the decline in nonperforming loans that resulted from the problem loan sale previously discussed. Improved loan yields were mitigated by the shift in the mix of earning assets.
The average cost of funds for 2005 was 2.21%, an increase of 42 basis points over the same period in 2004. The increases in the average cost of funds primarily resulted from higher deposit interest costs associated with increased general market interest rates. Total average interest-bearing liabilities were $1.65 billion for the year ended December 31, 2005, which represented a $76.2 million decrease from 2004. Total average interest-bearing deposits were $1.52 billion for the year ended December 31, 2005, a decrease of $59.7 million or 4% lower than the average interest-bearing deposits for 2004.
Provision for Loan Losses
The provision for loan losses represents management’s estimate of the expense necessary to maintain the allowance for loan losses at a level representative of probable credit losses inherent in the portfolio. The provision for loan losses totaled $28.5 million in 2005, compared to $19.7 million in 2004. Net loan charge-offs were $47.5 million, or 4.27% of average loans, for the year ended December 31, 2005 compared to $9.6 million, or 0.74% of average loans for 2004. The ratio of the allowance for loan losses to nonperforming loans was 112% at December 31, 2005 versus 73% at December 31, 2004. The ratio of allowance for loan losses to total loans was 2.04% and 3.13% at December 31, 2005 and 2004, respectively. The significant increase in the provision for loan losses in 2005 as compared to 2004 was a result of the Company’s decision to sell a substantial portion of its problem loans during 2005. See the “Analysis on Allowance for Loan Losses” and “Allocation of Allowance for Loan Losses” sections for further discussion.
Noninterest Income
The following table presents the major categories of noninterest income for the years ended December 31:
         
(Dollars in thousands) 2005  2004 
 
Service charges on deposits $11,586  $11,987 
ATM and debit card  1,680   1,374 
Financial services group fees and commissions  2,687   2,518 
Mortgage banking revenues  1,597   2,147 
Income from corporate owned life insurance  90   30 
Net gain on sale of credit card portfolio     1,177 
Net gain on sale and call of securities  14   248 
Net gain on sale of student loans held for sale  245    
Net gain on sale of commercial-related loans held for sale  9,369    
Net (loss) gain on sale of premises and equipment  (321)  2 
Net (loss) gain on sale of other real estate and repossessed assets  (9)  193 
Other  2,446   2,473 
       
         
Total noninterest income $29,384  $22,149 
       
Noninterest income increased 32.7% to $29.4 million in 2005 compared to $22.1 million in 2004. The increase was primarily attributed to the net gain of $9.4 million on the sale of commercial-related loans that more than offset the decline in mortgage banking activities, service charges on deposit accounts and other noninterest income categories. The Company also realized a $1.2 million gain on the sale of its credit card portfolio in 2004.

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Noninterest Expense
The following table presents the major categories of noninterest expense for the years ended December 31:
         
(Dollars in thousands) 2005  2004 
 
Salaries and employee benefits $34,763  $34,468 
Occupancy and equipment  9,022   8,436 
Supplies and postage  2,173   2,319 
Amortization of other intangible assets  430   709 
Computer and data processing  1,930   1,780 
Professional fees and services  5,074   3,439 
Other  12,100   10,616 
       
         
Total noninterest expense $65,492  $61,767 
       
Noninterest expense was $65.5 million in 2005 compared to $61.8 million in 2004. The most significant component of noninterest expense was salaries and benefits, which totaled $34.8 million in 2005 and $34.5 million in 2004. Salaries and benefits increased in 2005 from 2004, by only $295,000 or less than 1%. While salaries and benefits costs increased as a result of the additions to staff in the commercial loan origination and monitoring areas, the reduction in bonus and incentive compensation awards in 2005 as compared to 2004 offset the cost increase to a large degree. Occupancy and equipment increased to $9.0 million in 2005 from $8.4 in 2004. Higher expense was incurred throughout 2005 to implement the numerous organizational changes, the majority of which were included in other expense. Legal, consulting and professional fees totaled $4.7 million for 2005 and the increase was associated with resolving the Company’s asset quality issues, regulatory issues and restructuring, as well as legal costs related to the special committee’s investigation resulting from a demand letter received from a law firm representing a shareholder. The increase in noninterest expenses, coupled with the flattening of revenue growth, were the principal factors in the rise in the Company’s efficiency ratio to 70.18% for 2005, compared to 60.41% for 2004.
Income Tax Expense (Benefit) From Continuing Operations
The income tax expense (benefit) from continuing operations provides for federal and New York State income taxes, which amounted to a benefit of $1.8 million and expense of $3.2 million for the years ended December 31, 2005 and 2004, respectively. The fluctuation in income tax expense corresponded in general with taxable income levels for each year. The effective tax rate for 2005 was (61.9)%, compared to 19.7% in 2004. The 2005 effective tax rate was due to the relationship between the size of the favorable permanent differences and pre-tax income from continuing operations, which resulted in the unusual effective tax benefit rate.
Discontinued Operation
The Company disposed of its BGI subsidiary in 2005. As a result, the Company recorded a loss from operations of the discontinued subsidiary of $340,000, a loss on the sale of BGI of $1.1 million and income tax expense associated with discontinued operations of $1.0 million for the year ended December 31, 2005. For the year ended December 31, 2004, the Company recorded a loss from operations of discontinued subsidiary of $599,000 and associated income tax benefit of $149,000. BGI was originally acquired by FII in a tax-free reorganization that limited FII’s tax basis, resulting in a taxable gain on the sale of the subsidiary. See also Note 2 of the notes to consolidated financial statements.
20062008 FOURTH QUARTER RESULTS
Net incomeloss for the fourth quarter of 20062008 was $3.0$3.1 million, or $0.23$0.33 loss per diluted share, compared with a net incomeloss of $5.2$28.4 million, or $0.43$2.68 loss per diluted share, for the third quarter of 20062008 and net income of $2.9$4.1 million, or $0.22$0.34 earnings per diluted share, in the fourth quarter of the prior year. The declinenet losses in the third and fourth quarters of 2008 were a result of the impact of OTTI charges recorded on certain securities in the Company’s AFS securities portfolio.
Net interest income was $17.3 million for the fourth quarter of 2008, up $567 thousand or 3% from the third quarter of 2006 was attributed2008 and $2.1 million or 14% compared with the fourth quarter of 2007. Net interest margin improved to 4.07% in the combinationfourth quarter of a $389,000 decline in net interest income, a $570,000 increase in noninterest expense, the $491,000 credit for loan loss2008, compared with 3.98% in the third quarter of 2006 compared to no credit or provision for loan loss2008 and 3.75% in the fourth quarter of 2006 and the $1.4 million gain on the sale of the Company’s trust operations2007.
The Company recorded during the

47


third quarter of 2006. Fourth quarter 2006 net income of $3.0 million represented a slight increase from fourth quarter 2005 net income of $2.9 million. The slight increase from the fourth quarter last year is attributed to the combination of a $1.4 million decrease in provision for loan loss and a $1.0losses of $2.6 million decrease in noninterest expense, partially offset by a $1.7 million decline in net interest income.
Net interest income for the fourth quarter of 2006 declined $1.7 million2008, compared to the same quarter last year, or 10.7%, to $14.3 million primarily the result of an 11 basis point drop in tax-equivalent net interest margin, a $138.4 million reduction in average interest-earning assets coupled with a change$351 thousand in the fourth quarter of 2007. The increase in the provision for loan losses is primarily due to growth in the loan portfolio and the changing mix of those interest-earning assets fromthe loan portfolio together with higher yielding loans to lower yielding investments. The net interest margincharge offs. Net charge offs of $1.3 million for the fourth quarter of 2006 was 3.44% compared with 3.55% in the same quarter last year.2008 represented 46 basis points (annualized) of average loans.
The provision for loan losses totaled $1.4 million for fourth quarter 2005 compared with a credit for loan losses of $491,000 for the third quarter of 2006 and no credit or provision recordedNoninterest income (loss) for the fourth quarter of 2006. Net loan charge-offs were $633,000, or 0.27%2008 was $(25.1) million, compared with $(29.3) million and $5.0 million in the third quarter of average loans,2008 and the fourth quarter of 2007, respectively. The 2008 periods reflect OTTI charges on certain securities in the Company’s AFS securities portfolio totaling $29.9 million for the fourth quarter 2006 compared to $2.0and $34.6 million or 0.79% of average loans for the third quarter. Absent the OTTI charges in 2008, noninterest income would have been $4.8 million in the fourth quarter 2005.
Noninterest income forversus $5.2 million in the fourththird quarter of 2006 declined $142,000, or 2.9%, to $4.8 million, from $4.92008 and $5.0 million in the fourth quarter of 2005.2007. The primary reason wasdecrease, exclusive of OTTI charges, is primarily the $297,000 decline in financial services groupresult of lower service charges on deposits and broker-dealer fees and commissions as the Company sold its trust relationshipsoffset by higher income from company owned life insurance due to a $20.0 million purchase of company owned life insurance made during the third quarter of 2006 and experienced lower sales volumes in the broker-dealer business.2008.
Noninterest expense for the fourth quarter of 20062008 was $15.2$15.4 million, compared with $13.4 million and $14.5 million in the third quarter of 2008 and fourth quarter of 2007, respectively. The fourth quarter of 2008 results include a 6.2% decrease from $16.2$557 thousand prepayment charge on the early repayment of borrowed funds and also a $259 thousand increase in FDIC insurance expense compared with the fourth quarter of last year. The third quarter of 2008 included $1.0 million in reversals of accrued incentive compensation in recognition that certain senior management incentive targets contingent on 2008 financial results would not be met.
The Company recorded income tax (benefit) expense of $(22.6) million and $524 thousand in the fourth and third quarters of 2008, respectively, compared to $1.2 million in the fourth quarter of 2005. Salaries2007. In the third quarter of 2008, the tax benefit recognized on the OTTI charge was based on the treatment of a substantial portion of the charge being classified as a capital loss for tax purposes, which significantly limited the tax benefit. Subsequently, on October 3, 2008, the Emergency Economic Stabilization Act was enacted, which included a provision permitting banks, under certain circumstances, to recognize losses relating to Fannie Mae and benefits increased $387,000 to $8.3 million inFreddie Mac preferred stock as an ordinary loss, therefore the fourth quarter results reflected the recognition of 2006 compared to the same quarter last year. The increase resulted from stock compensation expense recorded in 2006 as a result of the adoption of SFAS No. 123(R) and the reversal of certain bonus and incentive accruals in the prior year due to full-year 2005 financial results. Professional fees and services decreased to $747,000 in the fourth quarter of 2006, down 45.5% from $1.4$12.0 million in the fourth quarter of 2005. Other noninterest expense decreased $878,000, or 25.4% to $2.6 million in the fourth quarter of 2006 compared to the same quarter last year. This decrease in other noninterest expenses was due in part to one-time restructuring costs incurred in the fourth quarter of 2005.
Average total deposits were down 7.7% for the fourth quarter 2006 to $1.631 billion in comparison to $1.766 billion in the same quarter last year. Contributing to the decline in deposits were fewer certificates of deposit, including brokered certificates of deposit, as the Company actively managed to lower the level of these higher cost deposits. Other deposit categories declined due to deposit outflowstax benefit associated with the effects of the 2005 loan sale and from competitors offering higher rate products.third quarter OTTI charge.
Average total loans declined 6.7% to $933.0 million for the fourth quarter 2006, compared with $1.002 billion for the same quarter in the prior year. The Company’s loan portfolio declined as loan payments outpaced new loan originations. The Company’s strategy is to rebuild a balanced quality loan portfolio and loan originations slowed due to more stringent underwriting requirements, firm pricing disciplines and a highly competitive marketplace for quality loans. NonperformingTotal assets at December 31, 20062008 were $17.0$1.917 billion, up $59.0 million compared with $14.4from $1.858 billion at December 31, 2007. Total loans were $1.121 billion at December 31, 2008, an increase of $156.9 million at September 30, 2006, and $19.7from $964.2 million at December 31, 2005. The2007, principally from a $120.1 million increase in indirect auto loans. Total deposits increased $57.3 million to $1.633 billion at December 31, 2008, versus $1.576 billion at December 31, 2007. Total borrowings, including junior subordinated debentures, increased $2.6 million to $70.8 million at December 31, 2008, up from $68.2 million at December 31, 2007. Total shareholders’ equity at December 31, 2008 was $190.3 million, compared with $195.3 million at December 31, 2007. The Company’s leverage ratio was 8.05% and total risk-based capital ratio was 13.08% at December 31, 2008, which is within the fourth quarter 2006 was principally dueregulatory standard to one credit in the dairy industry.be deemed a well-capitalized institution.

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LIQUIDITY AND CAPITAL RESOURCES
Liquidity
The objective of maintaining adequate liquidity is to assure the ability of the Company to meet its financial obligations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of matured borrowings, as they mature, the ability to fund new and existing loan commitments and the ability to take advantage of new business opportunities. The Company achieves liquidity by maintaining a strong base of core customer funds, maturing short-term assets, theits ability to sell securities, lines of credit,lines-of-credit, and access to the financial and capital markets.
Liquidity for the Bank is managed through the monitoring of anticipated changes in loans, the investment portfolio, core deposits and wholesale funds. The strength of the Bank’s liquidity position is a result of its base of core customer deposits. These core deposits are supplemented by wholesale funding sources that include credit lines with the other banking institutions, the FHLB and the Federal Reserve Bank.
The primary sources of liquidity for FII are dividends from the Bank and access to financial and capital markets. Dividends from the Bank are limited by various regulatory requirements related to capital adequacy and earnings trends. The Bank relies on cash flows from operations, core deposits, borrowings and short-term liquid assets. FSIS relies on cash flows from operations and funds from FII when necessary.
The Company’s cash and cash equivalents were $109.8$55.2 million at December 31, 2006, up from $91.9 million at December 31, 2005. The Company began investing in commercial paper due in less than 90 days during 2006 and has classified the short-term investment as a cash equivalent when applicable. No such commercial paper was held as of December 31, 2006.2008, up from $46.7 million as of December 31, 2007. The Company’s net cash provided by operating activities totaled $30.2$21.3 million and the principal source of operating activity cash flow was net (loss) income adjusted for noncash income and expense items and changes in other assets and other liabilities. Net cash provided byused in investing activities totaled $120.5$97.8 million, which included net loan origination funding of $161.4 million offset by net proceeds of $56.4$88.3 million from a declinethe net decrease in securities and $62.0 million of loan payments in excess of loan originations.securities. Net cash used inprovided by financing activities of $132.8$85.0 million was primarily attributed to the $99.6$57.3 million decreaseincrease in deposits.
The Company’s cashdeposits and cash equivalents were $91.9 million at December 31, 2005, an increase of $45.8 million from $46.1 million at December 31, 2004. The Company’s net cash provided by operating activities totaled $45.1 million. The principal source of operating activity cash flow was the Company’s net income adjusted for noncash income and expenses items and changes in other assets and other liabilities. The Company utilized its cash in investing activities through the net acquisition of $84.5$35.6 million in securitiesproceeds from issuance of preferred and $4.8 million in premises and equipment. Net cash provided from investment activities included $70.5 million of loan payments in excess of loan originations, $140.5 million generated from the sale of commercial-related loans and $4.5 million from the sale of the discontinued subsidiary. The Company utilized cash in financing activities by funding a $101.7 million decrease in deposits, reducing debt by $17.4 million and paying $6.9 million in dividends to shareholders.common shares.
Contractual Obligations and Other Commitments
The following table presentssummarizes the maturities of various contractual obligations and other commitments (in thousands):
                     
  At December 31, 2008 
  Within 1  Over 1 to 3  Over 3 to 5  Over 5    
  year  years  Years  years  Total 
Certificates of deposit (1)
 $546,266  $86,588  $14,102  $511  $647,467 
Long-term borrowings  508   30,145         30,653 
Junior subordinated debentures           16,702   16,702 
Operating leases  1,237   2,050   1,815   5,215   10,317 
Limited partnership investments(2)
  1,865   1,865         3,730 
Service agreements  720   108         828 
Commitments to extend credit(3)
  339,454             
Standby letters of credit(3)
  7,902             
(1)Includes the maturity of certificates of deposit amounting to $100 thousand or more as follows: $87.5 million in three months or less; $30.1 million between three months and six months; $33.3 million between six months and one year; and $13.7 million over one year.
(2)The Company has committed to capital investments in several limited partnerships of up to $5.5 million. As of December 31, 2008, the Company has contributed $1.8 million to the partnerships, including $425 thousand during 2008.
(3)The Company does not expect all of the commitments to extend credit and standby letters of credit to be funded. Thus, the total commitment amounts do not necessarily represent the Company’s future cash requirements.
With the exception of the Company’s contractual obligations at December 31, 2006:
                     
      Less Than          More Than 
  Total  1 Year  1-3 Years  3-5 Years  5 Years 
   
Operating leases $4,689  $769  $1,310  $831  $1,779 
Service agreements and other  2,049   536   575   575   363 
Long-term borrowings  38,187   12,321   25,720   146    
Junior subordinated debentures  16,702            16,702 
                
                     
Total contractual obligations $61,627  $13,626  $27,605  $1,552  $18,844 
                
in connection with its trust preferred securities and in connection with its irrevocable loan commitments, the Company had no other off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on its financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. For additional information on off-balance sheet arrangements, see Note 1, Summary of Significant Accounting Policies and Note 9, Commitments and Contingencies, in the notes to the accompanying consolidated financial statements.

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Off-Balance Sheet ArrangementsSecurity Yields and Maturities Schedule
The Company has guaranteed distributions and payments for redemption or liquidation of trust preferred securities issued by a wholly owned, deconsolidated subsidiary trust to the extent of funds held by the trust. Although the guarantee is not separately recorded, the obligation underlying the guarantee is fully reflected on the Company’s consolidated statement of financial condition as junior subordinated debentures. The subsidiary’s trust preferred securities currently qualify as Tier 1 capital under the Federal Reserve Board’s capital adequacy guidelines. For furtherfollowing table sets forth certain information regarding the junior subordinated debentures issued to unconsolidated subsidiary trust, see Note 10amortized cost (“Cost”), weighted average yields (“Yield”) and contractual maturities of the notes to consolidated financial statements.
In the normal courseCompany’s debt securities portfolio as of business, the Company has outstanding commitments to extend credit that are not reflected in its consolidated financial statements. The commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. At December 31, 2006 stand-by letters2008. Actual maturities may differ from the contractual maturities presented, because borrowers may have the right to call or prepay certain investments. No tax-equivalent adjustments were made to the weighted average yields (in thousands).
                                         
                  Due after five       
  Due in one year  Due from one to  years through  Due after    
  or less  five years  ten years  ten years  Total 
  Cost  Yield  Cost  Yield  Cost  Yield  Cost  Yield  Cost  Yield 
Available for sale debt securities:
                                        
U.S. Government agency and government-sponsored enterprise $28,899   3.12% $19,414   3.96% $4,994   4.05% $14,563   2.40% $67,871   3.27%
Mortgage-backed securities  7,518   3.82   85,709   4.18   56,121   4.19   190,226   4.89   339,574   4.57 
Other asset-backed securities              147   3.66   3,771   5.26   3,918   5.20 
State and municipal obligations  42,284   3.42   69,168   3.61   16,640   3.46   1,481   3.44   129,572   3.53 
                                    
   78,701   3.35   174,291   3.93   77,902   4.02   210,041   4.71   540,935   4.16 
                                         
Held to maturity debt securities:
                                        
State and municipal obligations  45,124   2.71   10,773   3.84   2,063   4.78   572   5.37   58,532   3.02 
                                    
  $123,825   3.12% $185,064   3.93% $79,965   4.04% $210,613   4.71% $599,467   4.05%
                                    
Contractual Loan Maturity Schedule
The following table summarizes the contractual maturities of credit totaling $5.8 million and unusedthe Company’s loan commitments of $258.6 million were contractually available. Comparable amounts for these commitmentsportfolio at December 31, 2005 were $9.5 million2008. Loans, net of deferred loan origination costs, include principal amortization and $231.5 million, respectively. The total commitment amounts do not necessarily represent future cash requirementsnon-accrual loans. Demand loans having no stated schedule of repayment or maturity and overdrafts are reported as many of the commitments are expected to expire without funding. For further information regarding the outstanding loan commitments, see Note 12 of the notes to consolidated financial statements.due in one year or less (in thousands).
The Company also extends rate lock agreements to borrowers related to the origination of residential mortgage loans. To mitigate the interest rate risk inherent in these rate lock agreements, as well as closed mortgage loans held for sale, the Company enters into forward commitments to sell individual mortgage loans. Rate lock agreements and forward commitments are considered derivatives and are recorded at fair value in accordance with SFAS No. 133. At December 31, 2006 and 2005, the total notional amount of these derivatives (rate lock agreements and forward commitments) held by the Company amounted to $4.5 million and $8.2 million, respectively.
                 
  Due in less  Due from one  Due after    
  than one year  to five years  five years  Total 
Commercial $87,175  $62,227  $9,141  $158,543 
Commercial real estate  70,694   132,735   58,805   262,234 
Agricultural  16,817   16,649   11,240   44,706 
Residential real estate  48,682   87,407   41,594   177,683 
Consumer indirect  96,718   151,771   6,565   255,054 
Consumer direct and home equity  53,735   102,707   66,417   222,859 
             
                 
Total loans $373,821  $553,496  $193,762  $1,121,079 
             
                 
Loans maturing after one year:                
With a predetermined interest rate     $192,464  $126,903  $319,367 
With a floating or adjustable rate      361,032   66,859   427,891 
              
                 
Total loans maturing after one year     $553,496  $193,762  $747,258 
              

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Capital Resources
The FRB has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies on a consolidated basis. The guidelines require a minimum Tier 1 leverage ratio of 4.00%, a minimum Tier 1 capital ratio of 4.00% and a minimum total risk-based capital ratio of 8.0%. Leverage ratio is also utilized in assessing capital adequacy with a minimum requirement that can range from 4.0% to 5.0%8.00%. The following table reflects the ratios and their components of those ratios:(in thousands):
             
         
(Dollars in thousands) 2006  2005  2004 
 
Total shareholders’ equity $182,388  $171,757  $184,287 
Less: Unrealized gain (loss) on securities available for sale  (6,800)  (6,178)  3,884 
Unrecognized net periodic pension costs  210       
Unrecognized net periodic postretirement costs  (1,814)      
Disallowed goodwill and other intangible assets  38,263   38,839   43,476 
Plus: Minority interests in consolidated subsidiaries        178 
Qualifying trust preferred securities  16,200   16,200   16,200 
          
             
Total Tier 1 capital $168,729  $155,296  $153,305 
          
             
Adjusted quarterly average assets $1,894,611  $2,042,731  $2,149,947 
          
             
Tier 1 leverage ratio  8.91%  7.60%  7.13%
             
Total Tier 1 capital $168,729  $155,296  $153,305 
Plus: Qualifying allowance for loan losses  13,355   14,191   17,271 
          
             
Total risk-based capital $182,084  $169,487  $170,576 
          
             
Net risk-weighted assets $1,064,686  $1,129,277  $1,359,803 
          
             
Total risk-based capital ratio  17.10%  15.01%  12.54%
The Company’s Tier 1 leverage ratio was 8.91% at December 31, 2006. The ratio increased from 7.60% at December 31, 2005. Total Tier 1 capital of $168.7 million at December 31, 2006 increased $13.4 million from

50


$155.3 million at December 31, 2005. Total shareholders’ equity increased $10.6 million in 2006, primarily resulting from the $17.4 million of net income and $865,000 in additional paid in capital from the amortization of unvested stock-based compensation, offset by $5.3 million in dividends declared, $604,000 in unrealized loss on securities available for sale and $1.6 million in unrecognized net periodic pension and postretirement costs associated with the adoption of SFAS No. 158.
The Company’s total risk-based capital ratio was 17.10% at December 31, 2006, up from 15.01% at December 31, 2005. Total risk-based capital was $182.1 million at December 31, 2006, an increase of $12.6 million from $169.5 million at December 31, 2005. The risk-based capital ratio improvement was also impacted by the change in the Company’s asset composition, as the Company experienced a decrease in higher risk-weighted loans, coupled with an increase in lower risk-weighted investment securities.
         
  2008  2007 
         
Total shareholders’ equity $190,300  $195,322 
Less: Unrealized gain (loss) on securities available for sale, net of tax  3,463   (500)
Unrecognized net periodic pension & postretirement benefits (costs), net of tax  (7,476)  1,167 
Disallowed goodwill and other intangible assets  37,650   37,956 
Disallowed deferred tax assets  22,437    
Plus: Qualifying trust preferred securities  16,200   16,200 
       
Tier 1 capital $150,426  $172,899 
       
Adjusted average total assets (for leverage capital purposes) $1,869,111  $1,848,584 
       
         
Tier 1 leverage ratio (Tier 1 capital to adjusted average total assets)  8.05%  9.35%
         
Total Tier 1 capital $150,426  $172,899 
Plus: Qualifying allowance for loan losses  15,936   13,753 
       
         
Total risk-based capital $166,362  $186,652 
       
         
Net risk-weighted assets $1,272,028  $1,098,476 
       
         
Tier 1 capital ratio (Tier 1 capital to net risk-weighted assets)  11.83%  15.74%
         
Total risk-based capital ratio (Total risk-based capital to net risk-weighted assets)  13.08%  16.99%
RECENT ACCOUNTING PRONOUNCEMENTS
See Note 1, “SummarySummary of Significant Accounting Policies — Recent Accounting Pronouncements, in the notes to consolidated financial statements for a discussion of recent accounting pronouncements.

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ItemITEM 7A. Quantitative and Qualitative Disclosures About Market Risk
Market RiskQUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The principal objective of the Company’s interest rate risk management is to evaluate the interest rate risk inherent in certain assets and liabilities, determine the appropriate level of risk to the Company given its business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with the guidelines approved by FII’s Board of Directors. The Company’s management is responsible for reviewing with the Board its activities and strategies, the effect of those strategies on the net interest margin, the fair value of the portfolio and the effect that changes in interest rates will have on the portfolio and exposure limits. Management developshas developed an Asset-Liability Policy that meets strategic objectives and regularly reviews the activities of the Bank.
Net Interest Income at Risk Analysis
The primary tool the Company uses to manage interest rate risk is a “rate shock” simulation to measure the rate sensitivity of the balance sheet.statement of financial condition. Rate shock simulation is a modeling technique used to estimate the impact of changes in rates on net interest income and economic value of equity. The following table sets forth the results of the modeling analysis atas of December 31, 2006:
(Dollars2008 (dollars in thousands):
                         
Change in Interest        
Rates in Basis Points Net Interest Income Economic Value of Equity
(Rate Shock) Amount $Change % Change Amount $Change % Change
 
200 $59,503  $(2,871)  (4.60)% $302,527  $(38,615)  (11.32)%
100  61,112   (1,262)  (2.02)%  321,789   (19,353)  (5.67)%
Static  62,374         341,142       
(100)  63,721   1,347   2.16%  362,643   21,501   6.30%
(200)  64,275   1,901   3.05%  377,987   36,845   10.80%
                         
Changes in Net Interest Income  Economic Value of Equity 
interest rate Amount  Change  Amount  Change 
                         
+ 200 basis points $71,287  $1,379   1.97% $381,831  $7,211   1.92%
+ 100 basis points  70,655   747   1.07   380,915   6,295   1.68 
- 100 basis points  69,087   (821)  (1.17)  379,048   4,427   1.18 
- 200 basis points  67,671   (2,237)  (3.20)  384,737   10,117   2.70 
The Company measures net interest income at risk by estimating the changes in net interest income resulting from instantaneous and sustained parallel shifts in interest rates of different magnitudes over a period of 12 months. As of December 31, 2006,2008, a 200 basis point increase in rates would decreaseincrease net interest income by $2.9$1.4 million, or 4.60%1.97%, over the next twelve-month period. A 200 basis point decrease in rates would increasedecrease net interest income by $1.9$2.2 million, or 3.05%3.20%, over a twelve-month period. As of December 31, 2006,2008, a 200 basis point increase in rates would decreaseincrease the economic value of equity by $38.6$7.2 million, or 11.32%1.92%, over the next twelve-month period. A 200 basis point decrease in rates would increase the economic value of equity by $36.8$10.1 million, or 10.80%2.70%, over a twelve-month period. This simulation is based on management’s assumption as to the effect of interest rate changes on assets and liabilities and assumes a parallel shift of the yield curve. It also includes certain assumptions about the future pricing of loans and deposits in response to changes in interest rates.

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Further, it assumes that delinquency rates would not change as a result of changes in interest rates, although there can be no assurance that this will be the case. While this simulation is a useful measure as to net interest income at risk due to a change in interest rates, it is not a forecast of the future results and is based on many assumptions that, if changed, could cause a different outcome.
In addition to the changes in interest rate scenarios listed above, the Company typically runs other scenarios to measure interest rate risk, which vary depending on the economic and interest rate environments.

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Gap Analysis
The following table (the “Gap Table”) sets forthpresents an analysis of the amounts ofCompany’s interest rate sensitivity gap position at December 31, 2008. All interest-earning assets and interest-bearing liabilities outstanding at December 31, 2006 which management anticipates,are shown based upon certain assumptions, to re-price or mature in each of the future time periods shown. Except as stated below, the amount of assets and liabilities shown which re-price or mature during a particular period were determined in accordance withon the earlier of the re-pricing date or thetheir contractual maturity or repricing date. The expected maturities are presented on a contractual basis or, if more relevant, based on projected call dates. Investment securities are at amortized cost for both securities available for sale and securities held to maturity. Loans, net of the asset or liability. The table sets forth an approximation of the projected re-pricing of assets and liabilities on the basisdeferred loan origination costs, include principal amortization adjusted for estimated prepayments (principal payments in excess of contractual maturities, anticipatedamounts) and non-accrual loans. Borrowings include junior subordinated debentures. Because the interest rate sensitivity levels shown in the table could be changed by external factors such as loan prepayments and scheduledliability decay rates or by factors controllable by the Company such as asset sales, it is not an absolute reflection of our potential interest rate adjustments within the selected time intervals. All non-maturity deposits (demand deposits and savings deposits) are subject to immediate withdrawal and are therefore shown to re-price in the period of less than 30 days. Prepayment and re-pricing rates can have a significant impact on the estimated gap. The results shown are based on numerous assumptions and there can be no assurance that the presented results will approximate actual future activity.risk profile (in thousands).
                                 
  December 31, 2006 
  Volumes Subject to Repricing Within 
  0-30  31-180  181-365  1-3  3-5  >5  Non-    
(Dollars in thousands) days  days  days  years  years  years  Sensitive  Total 
 
Interest-earning assets:                                
Federal funds sold and interest-bearing deposits $62,233  $  $194  $179  $  $  $  $62,606 
Investment securities (1)  9,004   100,480   68,695   257,052   164,300   176,005      775,536 
Loans (2)  299,341   60,852   71,477   193,521   141,558   155,317   5,408   927,474 
                         
Total interest- earning assets  370,578   161,332   140,366   450,752   305,858   331,322   5,408   1,765,616 
                         
                                 
Interest-bearing liabilities:                                
Interest-bearing demand, savings and money market  674,224                     674,224 
Certificates of deposit  84,846   207,841   288,737   77,043   10,743   478      669,688 
Borrowed funds (3)  32,315   1,023   11,294   25,720   145   16,702      87,199 
                         
Total interest- bearing liabilities  791,385   208,864   300,031   102,763   10,888   17,180      1,431,111 
                         
                                 
Period gap $(420,807) $(47,532) $(159,665) $347,989  $294,970  $314,142  $5,408  $334,505 
                         
                                 
Cumulative gap $(420,807) $(468,339) $(628,004) $(280,015) $14,955  $329,097  $334,505     
                         
                                 
Period gap to total assets  (22.06)%  (2.49)%  (8.37)%  18.24%  15.46%  16.47%  0.29%  17.54%
                         
                                 
Cumulative gap to total assets  (22.06)%  (24.55)%  (32.92)%  (14.68)%  0.78%  17.25%  17.54%    
                         
                                 
Cumulative interest-earning assets to cumulative interest- bearing liabilities  46.83%  53.18%  51.70%  80.04%  101.06%  123.00%  123.37%    
                         
                     
  At December 31, 2008 
      Over Three  Over       
  Three  Months  One Year       
  Months  Through  Through  Over    
  or Less  One Year  Five Years  Five Years  Total 
INTEREST-EARNING ASSETS:                    
Federal funds sold and interest-earning deposits in other banks $20,574  $  $85  $  $20,659 
Investment securities  86,574   201,816   277,543   34,457   600,390 
Loans held for sale  1,013            1,013 
Loans  346,857   208,972   486,835   78,415   1,121,079 
                 
Total interest-earning assets $455,018  $410,788  $764,463  $112,872   1,743,141 
                 
Cash and due from banks                  34,528 
Other assets(1)
                  139,250 
                    
Total assets                 $1,916,919 
                    
                     
INTEREST-BEARING LIABILITIES:                    
Interest-bearing demand, savings and money market $693,210  $  $  $  $693,210 
Certificates of deposit  208,856   337,410   100,690   511   647,467 
Borrowings  23,943   30   30,145   16,702   70,820 
                
Total interest-bearing liabilities $926,009  $337,440  $130,835  $17,213   1,411,497 
                 
Noninterest-bearing deposits                  292,586 
Other liabilities                  22,536 
                    
Total liabilities                  1,726,619 
Shareholders’ equity                  190,300 
                    
Total liabilities and shareholders’ equity                 $1,916,919 
                    
                     
Interest sensitivity gap $(470,991) $73,348  $633,628  $95,659  $331,644 
                
Cumulative gap $(470,991) $(397,643) $235,985  $331,644  $  
                 
                     
Cumulative gap ratio(2)
  49.1%  68.5%  116.9%  123.5%    
Cumulative gap as a percentage of total assets  (24.6)%  (20.7)%  12.3%  17.3%    
 
(1) Amounts shown include the amortized cost of held to maturity
(1)Includes net unrealized gain on securities and the fair value of available for sale securities.and allowance for loan losses.
 
(2) Amounts shown include loans held for sale and are net of unearned income and net deferred fees and costs.
(3)Amounts shown include junior subordinated debentures.Cumulative total interest-earning assets divided by cumulative total interest-bearing liabilities.
For purposes of interest rate risk management, the Company directs more attention on simulation modeling, such as “net interest income at risk” as previously discussed, rather than gap analysis. The net interest income at risk simulation modeling is considered by management to be more informative in forecasting future income at risk.

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ItemITEM 8. Financial Statements and Supplementary DataFINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
Index to Consolidated Financial Statements
Page
59
60
61
62
63
64
66
67

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Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for Financial Institutions, Inc. and its subsidiaries (the “Company”), as such term is defined in Exchange Act Rules 13a-15(f). The Company’s system of internal control over financial reporting has been designed to provide reasonable assurance to the Company’s management and board of directors regarding the reliability of financial reporting and the preparation and fair presentation of financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
Any system of internal control over financial reporting, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation and presentation.
The Company’s management has assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 20062008. To make this assessment, we used the criteria for effective internal control over financial reporting described inInternal Control — Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment and 2005based on such criteria, we believe that, as of December 31, 2008, the Company’s internal control over financial reporting was effective.
The Company’s independent registered public accounting firm that audited the Company’s consolidated financial statements has issued an attestation report on internal control over financial reporting as of December 31, 2008. That report appears herein.
/s/ Peter G. Humphrey
/s/ Ronald A. Miller
President and Chief Executive OfficerExecutive Vice President and Chief Financial Officer
March 12, 2009March 12, 2009

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Report of Independent Registered Public Accounting Firm
         
      
(Dollars in thousands, except per share amounts) 2006  2005 
 
Assets
        
Cash and due from banks $47,166  $46,987 
Federal funds sold and interest-bearing deposits in other banks  62,606   44,953 
Securities available for sale, at fair value  735,148   790,855 
Securities held to maturity (fair value of $40,421 and $42,898 at December 31, 2006 and 2005, respectively)  40,388   42,593 
Loans held for sale  992   1,253 
         
Loans  926,482   992,321 
Less: Allowance for loan losses  17,048   20,231 
       
Loans, net  909,434   972,090 
         
Premises and equipment, net  34,562   36,471 
Goodwill  37,369   37,369 
Other assets  39,887   49,821 
       
         
Total assets $1,907,552  $2,022,392 
       
         
Liabilities and Shareholders’ Equity
        
         
Liabilities:        
Deposits:        
Noninterest-bearing demand $273,783  $284,958 
Interest-bearing demand, savings and money market  674,224   755,229 
Certificates of deposit  669,688   677,074 
       
Total deposits  1,617,695   1,717,261 
Short-term borrowings  32,310   20,106 
Long-term borrowings  38,187   78,391 
Junior subordinated debentures issued to unconsolidated subsidiary trust (“Junior subordinated debentures”)  16,702   16,702 
Other liabilities  20,270   18,175 
       
         
Total liabilities  1,725,164   1,850,635 
         
Shareholders’ equity:        
3% cumulative preferred stock, $100 par value, authorized 10,000 shares, issued and outstanding 1,586 shares at December 31, 2006 and 2005  159   159 
8.48% cumulative preferred stock, $100 par value, authorized 200,000 shares, issued and outstanding 174,639 and 174,747 shares at December 31, 2006 and 2005, respectively  17,464   17,475 
Common stock, $0.01 par value, authorized 50,000,000 shares, issued 11,348,122 and 11,334,874 shares at December 31, 2006 and 2005, respectively  113   113 
Additional paid-in capital  24,439   23,278 
Retained earnings  148,730   136,925 
Accumulated other comprehensive loss  (8,404)  (6,178)
Treasury stock, at cost — 5,351 and 1,000 shares at December 31, 2006 and 2005, respectively  (113)  (15)
       
         
Total shareholders’ equity  182,388   171,757 
       
         
Total liabilities and shareholders’ equity $1,907,552  $2,022,392 
       
The Board of Directors and Shareholders
Financial Institutions, Inc.:
We have audited Financial Institutions, Inc. and subsidiaries’ (the Company) internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also includes performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control—Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of the Company as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2008, and our report dated March 12, 2009 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Buffalo, New York
March 12, 2009

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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders
Financial Institutions, Inc.:
We have audited the accompanying consolidated statements of financial condition of Financial Institutions, Inc. and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated statements of operations, changes in shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2008. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of the Company as of December 31, 2008 and 2007, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2008, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the Company’s internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control — Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated March 12, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting.
/s/ KPMG LLP
Buffalo, New York
March 12, 2009

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
         
  December 31, 
(Dollars in thousands, except share and per share data) 2008  2007 
ASSETS
        
Cash and cash equivalents:        
Cash and due from banks $34,528  $45,165 
Federal funds sold and interest-bearing deposits in other banks  20,659   1,508 
       
Total cash and cash equivalents  55,187   46,673 
Securities available for sale, at fair value  547,506   695,241 
Securities held to maturity, at amortized cost (fair value of $59,147 and $59,902, respectively)  58,532   59,479 
Loans held for sale  1,013   906 
Loans  1,121,079   964,173 
Less: Allowance for loan losses  18,749   15,521 
       
Loans, net  1,102,330   948,652 
Company owned life insurance  23,692   3,017 
Premises and equipment, net  36,712   34,157 
Goodwill  37,369   37,369 
Other assets  54,578   32,382 
       
Total assets $1,916,919  $1,857,876 
       
         
LIABILITIES AND SHAREHOLDERS’ EQUITY
        
Deposits:        
Noninterest-bearing demand $292,586  $286,362 
Interest-bearing demand  344,616   335,314 
Savings and money market  348,594   346,639 
Certificates of deposit  647,467   607,656 
       
Total deposits  1,633,263   1,575,971 
Short-term borrowings  23,465   25,643 
Long-term borrowings  47,355   42,567 
Other liabilities  22,536   18,373 
       
Total liabilities  1,726,619   1,662,554 
       
         
Commitments and contingencies (Note 9)        
         
Shareholders’ equity:        
Series A 3% Preferred Stock, $100 par value; 1,533 shares authorized and issued at December 31, 2008; 10,000 shares authorized, 1,586 shares issued at December 31, 2007  153   159 
Series A Preferred Stock, $100 par value; 7,503 shares authorized and issued at December 31, 2008, aggregate liquidation preference $37,515; net of $2,016 discount  35,499    
Series B-1 8.48% Preferred Stock, $100 par value, 200,000 shares authorized, 174,223 shares issued  17,422   17,422 
       
Total preferred equity  53,074   17,581 
Common stock, $0.01 par value, 50,000,000 shares authorized, 11,348,122 shares issued  113   113 
Additional paid-in capital  26,397   24,778 
Retained earnings  124,952   158,744 
Accumulated other comprehensive (loss) income  (4,013)  667 
Treasury stock, at cost — 550,103 and 336,971 shares, respectively  (10,223)  (6,561)
       
Total shareholders’ equity  190,300   195,322 
       
Total liabilities and shareholders’ equity $1,916,919  $1,857,876 
       
See accompanying notes to the consolidated financial statements.

53

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Operations
             
  Years ended December 31, 
(Dollars in thousands, except per share amounts) 2008  2007  2006 
Interest income:            
Interest and fees on loans $67,674  $68,560  $68,004 
Interest and dividends on investment securities  30,655   34,990   32,778 
Other interest income  619   1,662   2,288 
          
Total interest income  98,948   105,212   103,070 
          
Interest expense:            
Deposits  29,349   42,714   37,445 
Short-term borrowings  721   864   571 
Long-term borrowings  3,547   3,561   5,588 
          
Total interest expense  33,617   47,139   43,604 
          
             
Net interest income  65,331   58,073   59,466 
Provision (credit) for loan losses  6,551   116   (1,842)
          
Net interest income after provision (credit) for loan losses  58,780   57,957   61,308 
          
Noninterest (loss) income:            
Service charges on deposits  10,497   10,932   11,504 
ATM and debit card  3,313   2,883   2,233 
Broker-dealer fees and commissions  1,458   1,396   1,511 
Loan servicing  664   928   892 
Company owned life insurance  563   1,255   521 
Net gain on sale of loans held for sale  339   779   972 
Net gain on sale of other assets  305   89   169 
Net gain on investment securities  288   207   30 
Net gain on sale of trust relationships     13   1,386 
Impairment charges on investment securities  (68,215)      
Other  2,010   2,198   2,693 
          
Total noninterest (loss) income  (48,778)  20,680   21,911 
          
Noninterest expense:            
Salaries and employee benefits  31,437   33,175   33,563 
Occupancy and equipment  10,502   9,903   9,465 
Computer and data processing  2,433   2,126   1,903 
Professional services  2,141   2,080   2,837 
Supplies and postage  1,800   1,662   1,945 
Advertising and promotions  1,453   1,402   1,974 
Other  7,695   7,080   7,925 
          
Total noninterest expense  57,461   57,428   59,612 
          
(Loss) income before income taxes  (47,459)  21,209   23,607 
Income tax (benefit) expense  (21,301)  4,800   6,245 
          
Net (loss) income $(26,158) $16,409  $17,362 
          
Preferred stock dividends, net of accretion  1,538   1,483   1,486 
          
Net (loss) income applicable to common shareholders $(27,696) $14,926  $15,876 
          
(Loss) earnings per common share (Note 15):            
Basic $(2.56) $1.34  $1.40 
Diluted $(2.56) $1.33  $1.40 
See accompanying notes to the consolidated financial statements.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity
Years ended December 31, 2008, 2007 and 2006
                             
                  Accumulated        
          Additional      Other      Total 
  Preferred  Common  Paid-in  Retained  Comprehensive  Treasury  Shareholders’ 
(Dollars in thousands, except per share data) Equity  Stock  Capital  Earnings  Income (Loss)  Stock  Equity 
Balance at January 1, 2006
 $17,634  $113  $23,278  $136,925  $(6,178) $(15) $171,757 
Comprehensive income:                            
Net income           17,362         17,362 
Other comprehensive loss, net of tax              (622)     (622)
                            
Total comprehensive income                          16,740 
Adjustment to initially apply SFAS 158              (1,604)     (1,604)
Repurchase of 20,351 common shares                 (335)  (335)
Repurchase of Series B-1 8.48% Preferred Stock  (11)                 (11)
Share-based compensation plans:                            
Share-based compensation        865            865 
Stock options exercised        181         23   204 
Restricted stock awards issued        (130)        130    
Directors’ retainer        28         84   112 
Cash dividends declared:                            
Series A 3% Preferred-$3.00 per share           (5)        (5)
Series B-1 8.48% Preferred-$8.48 per share           (1,481)        (1,481)
Common-$0.34 per share           (3,854)        (3,854)
                      
Balance at December 31, 2006
 $17,623  $113  $24,222  $148,947  $(8,404) $(113) $182,388 
Comprehensive income:                            
Net income           16,409         16,409 
Other comprehensive income, net of tax              9,071      9,071 
                            
Total comprehensive income                          25,480 
Repurchase of 368,815 common shares                 (7,203)  (7,203)
Repurchase of Series B-1 8.48% Preferred Stock  (42)                 (42)
Share-based compensation plans:                            
Share-based compensation        955            955 
Stock options exercised        (53)        304   251 
Restricted stock awards issued        (344)        344    
Directors’ retainer        (2)        107   105 
Cash dividends declared:                            
Series A 3% Preferred-$3.00 per share           (5)        (5)
Series B-1 8.48% Preferred-$8.48 per share           (1,478)        (1,478)
Common-$0.46 per share           (5,129)        (5,129)
                      
Balance at December 31, 2007
 $17,581  $113  $24,778  $158,744  $667  $(6,561) $195,322 
                      
Continued on next page
See accompanying notes to the consolidated financial statements.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOMEConsolidated Statements of Changes in Shareholders’ Equity (Continued)
Years Endedended December 31, 2006, 20052008, 2007 and 20042006
             
(Dollars in thousands, except per share amounts) 2006  2005  2004 
 
Interest income:            
Interest and fees on loans $68,004  $71,649  $78,063 
Interest and dividends on securities  32,778   30,762   27,664 
Other interest income  2,288   1,476   448 
          
Total interest income  103,070   103,887   106,175 
          
             
Interest expense:            
Deposits  37,445   30,255   24,624 
Short-term borrowings  571   377   284 
Long-term borrowings  3,860   4,035   4,132 
Junior subordinated debentures  1,728   1,728   1,728 
          
Total interest expense  43,604   36,395   30,768 
          
             
Net interest income  59,466   67,492   75,407 
 
(Credit) provision for loan losses  (1,842)  28,532   19,676 
          
             
Net interest income after (credit) provision for loan losses  61,308   38,960   55,731 
          
             
Noninterest income:            
Service charges on deposits  11,504   11,586   11,987 
ATM and debit card  2,233   1,680   1,374 
Financial services group fees and commissions  1,890   2,687   2,518 
Mortgage banking revenues  1,194   1,597   2,147 
Income from corporate owned life insurance  521   90   30 
Net gain on sale of credit card portfolio        1,177 
Net gain on sale and call of securities  30   14   248 
Net gain on sale of student loans held for sale  670   245    
Net gain on sale of commercial-related loans held for sale  82   9,369    
Net (loss) gain on sale of premises and equipment  (3)  (321)  2 
Net gain (loss) on sale of other real estate and repossessed assets  90   (9)  193 
Net gain on sale of trust relationships  1,386       
Other  2,314   2,446   2,473 
          
Total noninterest income  21,911   29,384   22,149 
          
             
Noninterest expense:            
Salaries and employee benefits  33,563   34,763   34,468 
Occupancy and equipment  9,465   9,022   8,436 
Supplies and postage  1,945   2,173   2,319 
Amortization of other intangible assets  420   430   709 
Computer and data processing  1,903   1,930   1,780 
Professional fees and services  2,837   5,074   3,439 
Other  9,479   12,100   10,616 
          
Total noninterest expense  59,612   65,492   61,767 
          
             
Income from continuing operations before income taxes  23,607   2,852   16,113 
             
Income tax expense (benefit) from continuing operations  6,245   (1,766)  3,170 
          
             
Income from continuing operations  17,362   4,618   12,943 
             
Discontinued operations:            
Loss from operations of discontinued subsidiary     (340)  (599)
Loss on sale of discontinued subsidiary     (1,071)   
Income tax expense (benefit)     1,041   (149)
          
Loss on discontinued operations     (2,452)  (450)
          
             
Net Income $17,362  $2,166  $12,493 
          
             
Earnings per common share:            
Basic:            
Income from continuing operations $1.40  $0.28  $1.02 
Net income $1.40  $0.06  $0.98 
Diluted:            
Income from continuing operations $1.40  $0.28  $1.02 
Net income $1.40  $0.06  $0.98 
                             
                  Accumulated        
          Additional      Other      Total 
  Preferred  Common  Paid-in  Retained  Comprehensive  Treasury  Shareholders’ 
(Dollars in thousands, except per share data) Equity  Stock  Capital  Earnings  Income (Loss)  Stock  Equity 
Balance at December 31, 2007
 $17,581  $113  $24,778  $158,744  $667  $(6,561) $195,322 
Balance carried forward
                            
Comprehensive income:                            
Net loss           (26,158)        (26,158)
Other comprehensive loss, net of tax              (4,680)     (4,680)
                      
Total comprehensive loss                          (30,838)
Cumulative effect of adoption of EITF 06-4 and SFAS 158 transition adjustment           (241)        (241)
Repurchase of 272,861 common shares                 (4,818)  (4,818)
Repurchase of Series A 3% Preferred Stock  (6)     3            (3)
Warrant issued in connection with Series A Preferred Stock        2,025            2,025 
Issue shares of Series A Preferred Stock  37,515                  37,515 
Discount on Series A Preferred Stock  (2,025)                 (2,025)
Accretion of preferred stock discount  9           (9)           
Share-based compensation plans:                            
Share-based compensation        603   30         633 
Stock options exercised        (12)        44   32 
Restricted stock awards issued        (998)        998    
Directors’ retainer        (2)        114   112 
Accrued undeclared cumulative dividend on Series A Preferred Stock           (47)        (47)
Cash dividends declared:                            
Series A 3% Preferred-$3.00 per share           (5)        (5)
Series B-1 8.48% Preferred-$8.48 per share           (1,477)        (1,477)
Common-$0.54 per share           (5,885)        (5,885)
                      
Balance at December 31, 2008
 $53,074  $113  $26,397  $124,952  $(4,013) $(10,223) $190,300 
                      
See accompanying notes to the consolidated financial statements.

54

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN
SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME
Years Ended December 31, 2006, 2005 and 2004
                                 
                  Accumulated Other    
  3%  8.48%      Additional  Comprehensive  Total 
(Dollars in thousands, Preferred  Preferred  Common  Paid in  Retained  Income  Treasury  Shareholders’ 
     except per share amounts) Stock  Stock  Stock  Capital  Earnings  (Loss)  Stock  Equity 
 
Balance – December 31, 2003
 $167  $17,568  $113  $21,055  $136,938  $8,197  $(935) $183,103 
Purchase of 12 shares of 3% preferred stock  (2)        1            (1)
Purchase of 112 shares of 8.48% preferred stock     (11)     (1)           (12)
Purchase of 2,000 shares of common stock                    (30)  (30)
Issue 2,266 shares of common stock — directors plan           36         16   52 
Issue 65,975 shares of common stock - exercised stock options, net of tax           667         464   1,131 
Tax benefit from stock options exercised           204            204 
Issue 14,524 shares of common stock - Burke Group, Inc. acquisition and earnout           223         102   325 
Comprehensive income:                                
Net income              12,493         12,493 
Net unrealized loss on securities available for sale (net of tax of ($2,765))                 (4,164)     (4,164)
Reclassification adjustment for net gains included in net income (net of tax of $99)                 (149)     (149)
                                
Other comprehensive loss                              (4,313)
                                
Total comprehensive income                              8,180 
                                
Cash dividends declared:                                
3% Preferred — $3.00 per share              (5)        (5)
8.48% Preferred — $8.48 per share              (1,490)        (1,490)
Common — $0.64 per share              (7,170)        (7,170)
                         
Balance — December 31, 2004
 $165  $17,557  $113  $22,185  $140,766  $3,884  $(383) $184,287 
 
Purchase of 68 shares of 3% preferred stock  (6)        3            (3)
Purchase of 824 shares of 8.48% preferred stock     (82)     (4)           (86)
Purchase of 6,000 shares of common stock                    (89)  (89)
Issue 3,140 shares of common stock — directors plan           35         22   57 
Issue 67,253 shares of common stock - exercised stock options, net of tax           648         292   940 
Tax benefit from stock options exercised           129            129 
Issue 20,406 shares of common stock - Burke Group, Inc. contingent earnout           282         143   425 
Comprehensive loss:                                
Net income              2,166         2,166 
Net unrealized loss on securities available for sale (net of tax of ($6,670))                 (10,053)     (10,053)
Reclassification adjustment for net gains included in net income (net of tax of $5)                 (9)     (9)
                                
Other comprehensive loss                              (10,062)
                                
Total comprehensive loss                              (7,896)
                                
Cash dividends declared:                                
3% Preferred — $3.00 per share              (5)        (5)
8.48% Preferred — $8.48 per share              (1,483)        (1,483)
Common — $0.40 per share              (4,519)        (4,519)
                         
Balance — December 31, 2005
 $159  $17,475  $113  $23,278  $136,925  $(6,178) $(15) $171,757 
 
Purchase of 108 shares of 8.48% preferred stock     (11)                 (11)
Purchase of 20,351 shares of common stock                    (335)  (335)
Issue 5,693 shares of common stock – directors retainer           28         84   112 
Issue 10,355 shares of common stock - exercised stock options, net of tax           173         23   196 
Excess tax benefit from stock options exercised           8            8 
Issue 13,200 shares of common stock - restricted stock awards           131   (261)     130    
Amortization of unvested stock options           821            821 
Amortization of unvested restricted stock awards              44         44 
Defined benefit pension plan – adjustment for SFAS 158:                                
Net prior service cost (net of tax of ($1,087))                 (1,704)     (1,704)
Net loss (net of tax of ($70))                 (110)     (110)
                                
Net adjustment for defined benefit pension plan                              (1,814)
                                
Postretirement benefit plan – adjustment for SFAS 158:                                
Net prior service benefit (net of tax of $287)                 450      450 
Net loss (net of tax of ($153))                 (240)     (240)
                                
Net adjustment for postretirement benefit plan                              210 
                                
Comprehensive income:                                
Net income              17,362         17,362 
Net unrealized loss on securities available for sale (net of tax of ($229))                 (604)     (604)
Reclassification adjustment for net gains included in net income (net of tax of ($12))                 (18)     (18)
                                
Other comprehensive loss                              (622)
                                
Total comprehensive income                              16,740 
                                
Cash dividends declared:                                
3% Preferred — $3.00 per share              (5)        (5)
8.48% Preferred — $8.48 per share              (1,481)        (1,481)
Common — $0.34 per share              (3,854)        (3,854)
                         
Balance — December 31, 2006
 $159  $17,464  $113  $24,439  $148,730  $(8,404) $(113) $182,388 
                         
Consolidated Statements of Cash Flows
             
  Years ended December 31, 
(Dollars in thousands) 2008  2007  2006 
Cash flows from operating activities:            
Net (loss) income $(26,158) $16,409  $17,362 
Adjustments to reconcile net (loss) income to net cash provided by operating activities:            
Depreciation and amortization  3,959   3,991   4,125 
Net amortization (accretion) of premiums and discounts on securities  390   (185)  644 
Provision (credit) for loan losses  6,551   116   (1,842)
Share-based compensation  633   955   865 
Deferred income tax (benefit) expense  (23,848)  715   63 
Proceeds from sale of loans held for sale  28,685   48,048   69,451 
Originations of loans held for sale  (28,453)  (47,183)  (68,793)
Increase in company owned life insurance  (563)  (111)  (102)
Net gain on sale of loans held for sale  (339)  (779)  (972)
Net gain on sale and disposal of other assets  (305)  (89)  (169)
Net gain on investment securities  (288)  (207)  (30)
Net gain on sale of trust relationships     (13)  (1,386)
Impairment charge on investment securities  68,215       
(Increase) decrease in other assets  (1,322)  3,510   8,774 
(Decrease) increase in other liabilities  (5,866)  (2,406)  2,324 
          
Net cash provided by operating activities  21,291   22,771   30,314 
          
Cash flows from investing activities:            
Purchase of investment securities:            
Available for sale  (310,191)  (307,049)  (66,769)
Held to maturity  (54,925)  (54,926)  (32,524)
Proceeds from principal payments, maturities and calls on investment securities:            
Available for sale  337,704   308,323   119,305 
Held to maturity  57,325   36,169   34,724 
Proceeds from sale of securities available for sale  58,368   49,350   1,699 
Net loan originations  (161,414)  (41,778)  61,996 
Purchase of company owned life insurance  (20,112)  (58)  (112)
Proceeds from sales of other assets  1,783   1,294   2,506 
Proceeds from sale of trust relationships     13   1,386 
Purchase of premises and equipment  (6,333)  (3,407)  (1,871)
          
Net cash (used in) provided by investing activities  (97,795)  (12,069)  120,340 
          
Cash flows from financing activities:            
Net increase (decrease) in deposits  57,292   (41,724)  (99,566)
Net (decrease) increase in short-term borrowings  (2,178)  (6,668)  12,204 
Proceeds from long-term borrowings  30,000       
Repayment of long-term borrowings  (25,212)  (12,321)  (40,204)
Purchase of preferred and common shares  (4,821)  (7,245)  (346)
Proceeds from issuance of preferred and common shares  35,602   105   112 
Proceeds from issuance of common stock warrant  2,025       
Proceed from stock options exercised  32   251   204 
Cash dividends paid to preferred shareholders  (1,482)  (1,483)  (1,486)
Cash dividends paid to common shareholders  (6,240)  (4,716)  (3,740)
          
Net cash provided by (used in) financing activities  85,018   (73,801)  (132,822)
          
Net increase (decrease) in cash and cash equivalents  8,514   (63,099)  17,832 
Cash and cash equivalents, beginning of period  46,673   109,772   91,940 
          
Cash and cash equivalents, end of period $55,187  $46,673   109,772 
          
See accompanying notes to the consolidated financial statements.

55

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31, 2006, 2005 and 2004
             
(Dollars in thousands) 2006  2005  2004 
 
Cash flows from operating activities:            
Net income $17,362  $2,166  $12,493 
Adjustments to reconcile net income to net cash provided by operating activities:            
Depreciation and amortization  4,125   4,388   4,421 
Net amortization of premiums and discounts on securities  644   874   1,801 
(Credit) provision for loan losses  (1,842)  28,532   19,676 
Amortization of unvested stock options  821       
Amortization of unvested restricted stock awards  44       
Tax benefit from stock options exercised  22   129   204 
Deferred income tax expense (benefit)  63   7,702   (4,477)
Proceeds from sale of loans held for sale  69,451   86,258   66,451 
Originations of loans held for sale  (68,793)  (84,287)  (64,218)
Net gain on sale of securities  (30)  (14)  (248)
Net gain on sale of loans held for sale  (973)  (776)  (910)
Net gain on sale of credit card portfolio        (1,177)
Net gain on sale of commercial-related loans held for sale  (82)  (9,369)   
Net (gain) loss on sale and disposal of other assets  (87)  339   (195)
Loss on sale of discontinued subsidiary     1,071    
Minority interest in net income of subsidiaries     54   26 
Net gain on sale of trust relationships  (1,386)      
Decrease in other assets  8,538   9,279   4,782 
Increase (decrease) in other liabilities  2,325   (1,247)  2,943 
          
Net cash provided by operating activities  30,202   45,099   41,572 
             
Cash flows from investing activities:            
Purchase of securities:            
Available for sale  (66,769)  (260,291)  (353,567)
Held to maturity  (32,524)  (27,382)  (30,828)
Proceeds from maturity, call and principal pay-down of securities:            
Available for sale  119,305   176,604   181,707 
Held to maturity  34,724   24,091   38,603 
Proceeds from sale of securities available for sale  1,699   2,445   40,930 
Net loan pay-downs  61,996   70,511   68,833 
Net proceeds from sale of credit card portfolio        5,703 
Net proceeds from sale of commercial-related loans  659   140,453    
Net proceeds from sale of discontinued subsidiary     4,538    
Proceeds from sales of other assets  1,847   59   103 
Proceeds from sales of trust relationships  1,386       
Purchase of premises and equipment  (1,871)  (4,843)  (5,947)
Purchase of bank subsidiary minority interest     (212)   
Proceeds from sale of equity investment in Mercantile Adjustment Bureau        2,400 
          
Net cash provided by (used in) investing activities  120,452   125,973   (52,063)
             
Cash flows from financing activities:            
Net (decrease) increase in deposits  (99,566)  (101,689)  58 
Net increase (decrease) in short-term borrowings  12,204   (8,448)  5,029 
Repayment of long-term borrowings  (40,204)  (8,967)  (26,640)
Purchase of preferred and common shares  (346)  (178)  (43)
Issuance of common shares  112   57   52 
Stock options exercised  196   940   1,131 
Excess tax benefit from stock options exercised  8       
Dividends paid  (5,226)  (6,902)  (8,652)
          
Net cash used in financing activities  (132,822)  (125,187)  (29,065)
          
             
Net increase (decrease) in cash and cash equivalents  17,832   45,885   (39,556)
             
Cash and cash equivalents at the beginning of the year  91,940   46,055   85,611 
          
             
Cash and cash equivalents at the end of the year $109,772  $91,940  $46,055 
          
             
Supplemental disclosure of cash flow information:            
Cash paid during year for:            
Interest $42,438  $35,178  $29,398 
Income taxes paid  4,051      6,553 
Income taxes received  (6,300)      
Noncash investing and financing activities:            
Issuance of common stock in purchase acquisitions/earnouts $  $425  $325 
Net transfer of loans to/from held for sale at estimated fair value     131,658    
Real estate and other assets acquired in settlement of loans  2,502   1,833   3,082 
See accompanying notes to consolidated financial statements.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(1) Summary of Significant Accounting Policies
Basis of Presentation(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Financial Institutions, Inc. (“FII”), a bankfinancial holding company organized under the laws of New York State, and its subsidiaries (collectively the “Company”) provide deposit, lending and other financial services to individuals and businesses in Central and Western New York State.York. The Company is subject to regulation by certain federal and state agencies.
The Company for many years operated underowns all of the capital stock of Five Star Bank, a decentralized, “Super Community Bank” business model, with separate and largely autonomous subsidiary banks whose Boards and management had the authority to operate within guidelines set forth in broad corporate policies established at the holding company level. During 2005, FII’s Board of Directors implemented changes to the Company’s business model and governance structure. Effective December 3, 2005, the Company merged three of its bank subsidiaries, Wyoming County Bank (100% owned) (“WCB”), National Bank of Geneva (100% owned) (“NBG”) and Bath National Bank (100% owned) (“BNB”) into its New York State-chartered bank, subsidiary, First Tier Bank & Trust (100% owned) (“FTB”), which was then renamed Five Star Bank (“FSB” or the “Bank”). The merger was accounted for at historical cost as a combination of entities under common control.
FII formerly qualified as a financial holding company under the Gramm-Leach-Bliley Act, which allowed expansion of business operations to include financial services subsidiaries, namely,and Five Star Investment Services, Inc. (100% owned) (“FSIS”) (formerly known as, a broker-dealer subsidiary offering noninsured investment products. The FI Group, Inc. (“FIGI”)) and the Burke Group, Inc. (formerlyCompany also owns 100% owned) (“BGI”), collectively referred to as the “Financial Services Group” (“FSG”). FSIS is a brokerage subsidiary that commenced operations as a start-up company in March 2000. BGI, an employee benefits and compensation consulting firm, was acquired by the Company in October 2001. During 2005, the Company sold the stock of BGI and its results have been reported separately as a discontinued operation in the consolidated statements of income for all periods presented in these financial statements. Since the sale of BGI occurred during 2005, there are no assets or liabilities associated with the discontinued operation recorded at December 31, 2006 and 2005. BGI’s cash flows are shown in the consolidated statements of cash flows by activity (operating, investing and financing) consistent with the applicable source of cash flow.
During 2003, FII terminated its financial holding company status and now operates as a bank holding company. The change in status did not affect the non-financial subsidiaries or activities being conducted by the Company, although future acquisitions or expansions of non-financial activities may require prior Federal Reserve Board (“FRB”) approval and will be limited to those that are permissible for bank holding companies.
In February 2001, the Company formed FISI Statutory Trust I (100% owned) (the “Trust”) and capitalized the entity with a $502,000 investment in the Trust’s common securities. The Trust, which was formed to facilitatein February 2001 for the private placementpurpose of $16.2 million in capital securities (“issuing trust preferred securities”). Effective December 31, 2003,securities. References to “the Company” mean the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities,” resulted inconsolidated reporting entities and references to “the Bank” mean Five Star Bank.
The accounting and reporting policies conform to general practices within the deconsolidationbanking industry and to U.S. generally accepted accounting principles. Prior years’ consolidated financial statements are re-classified whenever necessary to conform to the current year’s presentation. The following is a description of the Trust. The deconsolidation resulted in the derecognitionsignificant accounting policies.
(a.) Principles of the $16.2 million in trust preferred securities and the recognition of $16.7 million in junior subordinated debentures and a $502,000 investment in the trust recorded in other assets in the Company’s consolidated statements of financial position.Consolidation
The consolidated financial information included herein combinesstatements include the resultsaccounts of operations, the assets, liabilities and shareholders’ equity of FIICompany and its subsidiaries. The Trust is not included in the consolidated financial statements of the Company. All significant inter-companyintercompany accounts and transactions and balances have been eliminated in consolidation.
The(b.) Use of Estimates
In preparing the consolidated financial statements have been prepared in accordanceconformity with U.S. generally accepted accounting principles, generally accepted in the United States of America and prevailing practices in the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amountsamount of assets and liabilities as of the date of the statement of financial condition and disclosurereported amounts of contingent assets and liabilities, and the reported revenuesrevenue and expenses forduring the reporting period. Actual results could differ from those estimates. A material estimate that is particularly

57


susceptibleMaterial estimates relate to near-term change isthe determination of the allowance for loan losses, which is discussed in further detail later in this note.
Certain amountsassumptions used in the prior years’ consolidated financial statements are reclassified when necessary to conformdefined benefit pension plan accounting, the carrying value of goodwill and deferred tax assets, and the valuation and other than temporary impairment considerations related to the securities portfolio. These estimates and assumptions are based on management’s best estimates and judgment and are evaluated on an ongoing basis using historical experience and other factors, including the current year’s presentation.economic environment. The Company adjusts these estimates and assumptions when facts and circumstances dictate. Illiquid credit markets and volatile equity have combined with declines in consumer spending to increase the uncertainty inherent in these estimates and assumptions. As future events cannot be determined with precision, actual results could differ significantly from the Company’s estimates.
(c.) Cash Flow Reporting
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows,equivalents include cash and due from banks, federal funds sold and interest-bearing deposits in other banksbanks. Net cash flows are consideredreported for loans, deposit transactions and short-term borrowings.
Supplemental cash and cash equivalents.flow information is summarized as follows for the years ended December 31 (in thousands):
             
  2008  2007  2006 
Cash paid during the year for:            
Interest expense $37,160  $49,687   42,438 
Income taxes, net of income tax refunds  3,797   4,031   (2,249)
Non-cash activity:            
Real estate and other assets acquired in settlement of loans $1,185  $2,443   2,502 
Dividends declared and unpaid  1,497   1,805   1,392 
Increase in unsettled security purchases  1,453   336    
(d.) Investment Securities
The Company classifies itsInvestment securities are classified as either available for sale or held to maturity at the time of purchase. Securitiesmaturity. Debt securities that the Companymanagement has the abilitypositive intent and intentability to hold to maturity are carried at amortized cost and classified as held to maturity. Securitiesmaturity and are recorded at amortized cost. Other investment securities are classified as available for sale are carriedand recorded at estimated fair value. Unrealizedvalue, with unrealized gains orand losses related to securities available for sale are included in accumulated other comprehensive income (loss),excluded from earnings and reported as a component of shareholders’ equity, netequity.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the related deferred income tax effect.
Asecurities. Securities are evaluated periodically to determine whether a decline in their fair value is other than temporary. Management utilizes criteria such as, the magnitude and duration of the decline and, when appropriate, consideration of negative changes in expected cash flows, in addition to the reasons underlying the decline, including creditworthiness, capital adequacy and near term prospects of issuers, the level of credit subordination, estimated loss severity, prepayments and future delinquencies, to determine whether the loss in value is other than temporary. The term “other than temporary” is not intended to indicate that the decline is permanent, but indicates that the prospect for a near-term recovery of value is not necessarily favorable. Declines in the fair value of any securityinvestment securities below their cost that isare deemed other-than-temporary is charged to incomebe other than temporary are reflected in earnings as realized losses resulting in the establishment of a new cost basis for the security. Interest income includes interest earnedsecurities. Gains and losses on the securities adjusted for amortization of premiums and accretion of discounts on the related securities using the interest method. Realized gains or losses from the sale of available for sale securities are recognizedrecorded on the trade date and are determined using the specific identification method.
The Company classifies securities in the following categories:
U.S. treasury securities;
U.S. government agency securities;
U.S. government-sponsored enterprise (“GSE”(e.) securities;
Mortgage-backed pass-through securities (“MBS”), collateralized mortgage obligations (“CMO”) and other asset-backed securities (“ABS”);
State and municipal obligations;
Corporate bonds and other; and
Equity securities
Loans Held for Sale and Mortgage Banking Activities
Loans held for sale are recorded at the lower of aggregated cost or fair value, by category.value. If necessary, a valuation allowance is recorded by a charge to income for unrealized losses attributable to changes in market interest rates. Subsequent increases in fair value are adjusted through the valuation allowance, but only to the extent of the valuation allowance. Gains and losses on the disposition of loans held for sale are determined on the specific identification method. Loan servicing fees are recognized on an accrual basis.
The Company originates and sells certain residential real estate loans in the secondary market. The Company typically retains the right to service the mortgages upon sale. The Company makes the determination of whether or not to identify the mortgage as a loan held for sale at the time the application is received from the borrower based on the Company’s intent and ability to hold the loan.
Capitalized mortgage servicing rights are recorded at their fair value at the time a loan is sold and servicing rights are retained. Capitalized mortgage servicing rights are reported in other assets in the consolidated statements of financial position and are amortized to noninterest income in the consolidated statements of incomeoperations in proportion to and over the period of estimated net servicing income. The Company uses a valuation model that calculates the present value of future cash flows to determine the fair value of servicing rights. In using this valuation method, the Company incorporates assumptions that market participants would use in estimatingto estimate future net servicing

58


income, which include estimates of the cost to service the loan, the discount rate, an inflation rate and prepayment speeds. The carrying value of originated mortgage servicing rights is periodically evaluated for impairment. Impairment is determined by stratifying rights by predominant risk characteristics, such as interest rates and terms, using discounted cash flows and market-based assumptions. Impairment is recognized through a valuation allowance, to the extent that fair value is less than the capitalized asset. Subsequent increases in fair value are adjusted through the valuation allowance, but only to the extent of the valuation allowance.
The Company also extends rate lock commitments to borrowers related to the origination of residential mortgage loans. To mitigate the interest rate risk inherent in these rate lock commitments, as well as closed mortgage loans held for sale, the Company enters into forward sale commitments to sell individual mortgage loans. Rate lock and forward sale commitments are considered derivatives and are recorded at fair value in accordance with SFAS No. 133. These amounts are not significant at December 31, 2008 and 2007. The mortgage forward sale commitments are primarily with U.S. government agencies or government-sponsored enterprises, namely Federal Home Loan Mortgage Corporation (“FHLMC”), State of New York Mortgage Agency (“SONYMA”) andor Federal Housing Agency (“FHA”).
Mortgage banking activitiesLoan servicing income (a component of noninterest income in the consolidated statements of income) consistoperations) consists of fees earned for servicing mortgage loans sold to third parties, net gains (or net losses) recognized on sales of residential real state loans, and amortization expense and impairment losses recognized onassociated with capitalized mortgage servicing assets.
The Company also originates student loans and has a forward commitment to sell the student loans to a third-party at a fixed premium on the day of origination. The Company does not retain the right to service the loans upon sale.
During 2005, the Company decided to sell a substantial amount of commercial-related problem loans. The Company transferred the commercial-related loans to held for sale at the estimated fair value less costs to sell, which resulted in commercial-related charge-offs being recorded. The majority of the commercial-related loans held for sale were sold or settled during 2005 resulting in a net gain.
(f.) Loans
Loans are stated at the principal amount outstanding, net of unearned income and deferred direct loan origination fees and costs, which are accreted or amortized to interest income based on the interest method. Interest income on loans is recognized based on loan principal amounts outstanding at applicable interest rates. Accrual of interest on loans is suspended and all unpaid accrued interest is reversed when management believes that reasonable doubt exists with respect to the collectibility of principal or interest.
Loans, including impaired loans, are generally classified as nonaccruing if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, (120 days for consumer loans), unless such loans are well-collateralized and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccruing if repayment in full of principal and/or interest is uncertain.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment and there is a sustained period of repayment performance (generally a minimum of six months) in accordance with the contractual terms of the loan.
While a loan is classified as nonaccruing, payments received are generally used to reduce the principal balance. When the future collectibility of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccruing loan had been partially charged-off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Interest collections in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.
A loan isCommercial-related loans are considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts of principal and interest under the original terms of the agreement or the loan isand all loans that are restructured in a troubled debt restructuring. Accordingly, the Company evaluates impaired commercial and agricultural loans individually based on the present value of future cash flows discounted at the loan’s effective

59


interest rate, or at the loan’s observable market price or the net realizablefair value of the collateral, if the loan is collateral dependent. The majority of the Company’s impaired loans are secured.collateral dependent.
(g.) Allowance for Loan Losses
The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and subsequent recoveries, if any, are credited to the allowance.
The Company periodically evaluates the allowance for loan losses in order to maintain the allowance at a level that represents management’s estimate of probable losses in the loan portfolio at the balance sheetstatement of financial condition date. Management’s evaluation of the allowance is based on a continuing review of the loan portfolio.
For larger balance commercial-related loans, the Company conducts a periodic assessment on a loan-by-loan basis of losses, when it is deemed probable, based upon known facts and circumstances, that full contractual interest and principal on an individual loan will not be collected in accordance with its contractual terms, and the loan is considered impaired. An impairment reserve is typically established based upon the present value of expected future cash flows, discounted at the loan’s original effective interest rate, or as a practical expedient, at the loan’s observable market price or the fairnet realizable value of the collateral, ifas a majority of the loan isCompany’s loans are collateral dependent. Generally, impaired loans include loans in nonaccruing status, loans that have been assigned a specific allowance for credit losses, loans that have been partially charged off, and loans designated as a troubled debt restructuring. Problem commercial loans are assigned various risk ratings under the allowance for credit losses methodology.Company’s loan monitoring procedures.
The allowance for loan losses for smaller balance homogeneous loans are estimated based on historical charge-off experience, levels and trends of delinquent and nonaccruing loans, trends in volume and terms, effects of changes in lending policy, the experience, ability and depth of management, national and local economic trends and conditions, and concentrations of credit risk.
The unallocated portion of the allowance for loan losses is based on management’s consideration of such elements as risks associated with variances in the rate of historical loss experiences, information risks associated with the dependence upon timely and accurate risk ratings on loans, and risks associated with the dependence on collateral valuation techniques.
While management evaluates currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution’s allowance for loan losses. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.
(h.) Company owned Life Insurance
The Company holds life insurance policies on certain current and former employees. The Company is the owner and beneficiary of the policies. The cash surrender value of these policies is included as an asset on the consolidated statements of financial condition, and any increase in cash surrender value is recorded as noninterest income on the consolidated statement of income. In the event of the death of an insured individual under these policies, the Company would receive a death benefit which would be recorded as noninterest income.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(i.) Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation is computed on the straight-line method over the estimated useful lives of the assets. The Company generally amortizes buildings and building improvements over a period of 15 to 39 years and furniture and equipment over a period of 3 to 10 years. Leasehold improvements are amortized over the shorter of the lease term or the useful life of the improvements. Premises and equipment are periodically reviewed for impairment or when circumstances present indicators of impairment.
(j.) Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of net assets acquired in accordance with the purchase method of accounting for business combinations. Goodwill is not being amortized, but is required to be tested for impairment annually or more often if certain events occur. Goodwill impairment testing is performed at the segment (or “reporting unit”) level. Currently, the Company’s goodwill is evaluated at the entity level as there is only one reporting unit. Goodwill is assigned to reporting units at the date it is initially recorded. Once goodwill has been assigned to reporting units, it no longer retains its association with a particular acquisition, and if an event occurs or circumstances change that would make it more likely than not to reduceall of the fair value ofactivities within a reporting unit, below its carrying value. whether acquired or organically grown, are available to support the value of the goodwill.
Other intangible assets are being amortized on the straight-line method, over the expected periods to be benefited. Other intangible assets are periodically reviewed for impairment or when events or changed circumstances may affect the underlying basis of the assets.

60


(k.) Federal Home Loan Bank (“FHLB”) and Federal Reserve Bank (“FRB”) Stock
The non-marketable investments in FHLB and FRB stock are included in other assets in the consolidated statements of financial condition at par value or cost and are periodically reviewed for impairment. The dividends received relative to these investments are included in other noninterest income in the consolidated statements of operations.
As a member of the FHLB system, the Company is required to maintain a specified investment in FHLB New York stock in proportion to the volume of certain transactions with the FHLB. FHLB New York stock totaled $3.2 million and $3.1 million as of December 31, 2008 and 2007, respectively. Deterioration in the soundness of the FHLB System may increase the potential that the investments in FHLB stock recorded on the Company’s consolidated statements of financial condition be designated as impaired and that the Company may incur a write-down in the future.
As a member of the FRB system, the Company is required to maintain a specified investment in FRB stock based on a ratio relative to the Company’s capital. FRB stock totaled $2.8 million as of December 31, 2008 and 2007.
(l.) Equity Method Investments
The Company has investments in limited partnerships and accounts for these investments under the equity method. These investments are included in other assets in the consolidated statements of financial condition and totaled $2.4 million and $2.0 million as of December 31, 2008 and 2007, respectively.
(m.) Other Real Estate Owned
Other real estate owned consists of properties formerly pledged as collateral to loans, which have been acquired by the Company through foreclosure proceedings or acceptance of a deed in lieu of foreclosure. Upon transfer of a loan to foreclosure status, an appraisal is obtained and any difference of the loan balance over the fair value, less estimated costs to sell, is recorded against the allowance for loan losses. Other real estate owned is subsequently recorded at the lower of cost or fair value, less estimated costs to sell. Expenses and subsequent adjustments to the fair value are treated as other noninterest expense in the consolidated statements of income.operations.
Federal Home Loan Bank (“FHLB”(n.) and Federal Reserve Bank (“FRB”)Treasury Stock
The non-marketable investments in FHLB and FRBAcquisitions of treasury stock are includedrecorded at cost. The reissuance of shares in other assets in the consolidated statements of financial conditiontreasury is recorded at par value or cost and are periodically reviewed for impairment. The dividends received relative to these investments are included in other noninterest income in the consolidated statements of income.
As a member of the FHLB system, the Company is required to maintain a specified investment in FHLB stock in proportion to the volume of certain transactions with the FHLB. FHLB stock totaled $3.6 million and $4.4 million at December 31, 2006 and 2005, respectively.
As a member of the FRB system, the Company is required to maintain a specified investment in FRB stock based on a ratio relative to the Company’s capital. FRB stock totaled $2.8 million and $2.7 million at December 31, 2006 and 2005, respectively.
Equity Method Investments
During 2002, the Company made a $2.4 million cash investment to acquire a 50% interest in Mercantile Adjustment Bureau, LLC, a full-service accounts receivable management firm located in Rochester, New York. The Company accounted for this investment using the equity method. During 2004, the Company sold its 50% interest in Mercantile Adjustment Bureau, LLC. As part of the transaction, the Company accepted a $300,000 term note and received $2.4 million in cash. The entire unpaid principal and interest on the term note is due and payable in June 2009.
The Company also has investments in limited partnerships and accounts for these investments under the equity method. These investments are included in other assets in the consolidated statements of financial position and totaled $1.9 million and $1.7 million at December 31, 2006 and 2005, respectively.
Securities Sold Under Repurchase Agreements
Securities sold under repurchase agreements (“repurchase agreements”) are agreements in which the Company transfers the underlying securities to a third-party custodian’s account that explicitly recognizes the Company’s interest in the securities. The repurchase agreements are accounted for as secured financing transactions provided the Company maintains effective control over the transferred securities and meets other criteria as specified in Statement of Financial Accounting Standard (“SFAS”) No. 140. The Company’s repurchase agreements are accounted for as secured financings; accordingly, the transaction proceeds are reflected as liabilities and the securities underlying the repurchase agreements continue to be carried in the Company’s securities portfolio.weighted-average cost.

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RetirementFINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and Postretirement Benefit Plans2006
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(o.) Employee Benefits
Contributions due under defined contribution plans are accrued as earned by employees. The Company participates in a non-contributory defined benefit pension plan and defined contribution profit sharing (401(k)) plan benefits are expensed as applicablefor certain employees earn benefits. The recognition of defined benefit pension plan and postretirement plan expense is significantly impacted by estimates made by management such as discount rates used to value certain liabilities and expected return on assets.who met participation requirements. The Company uses third-party specialistsalso provides post-retirement benefits, principally health and dental care, to assist management in appropriately measuringemployees of a previously acquired entity. The Company has closed the expense associated with the defined benefit pension and postretirementpost-retirement plans to new participants. The actuarially determined pension benefit plans.is based on years of service and the employee’s highest average compensation during five consecutive years of employment. The Company’s policy is to at least fund the minimum amount required by the Employment Retirement Income Security Act of 1974 (“ERISA”). The cost of the pension and post-retirement plans are based on actuarial computations of current and future benefits for employees, and is charged to noninterest expense in the consolidated statements of operations.
Effective December 31, 2006,The Company accounts for the Company adopted certain provisions ofpension and post-retirement plans in accordance with SFAS No. 158 “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans,” which requires recognition in the consolidated financial statements of an amendmentasset for the respective plans’ overfunded status or a liability for a plan’s underfunded status. The Company reports changes in the funded status of FASB Statements No. 87, 88, 106, and 132(R).” SFAS No. 158 requires the Company to recognize the over-funded status (asset) or under-funded status (liability) of its defined benefit pension and postretirement plan as a component of other comprehensive income, net of applicable taxes, in the year in which changes occur.
Beginning in 2008, the plans’ assets and obligations that determine its future funded status was measured as of the end of the Company’s fiscal year as required by SFAS No. 158.
(p.) Share-Based Compensation Plans
The Company maintains two stock benefit plans on itsunder which fixed award stock options and restricted stock may be granted to certain directors and key employees. These plans are accounted for under SFAS No. 123(R), “Share-Based Payment,” which requires the recognition of compensation expense in the consolidated statements of financial positionoperations over the requisite service period, based on the grant-date fair value of stock options and other equity-based compensation (such as an adjustmentrestricted stock) issued to accumulated other comprehensive income (loss).
Stock Compensation Plans
Priordirectors and certain employees. The fair values of options are estimated using a pricing model. For restricted stock awards, compensation expense is recognized on a straight-line basis over the vesting period for the fair value of the award, measured at the grant date. The Company chose to apply the modified prospective approach as the transition method upon adoption of SFAS No. 123(R) as of January 1, 2006, the Company2006. Accordingly, awards that were granted, modified, or settled after this date are accounted for stock-based compensation underin accordance with SFAS No. 123(R) and any unvested equity awards granted prior to that date are being recognized in the recognition and measurement provisionsconsolidated statements of Accounting Principles Board (“APB”) No. 25, “Accounting for Stock Issued to Employees”operations as permitted byservice is rendered based on their grant-date fair value, calculated in accordance with SFAS No. 123 “Accounting for Stock-Based Compensation”. Effective January 1, 2006, the Company adopted the fair value recognition provisions of SFAS No. 123(R), “Share-Based Payment” using the modified-prospective transition method. Under that transition method, compensation cost recognized in 2006 included compensation cost for all share-based payments granted prior to, but not yet vested as of January 1, 2006, and those granted subsequent to January 1, 2006, based on the grant-date fair value estimate in accordance with the provisions of SFAS No. 123(R).Compensation.”
The following table illustratesCompany records share-based compensation expense for awards under the effect on net earningsManagement Stock Incentive Plan in salaries and earnings per share as ifemployee benefits in the Company had appliedConsolidated Statements of Operations. Expense related to awards granted under the fair value recognition provisionDirector’s Stock Incentive Plan is included in other noninterest expense in the consolidated statements of SFAS No. 123 to stock-based compensation during the years ended December 31, 2005 and 2004:
         
(Dollars in thousands, except per share amounts) 2005  2004 
 
Reported net income $2,166  $12,493 
         
Less: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects (1)  348   307 
       
         
Pro forma net income  1,818   12,186 
         
Less: Preferred stock dividends  1,488   1,495 
       
         
Pro forma net income available to common shareholders $330  $10,691 
       
         
Basic income per share:        
Reported $0.06  $0.98 
Pro forma  0.03   0.96 
         
Diluted income per share:        
Reported $0.06  $0.98 
Pro forma  0.03   0.95 
(1)For purposes of this pro forma disclosure, the value of the stock-based compensation is amortized to expense on a straight-line basis over the vesting periods.
operations.
(q.) Income Taxes
Income taxes are accounted for underusing the asset and liability method. Deferred tax assets and liabilities are recognized for the estimated future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and thetheir respective tax bases. Deferred tax assets and liabilities

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are measured using enacted tax rates in effect for the year in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. NetA valuation allowance is recognized on deferred tax assets are periodically evaluatedif, based upon the weight of available evidence, it is more likely than not that some or all of the assets may not be realized. The Company recognizes interest and/or penalties related to determine if a valuation allowance is required.income tax matters in income tax expense.
(r.) (Loss) Earnings Per Share
Basic (loss) earnings per share (“EPS”) is computed by dividing net income (or loss) available to common shareholders by the weighted average number of our common shares outstanding for the period. Diluted EPS reflects the potential dilution that could occur if securities or other contracts to issue common stock, such as stock options and warrants, were exercised or converted into common stock or resulted in the issuance of common stock that then shared in earnings. Anti-dilutive common stock equivalents are not included in the determination of diluted EPS when a company is in a net loss position for a reporting period, as all common stock equivalents are considered to be anti-dilutive.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
(s.) Financial Instruments Withwith Off-Balance Sheet Risk
The Company’s financial instruments with off-balance sheet risk are commercial stand-by letters of credit and mortgage, home equity and commercial loan commitments. These financial instruments are reflected in the statements of financial condition upon funding.
Financial Services Group (“FSG”(t.) Fees and Commissions
FSG fees and commissions are derived from sales of investment products and services to customers and from trust services provided to customers prior to the sale of the trust relationships during the third quarter of 2006. Fees and commissions are recorded on the accrual basis of accounting. Assets held in fiduciary or agency capacities for customers were not included in the accompanying consolidated statements of financial condition, since such items are not assets of the Company.
Segment InformationRecent Accounting Pronouncements
In accordance withJanuary 2009, the provisions of SFAS No. 131, “Disclosures About Segments of an Enterprise and Related Information,” the Company’s primary reportable segment is its subsidiary bank, Five Star BankFinancial Accounting Standards Board (“FSB”FASB”). During 2005, the Company completed a strategic realignment, which involved the merger of its subsidiary banks into a single state-chartered bank, FSB. FSG was also deemed a reportable segment in prior years, as the Company evaluated the performance of this line of business separately. However, with the sale of BGI during 2005, the FSG segment no longer meets the thresholds included in SFAS No. 131 for separation.
Recent Accounting Pronouncements
In December 2004, the FASB issued SFAS No. 123(R), “Share Based Payment,” which revised SFAS No. 123 and superseded APB Opinion No. 25. SFAS No. 123(R) requires companies to recognize in the income statement, over the requisite service period, the estimated grant-date fair value of stock options and other equity-based compensation issued to employees and directors using option pricing models, which eliminates the ability to account for stock options under the intrinsic value method prescribed by APB Opinion No. 25 and allowed under the original provisions of SFAS No. 123. The Company adopted this statement effective January 1, 2006 and chose to apply the modified-prospective transition method. Accordingly, awards granted, modified or settled after January 1, 2006 are accounted for in accordance with SFAS No. 123(R) and any unvested equity awards granted prior to that date are recognized in the consolidated statements of income as service is rendered based on their grant-date fair value calculated in accordance with SFAS No. 123. The disclosures required by SFAS No. 123(R) are included in Note 14 and the pro forma expense disclosures for the years ended December 31, 2005 and 2004 are disclosed in the “Stock Compensation Plans” section of Note 1.
In November 2005, the FASB issued Staff Position No. FAS 115-1 and FAS 124-1, “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” (the “FSP”(“FSP”). The FSP addresses the determination of when an investment is considered impaired; whether the impairment is other-than-temporary; and how to measure an impairment loss. The FSP also addresses accounting considerations subsequent to the recognition of an other-than-temporary impairment on a debt security, and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The FSP replaces the impairment guidance in Emerging Issues Task Force (“EITF”) 99-20-1, Amendments to the Impairment Guidance of EITF Issue No. 03-1 with references99-20(“FSP EITF 99-20-1”). This FSP amends EITF Issue No. 99-20,Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to existing authoritative literature concerning other-than-temporary determinations (principally SFAS No. 115Be Held by a Transferor in Securitized Financial Assets,by eliminating the requirement that a holder’s best estimate of cash flows be based upon those that a market participant would use. Instead, FSP EITF 99-20-1 eliminates the use of market participant assumptions and Securities and Exchange Commission (“SEC”) Staff Accounting Bulletin 59). Underrequires the use of management’s judgment in the determination of whether it is probable there has been an adverse change in estimated cash flow. This FSP impairment losses mustwas effective for reporting periods ending after December 15, 2008, but could not be recognized in earnings equalretro-actively applied to the entire difference between the security’s cost and its fair value at the financial statement date, without considering partial recoveries subsequent to that date. The FSP requires that an investor recognize an other-than-temporary impairment loss when it determines that an impaired security will not fully recoverperiods prior to the expected time of sale or maturity. The Company adopted the FSP effective January 1, 2006

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September 30, 2008, and adoption did not have ana material impact on the Company’s consolidated financial statements.
In June 2008, the FASB issued FSP EITF 03-6-1,Determining Whether Instruments Granted in Share-Based Payment Transactions Are Participating Securities. FSP EITF 03-6-1 was issued to specify that unvested share-based payment awards that contain non-forfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method. FSP EITF 03-6-1 is effective for financial statements issued for fiscal years beginning after December 15, 2008 and interim periods within those years. The Company has issued annual share-based compensation awards in the form of restricted stock, which are considered participating securities under FSP EITF 03-6-1. Beginning for the quarter ending March 31, 2009, the Company’s earnings per share will be presented using the two-class method, however, the Company does not expect adoption of this statement to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.
In February 2006,May 2008, the Financial Accounting Standards Board (“FASB”)FASB issued SFAS No. 155, “Accounting162,The Hierarchy of Generally Accepted Accounting Principles(“SFAS 162”). SFAS 162 is intended to improve financial reporting by identifying a consistent framework, or hierarchy, for Certain Hybrid Financial Instruments.”selecting accounting principles to be used in preparing financial statements that are presented in conformity with generally accepted accounting principles in the United States for non-governmental entities. SFAS 162 is effective 60 days following approval by the Securities and Exchange Commission of the Public Company Accounting Oversight Board’s amendments to AU Section 411,The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles. The Company does not expect adoption of this statement to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.
In April 2008, the FASB Staff Position (“FSP”) No. 142-3,Determination of the Useful Life of Intangible Assetswas issued, which amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under SFAS No. 155 amends 142,Goodwill and Other Intangible Assets(“SFAS No. 133142”). This new guidance applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and SFAS No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides a meansasset acquisitions. The Company is required to simplify the accountingadopt this statement for these instruments. Specifically, SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued in fiscal yearsyear beginning after SeptemberDecember 15, 2006.2008. The Company plans to adopt this statement effectiveon January 1, 20072009 and does not expect the adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.
In March 2008, the FASB issued SFAS No. 161,Disclosures about Derivative Instruments and Hedging Activities — an amendment of FASB Statement No. 133(“SFAS 161”). The statement requires enhanced disclosures regarding the use of derivative instruments, the accounting for derivative instruments under SFAS No. 133 and related interpretations, and the impact of derivative instruments and related hedged items on financial position, financial performance, and cash flows, particularly from a risk perspective. SFAS No. 161 is effective for fiscal years beginning after November 15, 2008. The Company plans to adopt this statement on January 1, 2009 and does not expect adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.
In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets,” an amendment of SFAS No. 140, which requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable and permits the entities to elect either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of SFAS No. 140 for subsequent measurement. SFAS No. 156 is effective for fiscal years beginning after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements for any period of that fiscal year. The Company did not elect for early adoption and plans to adopt this statement effective January 1, 2007 and does not expect adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.
In June 2006, FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company plans to adopt this statement effective January 1, 2007 and does not expect adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.
In September 2006, the SEC issued Staff Accounting Bulletin (“SAB”) No. 108, “Considering the Effects of Prior Year Misstatements when Quantifying Misstatements in Current Year Financial Statements.” SAB No. 108 addresses how the effects of uncorrected misstatements should be considered when quantifying misstatements in current year financial statements. SAB No. 108 requires companies to quantify misstatements using a balance sheet and income statement approach and to evaluate whether either approach results in quantifying an error that is material in light of relevant quantitative and qualitative factors. SAB No. 108 is effective for the Company’s fiscal year ended December 31, 2006 and application did not have an effect on consolidated financial position, consolidated results of operations, or liquidity.
In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and states that a fair value measurement should be determined based on assumptions that market participants would use in pricing the asset or liability. The Company is required to adopt SFAS No. 157 for fiscal years beginning after November 15, 2007. The Company plans to adopt this statement on January 1, 2008 and is currently assessing the impact that the adoption will have on its consolidated financial position, consolidated results of operations, or liquidity.
In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R).” SFAS No. 158 requires companies to recognize the over-funded or under-funded status of a defined benefit postretirement plan (other than a multi-employer plan) as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The Company adopted this provision of SFAS No. 158 for the year ended December 31, 2006 and the required disclosures are included in

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Note 13. SFAS No. 158 also requires companies to measure the funded status of a plan as of the date of the company’s fiscal year-end, with limited exceptions. The Company is required and plans to adopt this provision for the fiscal year ending FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and does not expect adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.2006
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In February 2007, the FASB issued SFAS No. 159, “TheThe Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.” 115(“SFAS No.159”). SFAS 159 allows entities to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities that are not otherwise required to be measured at fair value, with changes in fair value recognized in earnings as they occur. SFAS No. 159 also requires entities to report those financial assets and financial liabilities measured at fair value in a manner that separates those reported fair values from the carrying amounts of similar assets and liabilities measured using another measurement attribute on the face of the statement of financial position.condition. Lastly, SFAS No. 159 establishes presentation and disclosure requirements designed to improve comparability between entities that elect different measurement attributes for similar assets and liabilities. The Company is required to adopt SFAS No. 159 for fiscal years beginning after November 15, 2007, with early adoption permitted if an entity also early adopts the provisions of SFAS No. 157. The Company plans to adoptadopted this statement on January 1, 2008 and is currently assessingdid not elect the impactSFAS 159 fair value option for any of its financial assets or liabilities, therefore the adoption willdid not have an impact on its consolidated financial position, consolidated results of operations, or liquidity.
(2) Discontinued Operation
In 2005,September 2006, the Company decidedFASB issued SFAS No. 158,Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R)(“SFAS 158”). SFAS 158 requires companies to disposerecognize the over-funded or under-funded status of a defined benefit plan (other than a multi-employer plan) as an asset or liability in its BGI subsidiary. The results of BGI have been reported separately as a discontinued operationbalance sheet and to recognize changes in that funded status in the consolidated statementsyear in which the changes occur through comprehensive income. The Company adopted this provision of income. As a result, the Company recorded a loss from operations of the discontinued subsidiary of $340,000, a loss on the sale of BGI of $1.1 million and income tax expense associated with discontinued operations of $1.0 millionSFAS 158 for the year ended December 31, 2005. Since2006.
SFAS 158 also requires companies to measure the sale occurred during 2005, therefunded status of a plan as of the date of the Company’s fiscal year-end, with limited exceptions. In 2008, the Company adopted the measurement date provisions of SFAS 158 and changed the measurement date for its defined benefit plans to December 31. Prior to 2008, the Company measured its defined benefit plans’ assets and obligations as of September 30 of each year. See Note 16, Employee Benefit Plans, for further information relating to the adoption of this provision of SFAS 158.
In September 2006, the FASB issued SFAS No. 157,Fair Value Measurements(“SFAS 157”). SFAS 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles and expands disclosures about fair value measurements. SFAS 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and states that a fair value measurement should be determined based on assumptions that market participants would use in pricing the asset or liability. In February 2008, the FASB issued FSP SFAS 157-1,Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13, which removes certain leasing transactions from the scope of SFAS 157, and FSP SFAS 157-2,Effective Date of FASB Statement No. 157, which defers the effective date of SFAS 157 for one year for certain nonfinancial assets and nonfinancial liabilities, except those that are no assetsrecognized or liabilities associated with the discontinued operation recordeddisclosed at fair value in the consolidatedfinancial statements on a recurring basis. In October 2008, the FASB also issued FSP SFAS 157-3,Determining the Fair Value of financial condition at December 31, 2006a Financial Asset When the Market for That Asset Is Not Active, which clarifies the application of SFAS 157 in an inactive market and 2005. Cash flows from BGI are shown in the consolidated statements of cash flows by activity (operating, investing and financing) consistent with the applicable source of the cash flow.
(3) Securities
The aggregate amortized cost andillustrates how an entity would determine fair value when the market for a financial asset is not active. On January 1, 2008, the Company adopted the provisions of securities availableSFAS 157 related to financial assets and liabilities and to nonfinancial assets and liabilities measured at fair value on a recurring basis. See Note 16, Employee Benefit Plans, for salefurther details.
Beginning January 1, 2009, the Company will adopt the provisions for nonfinancial assets and heldnonfinancial liabilities that are not required or permitted to maturity are as followsbe measured at December 31:
                 
(Dollars in thousands) 2006 
  Amortized  Gross Unrealized  Fair 
  Cost  Gains  Losses  Value 
 
Securities available for sale:                
GSE $235,724  $59  $3,987  $231,796 
MBS, CMO and ABS  308,141   106   8,204   300,043 
State and municipal obligations  198,428   1,272   1,390   198,310 
Corporate bonds and other  3,913      1   3,912 
Equity securities  80   1,007      1,087 
             
                 
Total securities available for sale $746,286  $2,444  $13,582  $735,148 
             
                 
Securities held to maturity:                
State and municipal obligations $40,388  $157  $124  $40,421 
             
                 
Total securities held to maturity $40,388  $157  $124  $40,421 
             
fair value on a recurring basis, which include those measured at fair value in goodwill impairment testing, indefinite-lived intangible assets measured at fair value for impairment assessment, nonfinancial long-lived assets measured at fair value for impairment assessment, asset retirement obligations initially measured at fair value, and those initially measured at fair value in a business combination. The Company does not expect the provisions of SFAS 157 related to these items to have a material impact on its consolidated financial statements. See Note 17, Fair Value of Financial Instruments, for further details.

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(Dollars in thousands) 2005 
  Amortized  Gross Unrealized  Fair 
  Cost  Gains  Losses  Value 
 
Securities available for sale:                
GSE $256,827  $122  $5,014  $251,935 
MBS, CMO and ABS  324,399   297   7,069   317,627 
State and municipal obligations  219,824   2,179   1,743   220,260 
Equity securities  81   952      1,033 
             
                 
Total securities available for sale $801,131  $3,550  $13,826  $790,855 
             
                 
Securities held to maturity:                
State and municipal obligations $42,593  $479  $174  $42,898 
             
                 
Total securities held to maturity $42,593  $479  $174  $42,898 
             
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(1.) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES (Continued)
In September 2006, the EITF reached a final consensus on Issue 06-04,Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements(“EITF 06-04”). In accordance with EITF 06-04, an agreement by an employer to share a portion of the proceeds of a life insurance policy with an employee during the postretirement period is a postretirement benefit arrangement required to be accounted for in accordance with SFAS 106 or Accounting Principles Board Opinion No. 12,Omnibus Opinion — 1967 (“APB 12”). Furthermore, the purchase of a split dollar life insurance policy does not constitute a settlement under SFAS No. 106 and, therefore, a liability for the postretirement obligation must be recognized under SFAS 106 if the benefit is offered under an arrangement that constitutes a plan or under APB 12 if it is not part of a plan. The provisions of EITF 06-04 are to be applied through either a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption or retrospective application. The Company adopted this statement on January 1, 2008 and recorded a liability (included in other liabilities in the consolidated statement of financial position) of $284 thousand and a corresponding cumulative-effect adjustment to retained earnings as disclosed in the consolidated statement of changes in shareholders’ equity.
(2.) INVESTMENT SECURITIES
The amortized cost and estimated fair value of investment securities are summarized below (in thousands).
                 
  December 31, 2008 
  Adjusted          
  Amortized  Unrealized  Unrealized  Fair 
  Cost  Gains  Losses  Value 
Securities available for sale:
                
U.S. Government agency and government-sponsored enterprise securities $67,871  $609  $307  $68,173 
Mortgage-backed securities  339,574   6,813   3,835   342,552 
Other asset-backed securities  3,918         3,918 
State and municipal obligations  129,572   2,181   42   131,711 
Equity securities  923   281   52   1,152 
             
Total available for sale securities $541,858  $9,884  $4,236  $547,506 
             
Securities held to maturity:
                
State and municipal obligations $58,532  $619  $4  $59,147 
             
                 
  December 31, 2007 
  Amortized  Unrealized  Unrealized  Fair 
  Cost  Gains  Losses  Value 
Securities available for sale:
                
U.S. Government agency and government-sponsored enterprise securities $158,920  $344  $324  $158,940 
Mortgage-backed securities  297,798   832   2,758   295,872 
Other asset-backed securities  34,115   55   972   33,198 
State and municipal obligations  171,294   1,568   261   172,601 
Equity securities  33,930   700      34,630 
             
Total available for sale securities $696,057  $3,499  $4,315  $695,241 
             
Securities held to maturity:
                
State and municipal obligations $59,479  $431  $8  $59,902 
             
The U.S. Government agency and government-sponsored enterprise (“GSE”) securities portfolio, all of which was classified as available for sale, is comprised of debt obligations issued directly by U.S. Government agencies or GSEs and totaled $68.2 million and $158.9 million as of December 31, 2008 and 2007, respectively.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(2.) INVESTMENT SECURITIES (Continued)
The MBS portfolio, all of which was classified as available for sale, totaled $342.6 million as of December 31, 2008, which was comprised of $239.5 million of mortgage-backed pass-through securities (“pass-through”) and $103.1 million of collateralized mortgage obligations (“CMO”). As of December 31, 2007, the MBS portfolio totaled $295.9 million, which consisted of $160.0 million of pass-throughs and $135.9 million of CMOs. The pass-throughs were primarily issued by GNMA, FNMA and FHLMC. The CMO portfolio consisted of two principal groups, with balances as of December 31, 2008 as follows: (1) $63.6 million of fixed and variable rate CMOs issued by GNMA, FNMA or FHLMC that carried a full guaranty by the issuing agency of both principal and interest, and (2) $39.5 million of privately issued whole loan CMOs.
The ABS portfolio, all of which was classified as available for sale, totaled $3.9 million as of December 31, 2008 and was comprised of positions in 14 different pooled trust preferred securities issues and one Student Loan Marketing Association (“SLMA”) floater or variable rate security backed by student loans. All of the trust preferred securities are backed by preferred debt issued by many different financial institutions and insurance companies. As of December 31, 2007, the ABS portfolio, all of which was classified as available for sale, totaled $33.2 million and was comprised of 14 pooled trust preferred securities issues and one SLMA security.
As of December 31, 2008, the Company had $1.2 million in equity securities including $528 thousand of auction rate preferred equity securities collateralized by FNMA and FHLMC preferred stock and $624 thousand of common equity securities. As of December 31, 2007, the Company had $34.6 million in equity securities, including $33.8 million of auction rate preferred equity securities collateralized by FNMA and FHLMC preferred stock and $780 thousand of common equity securities. The dividend income related to both the common and auction rate preferred equity securities qualifies for the Federal income tax dividend received deduction.
Interest and dividends on securities totaled $32.8 million, $30.8 million and $27.7 million for the years ended December 31, 2008, 2007 and 2006 2005 and 2004, respectively. Taxable interest and dividend income totaled $23.9 million, $22.2 million and $19.4 million for the years ended December 31, 2006, 2005 and 2004, respectively. Non-taxable interest and dividend income totaled $8.9 million, $8.6 million and $8.3 million for the years ended December 31, 2006, 2005 and 2004, respectively.is summarized as follows (in thousands):
             
  2008  2007  2006 
             
Taxable interest $21,882  $25,414  $23,859 
Tax-exempt interest  7,299   8,501   8,881 
Tax-preferred interest  1,474   1,075   38 
          
Total interest and dividends on securities $30,655  $34,990  $32,778 
          
The amortized costfollowing tables show the investments’ gross unrealized losses (excluding unrealized losses that have been written down through the consolidated statements of operations) and fair value, of debt securitiesaggregated by contractual maturity follow at December 31:
                 
(Dollars in thousands) 2006 
  Available for Sale  Held to Maturity 
  Amortized  Fair  Amortized  Fair 
  Cost  Value  Cost  Value 
 
Due in one year or less $97,157  $96,778  $30,440  $30,387 
Due in one to five years  342,134   336,434   6,832   6,838 
Due in five to ten years  117,563   115,208   2,198   2,250 
Due after ten years  189,352   185,641   918   946 
             
                 
  $746,206  $734,061  $40,388  $40,421 
             
Maturities of MBS, CMOinvestment category and ABS are classified in accordance with the contractual repayment schedules, however actual maturities may differ from contractual maturities for these types of securities since issuers generally have the right to prepay obligations.
During 2006, proceeds from sale of securities available for sale were $1.7 million, realized gross gains were $30,000 and there were no gross losses. During 2005, proceeds from sale of securities available for sale were $2.4 million, realized gross gains were $14,000 and there were no gross losses. During 2004, proceeds from sale of securities available for sale were $40.9 million, realized gross gains were $248,000 and there were no gross losses.
Securities held to maturity and available for sale with carrying values of $544.8 million and $560.8 million were pledged as collateral for municipal deposits and repurchase agreements at December 31, 2006 and 2005, respectively.
Information on temporarily impaired securities segregated according to the periodlength of time suchthat individual securities werehave been in a continuous unrealized loss position is summarized as follows at December 31:31, 2008 and 2007 (in thousands).
                         
  December 31, 2008 
  Less than 12 months  12 months or longer  Total 
  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
  Value  Losses  Value  Losses  Value  Losses 
Securities available for sale:
                        
U.S. Government agency and government-sponsored enterprise securities $50  $1  $11,704  $306  $11,754  $307 
Mortgage-backed securities  41,445   2,128   26,923   1,707   68,368   3,835 
State and municipal obligations  6,191   41   84   1   6,275   42 
Equity securities  310   52         310   52 
                   
Total available for sale securities  47,996   2,222   38,711   2,014   86,707   4,236 
Securities held to maturity:
                        
State and municipal obligations  554   4         554   4 
                   
Total temporarily impaired securities
 $48,550  $2,226  $38,711  $2,014  $87,261  $4,240 
                   

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(Dollars in thousands) 2006 
  Less than  12 Months    
  12 Months  or Longer  Total 
  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
  Value  Losses  Value  Losses  Value  Losses 
 
Securities available for sale:                        
GSE $5,231  $36  $223,565  $3,951  $228,796  $3,987 
MBS, CMO and ABS  45,967   627   233,972   7,577   279,939   8,204 
State and municipal obligations  15,004   38   89,258   1,352   104,262   1,390 
Corporate bonds and other  3,912   1         3,912   1 
                   
                         
Total securities available for sale  70,114   702   546,795   12,880   616,909   13,582 
 
Securities held to maturity:                        
State and municipal obligations  27,706   69   3,495   55   31,201   124 
                   
                         
Total temporarily impaired securities $97,820  $771  $550,290  $12,935  $648,110  $13,706 
                   
FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
                         
(Dollars in thousands) 2005 
  Less than  12 Months    
  12 Months  or Longer  Total 
  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
  Value  Losses  Value  Losses  Value  Losses 
 
Securities available for sale:                        
GSE $95,853  $1,403  $141,975  $3,611  $237,828  $5,014 
MBS, CMO and ABS  180,971   2,984   110,774   4,085   291,745   7,069 
State and municipal obligations  72,726   834   33,546   909   106,272   1,743 
                   
                         
Total securities available for sale  349,550   5,221   286,295   8,605   635,845   13,826 
 
Securities held to maturity:                        
State and municipal obligations  23,955   169   235   5   24,190   174 
                   
                         
Total temporarily impaired securities $373,505  $5,390  $286,530  $8,610  $660,035  $14,000 
                   
(2.) INVESTMENT SECURITIES (Continued)
                         
  December 31, 2007 
  Less than 12 months  12 months or longer  Total 
  Fair  Unrealized  Fair  Unrealized  Fair  Unrealized 
  Value  Losses  Value  Losses  Value  Losses 
Securities available for sale:
                        
U.S. Government agency and government-sponsored enterprise securities $18,287  $45  $64,937  $279  $83,224  $324 
Mortgage-backed securities  38,479   398   170,532   2,360   209,011   2,758 
Other asset-backed securities  26,418   971   808   1   27,226   972 
State and municipal obligations  701   17   45,657   244   46,358   261 
                   
Total available for sale securities  83,885   1,431   281,934   2,884   365,819   4,315 
Securities held to maturity:
                        
State and municipal obligations  7,153   4   875   4   8,028   8 
                   
Total temporarily impaired securities
 $91,038  $1,435  $282,809  $2,888  $373,847  $4,323 
                   
The tables above represent 1,173 and 1,113 ofCompany reviews investment securities whereon an ongoing basis for the currentpresence of other-than-temporary-impairment (“OTTI”) with formal reviews performed quarterly. OTTI losses on individual investment securities are recognized as a realized loss through earnings when it is probable that not all of the contractual cash flows will be collected or it is determined that the Company will be unable to hold the securities until a recovery of fair value, is less thanwhich may be maturity.
Based upon the evaluations performed throughout the year, the Company recorded impairment charges totaling $68.2 million during 2008 related amortized cost asto certain debt and equity securities in the available for sale portfolio considered to be other-than-temporarily impaired. The decision to deem these securities OTTI was based on a specific analysis of the structure of each security and an evaluation of the underlying collateral, the creditworthiness, capital adequacy and near term prospects of issuers, the level of credit subordination, estimates of loss severity, prepayments and future delinquencies, using information and industry knowledge available to the Company. Future reviews for OTTI will consider the particular facts and circumstances during the reporting period in review. There were no securities deemed OTTI, and therefore no impairment charges were recorded, during the year ended December 31, 20062007.
The following summarizes the amounts of OTTI recognized during the year ended December 31, 2008 by investment category (in thousands):
     
Mortgage-backed securities — Privately issued whole loan CMOs $6,463 
Other asset-backed securities — Trust preferred securities  29,429 
Equity securities — Auction rate securities  32,323 
    
  $68,215 
    
The Company has both the ability and 2005, respectively. Theintent to hold debt securities in an unrealized loss position, other than those for twelve months or longer totaled 842 and 348which an impairment charge was taken at December 31, 20062008, until such time as the value recovers or the securities mature and 2005, respectively. Management evaluatesmanagement believes that the unrealized losses on these debt securities for other-than-temporary impairment on a quarterly basis, or as economic or market concerns warrant such evaluation. Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospectsat December 31, 2008 represent temporary impairments. Also, at December 31, 2008, certain of the issuer, and (3) the intent and ability of the Company to retain its investmentCompany’s equity securities were in the issueran unrealized loss position for a period of time sufficient to allow for any anticipated recovery in fair value. The unrealized losses presented above do not reflect deterioration in the credit worthiness of the issuing securities and result primarily from fluctuations in market interest rates.short duration. The Company has the ability and intent to hold these securities until their fair value recovers to their amortized cost, thereforemarket recovery. Therefore, management has determined that thethese unrealized losses on equity securities that were in an unrealized loss position at December 31, 2006,2008 are temporary.
Further deterioration in credit quality and/or a continuation of the current imbalances in liquidity that exist in the marketplace might adversely effect the fair values of the Company’s investment portfolio and 2005 represent onlymay increase the potential that certain unrealized losses will be designated as other than temporary declines in fair value.
(4) Loans Held for Sale
During the year ended December 31, 2005,future periods and that the Company transferred $169.0 millionwill incur additional write-downs in commercial-related loans to held for sale, at an estimated fair value less costs to sell of $132.3 million. As a result, $36.7 million in commercial-related charge-offs were recorded. Subsequent to the transfer date, the Company decided not to proceed with the sale of $613,000 of these commercial-related loans held for sale and returned the loans to portfolio at the lower of cost or fair value. In the second half of 2005, the Company realized a net gain of $9.4 million on the ultimate sale or settlement of commercial-related loans held for sale.future.

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A summaryFINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(2.) INVESTMENT SECURITIES (Continued)
At December 31, 2008, the amortized cost and fair value of debt securities by contractual maturity were as follows (in thousands):
         
  Adjusted    
  Amortized  Fair 
  Cost  Value 
Debt securities available for sale:
        
Due in one year or less $78,701  $79,298 
Due from one to five years  174,291   177,645 
Due after five years through ten years  77,902   79,231 
Due after ten years  210,041   210,180 
       
  $540,935  $546,354 
       
Debt securities held to maturity:
        
Due in one year or less $45,124  $45,313 
Due from one to five years  10,773   11,031 
Due after five years through ten years  2,063   2,188 
Due after ten years  572   615 
       
  $58,532  $59,147 
       
Maturities of mortgage-backed and asset-backed securities are classified in accordance with their final contractual maturities; however the effective lives are expected to be significantly shorter due to prepayments of the underlying loans and the nature of the securities.
(3.) LOANS HELD FOR SALE
Loans held for sale iswere entirely comprised of residential real estate mortgages and totaled $1.0 million and $906 thousand as follows atof December 31:31, 2008 and 2007, respectively.
         
(Dollars in thousands) 2006  2005 
 
Commercial and agricultural * $  $577 
Residential real estate  992   676 
       
 
Total loans held for sale $992  $1,253 
       
*All commercial and agricultural loans held for sale are in nonaccruing status.
The Company sells certain qualifying newly originated or refinanced residential real estate mortgages on the secondary market. Residential real estate mortgages serviced for others, amounting to $355.2 million and $377.6 million at December 31, 2006 and 2005, respectively,which are not included in the consolidated statements of financial condition. Proceeds from the sale of loans held for sale (excluding commercial-related) were $69.5 million, $86.3.condition, amounted to $315.7 million and $66.5$338.1 million for the years endedas of December 31, 2006, 20052008 and 2004, respectively. Net gain on the sale of loans held for sale (excluding commercial-related) was $973,000, $776,000 and $910,000 for the years ended December 31, 2006, 2005 and 2004,2007, respectively.
The activity in capitalized mortgage servicing assets, included in other assets in the consolidated statements of financial condition, is summarized as follows for the years ended December 31:31 (in thousands):
             
(Dollars in thousands) 2006  2005  2004 
 
Mortgage servicing assets at beginning of year $1,557  $1,946  $2,294 
 
Originations  224   309   451 
Amortization  (616)  (698)  (799)
          
             
Mortgage servicing assets at end of year  1,165   1,557   1,946 
 
Valuation allowance  (2)  (3)  (70)
          
             
Mortgage servicing assets at end of year, net $1,163  $1,554  $1,876 
          
             
  2008  2007  2006 
             
Mortgage servicing assets, beginning of year $1,000  $1,165  $1,557 
Originations  230   307   224 
Amortization  (305)  (472)  (616)
          
Mortgage servicing assets, end of year  925   1,000   1,165 
Valuation allowance  (362)  (19)  (2)
          
Mortgage servicing assets, net, end of year $563  $981  $1,163 
          

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(5) Loans
(4.)
LOANS
Loans outstanding,receivable, including net unearned income and net deferred fees and costs of $4.5$12.3 million and $3.3$5.9 million atas of December 31, 20062008 and 2005,December 31, 2007, respectively, are summarized as follows:follows (in thousands):
                
(Dollars in thousands) 2006 2005 
 2008 2007 
 
Commercial $105,806 $116,444  $158,543 $136,780 
Commercial real estate 243,966 264,727  262,234 245,797 
Agricultural 56,808 75,018  44,706 47,367 
Residential real estate 268,446 274,487  177,683 166,863 
Consumer and home equity 251,456 261,645 
     
Consumer indirect 255,054 134,977 
Consumer direct and home equity 222,859 232,389 
      
Total loans 926,482 992,321  1,121,079 964,173 
Less: Allowance for loan losses 18,749 15,521 
      
Allowance for loan losses  (17,048)  (20,231)
Total loans, net $1,102,330 $948,652 
          
 
Loans, net $909,434 $972,090 
     
The Company’s significant concentrations of credit risk in the loan portfolio relate to a geographic concentration pertaining toin the communities that the Company serves.

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


The table below details additional information on the loan portfolio as of December 31 of the year indicated (in thousands):
             
  2008  2007  2006 
             
Non-accruing loans $8,189  $8,075  $15,837 
Interest income that would have been recorded if loans had been performing in accordance with original terms  546   713   1,542 
Accruing loans 90 days or more delinquent  7   2   3 
Balance of impaired loans, end of period  3,180   4,132   11,702 
Balance of impaired loans requiring a specific allowance, end of period  599   1,572   5,281 
Allowance relating to impaired loans included in allowance for loan losses  142   454   450 
Average balance of impaired loans  3,088   6,446   11,972 
Interest income recognized on impaired loans         
There were no restructured loans outstanding at December 31, 2008 or 2007.
In the ordinary course of business, the Company grants loans to related parties including directors, executive officers and others. Such loans totaled $823 thousand and $911 thousand at December 31, 2008 and 2007, respectively. These loans were made substantially on the same terms, including interest rates and required collateral coverage ratios, as those prevailing at the time for comparable transactions with other unrelated persons. These loans do not involve more than the normal risk of collectibility. During 2008, total principal additions on these related party loans were $35 thousand and total principal reductions were $123 thousand.
The following table sets forth the changes in the allowance for loan losses for the years ended December 31:31 (in thousands):
             
(Dollars in thousands) 2006  2005  2004 
 
Allowance for loan losses at beginning of year $20,231  $39,186  $29,064 
             
Loan charge-offs  4,199   49,286   10,797 
Loan recoveries  2,858   1,799   1,243 
          
Net charge-offs  1,341   47,487   9,554 
             
(Credit) provision for loan losses  (1,842)  28,532   19,676 
          
             
Allowance for loan losses at end of year $17,048  $20,231  $39,186 
          
The following table sets forth information regarding nonaccruing loans and other nonperforming assets at December 31:
         
(Dollars in thousands) 2006  2005 
 
Nonaccruing loans:        
Commercial $2,205  $4,389 
Commercial real estate  4,661   6,985 
Agricultural  4,836   2,786 
Residential real estate  3,602   3,096 
Consumer and home equity  533   505 
       
Total nonaccruing loans  15,837   17,761 
         
Accruing loans 90 days or more delinquent  3   276 
       
         
Total nonperforming loans  15,840   18,037 
         
Other real estate owned (“ORE”)  1,203   1,099 
       
         
Total nonperforming loans and ORE  17,043   19,136 
         
Nonaccruing commercial-related loans held for sale     577 
       
 
Total nonperforming assets $17,043  $19,713 
       
During the years ended December 31, 2006, 2005 and 2004, the amount of interest income forgone on nonaccruing loans outstanding at the respective year-ends totaled $1.5 million, $1.4 million and $4.8 million, respectively.
Impaired loans, all of which were assigned a specific allowance for loan losses, totaled $11.7 million and $14.2 million at December 31, 2006 and 2005, respectively. The total specific allowance for impaired loans totaled $1.6 million and $2.6 million at December 31, 2006 and 2005, respectively.
Additional information related to impaired loans is as follows for the years ended December 31:
             
(Dollars in thousands) 2006  2005  2004 
 
Average balance of impaired loans $11,972  $25,182  $45,645 
Interest income recognized on impaired loans (cost recovery)        102 
Loans outstanding to certain officers, directors, or companies in which they have 10% or more beneficial ownership, including officers and directors of the Company, as well as its subsidiaries (“Insiders”), approximated $1.1 million and $2.0 million at December 31, 2006 and 2005, respectively. At December 31, 2006, there were no loans to insiders identified as potential problem loans. At December 31, 2005, there were no loans to insiders identified as potential problem loans, however there was an insider loan totaling $155,000 classified as nonaccruing and impaired. These loans were made on substantially the same terms, including interest rate and collateral, as comparable transactions with other customers.
             
  2008  2007  2006 
             
Balance, beginning of year $15,521  $17,048  $20,231 
Charge-offs  5,459   3,895   4,199 
Recoveries  2,136   2,252   2,858 
          
Net charge-offs  3,323   1,643   1,341 
Provision (credit) for loan losses  6,551   116   (1,842)
          
Balance, end of year $18,749  $15,521  $17,048 
          

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An analysis of activity with respect to insider loans is as follows during the years ended FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31:
         
(Dollars in thousands) 2006  2005 
 
Insider loans at beginning of year $2,007  $27,165 
         
New loans to insiders  445   576 
Repayments received from insiders  (858)  (916)
Other changes (primarily changes in director and subsidiary director status)  (475)  (24,818)
       
         
Insider loans at end of year $1,119  $2,007 
       
For purposes of analyzing the activity in insider loans, credit renewals are not included as new loans to insiders.31, 2008, 2007 and 2006
(6) Premises and Equipment(5.) PREMISES AND EQUIPMENT, NET
A summaryMajor classes of premises and equipment isat December 31, 2008 and 2007 are summarized as follows at December 31:(in thousands):
                
(Dollars in thousands) 2006 2005 
 2008 2007 
 
Land and land improvements $4,344 $4,344  $4,334 $4,344 
Buildings and leasehold improvements 34,287 34,017  39,298 35,020 
Furniture, fixtures, equipment and vehicles 22,368 21,695  24,480 23,039 
          
Premises and equipment 60,999 60,056  68,112 62,403 
 
Accumulated depreciation and amortization  (26,437)  (23,585)  (31,400)  (28,246)
     
      
Premises and equipment, net $34,562 $36,471  $36,712 $34,157 
          
Depreciation and amortization expense, included in occupancy and equipment expense in the consolidated statements of income,operations, amounted to $3.7 million $3.8 million and $3.4 million for each of the years ended December 31, 2006, 20052008, 2007 and 2004, respectively.2006.
(7) Goodwill and Other Intangible Assets(6.) GOODWILL AND OTHER INTANGIBLE ASSETS
The carrying amount of goodwill all of which was allocated to FSB, totaled $37.4 million atas of December 31, 20062008 and 2005.2007. In accordance with SFAS No. 142, the Company has evaluatedperformed the required annual goodwill impairment tests and determined that goodwill was not impaired at September 30, 2008. During the fourth quarter of 2008 the Company sustained a significant decrease in market capitalization, which combined with the current adverse industry conditions and recent operating losses, were triggering indicators that goodwill should be re-evaluated for potential impairment. The Company re-tested its goodwill for impairment annually using a discounted cash flow analysisas of December 31, 2008 and determined that no impairment existed. There were no indicators
At December 31, 2008, the Company’s market capitalization related to its common stock was $155.0 million which exceeded the book value of impairment afterits common stock. Further declines in the annual test was performed.market value of the Company’s publicly traded stock price or declines in the Company’s ability to generate future cash flows may increase the potential that goodwill recorded on the Company’s consolidated statement of financial position be designated as impaired and that the Company may incur a goodwill write-down in the future.
Other intangible assets, included in other assets in the consolidated statements of financial condition, consist entirely of core deposit intangibles and are summarized as follows atas of December 31:31 (in thousands):
                
(Dollars in thousands) 2006 2005 
 2008 2007 
Other intangible assets $11,263 $11,452  $11,263 $11,263 
 
Accumulated amortization  (10,369)  (10,138)  (10,983)  (10,676)
     
      
Other intangible assets, net $894 $1,314  $280 $587 
          

70


Intangible amortization expense for these other intangible assets amounted to $420,000, $430,000 and $709,000$307 thousand for each of the years ended December 31, 2006, 20052008 and 2004, respectively.2007, and $420 thousand for the year ended December 31, 2006. Amortization of other intangible assets was computed using the straight-line method over the estimated lives of the respective assets (primarily 5 and 7 years). Based on the current levelThe remaining balance of intangible assets, estimated future amortization expense for other intangible assets$280 thousand is as follows:scheduled to be fully amortized during 2009.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
Year ending December 31:(7.) DEPOSITS
     
(Dollars in thousands)    
2007 $307 
2008  307 
2009  280 
    
     
  $894 
    
(8) Deposits
Scheduled maturities for certificatesA summary of depositdeposits at December 31, 20062008 and 2007 are as follows:follows (dollars in thousands):
Mature in year ending December 31:
     
(Dollars in thousands)    
2007 $581,430 
2008  68,685 
2009  8,352 
2010  7,900 
2011  2,844 
Thereafter  477 
    
     
  $669,688 
    
         
  2008  2007 
         
Noninterest-bearing demand $292,586  $286,362 
Interest-bearing demand  344,616   335,314 
Savings and money market  348,594   346,639 
Certificates of deposit, due:        
Within one year  546,266   547,243 
One to two years  78,963   40,824 
Two to three years  7,625   12,012 
Three to five years  14,102   6,995 
Thereafter  511   582 
       
Total certificates of deposits  647,467   607,656 
       
Total deposits $1,633,263  $1,575,971 
       
Certificates of deposit greater thanin denominations of $100,000 totaled $195.4 million and $199.8 millionor more at December 31, 2008, 2007 and 2006 amounted to $164.6 million, $154.5 million and 2005,$195.4 million, respectively. Interest expense on those certificates of deposit greater than $100,000 amounted tototaled $5.7 million, $9.5 million and $9.0 million $7.1 millionin 2008, 2007 and $6.0 million2006, respectively.
Interest expense by deposit type for the years ended December 31, 2008, 2007 and 2006 2005 and 2004, respectively.is summarized as follows (in thousands):
As of December 31, 2006 and 2005, overdrawn deposits included in loans on the consolidated statements of financial condition amounted to $864,000 and $905,000, respectively.
             
  2008  2007  2006 
             
Interest-bearing demand $3,246  $5,760  $6,705 
Savings and money market  3,773   5,863   4,320 
Certificates of deposit  22,330   31,091   26,420 
          
Total interest expense on deposits $29,349  $42,714  $37,445 
          
(9) Borrowings(8.) BORROWINGS
Outstanding borrowings are as follows at December 31:
         
(Dollars in thousands) 2006  2005 
 
Short-term borrowings:        
Federal funds purchased and securities sold under repurchase agreements $32,310  $20,106 
       
Long-term borrowings:        
FHLB advances $38,187  $53,391 
Other     25,000 
       
         
Total long-term borrowings $38,187  $78,391 
       
Information related to federal funds purchased and securities sold under repurchase agreements aresummarized as follows as of and for the years ended December 31:31 (in thousands):
             
(Dollars in thousands) 2006  2005  2004 
 
Weighted average interest rate at year-end  2.15%  1.46%  0.92%
Maximum outstanding at any month-end $32,353  $27,675  $30,524 
Average amount outstanding during the year $25,892  $24,550  $25,764 
         
  2008  2007 
         
Short-term borrowings:        
Federal funds purchased and repurchase agreements $23,465  $22,833 
FHLB advances     2,810 
       
Total short-term borrowings  23,465   25,643 
       
Long-term borrowings:        
FHLB advances and repurchase agreements  30,653   25,865 
Junior subordinated debentures  16,702   16,702 
       
Total long-term borrowings  47,355   42,567 
       
Total borrowings $70,820  $68,210 
       
The average amounts outstanding are computed using daily average balances. Related interest expense for 2006, 2005 and 2004 was $559,000, $364,000 and $241,000, respectively.

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At December 31, 2006, FHLB advances totaled $38.2 million and carried a weighted average interest rate of 5.12%. FHLBCompany classifies borrowings include both term and amortizing advances and are classified as short-term or long-term in accordance with the original terms. Atterms of the agreement. The Company’s FHLB advances bear fixed interest rates ranging from 5.50% to 7.81% and had a weighted average rate of 6.03% at December 31, 2008. Long-term repurchase agreements bear fixed interest rates ranging from 3.48% to 3.98% and had a weighted average rate of 3.67% at December 31, 2008.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(8.) BORROWINGS (Continued)
Interest expense on borrowings for the years ended December 31, 2008, 2007 and 2006 allis summarized as follows (in thousands):
             
  2008  2007  2006 
             
Short-term borrowings $721  $864  $571 
Long-term borrowings (excluding junior subordinated debentures)  1,819   1,833   3,860 
Junior subordinated debentures  1,728   1,728   1,728 
          
Total interest expense on borrowings $4,268  $4,425  $6,159 
          
The Company has lines of the advances were classified as long-term and mature on various dates through 2011. FHLB advances include a $20.0 million fixed-rate callable advance, which can be called bycredit with the FHLB, onFRB and several commercial banks that provide a quarterly basis.secondary funding source for lending, liquidity and asset and liability management. FHLB advances are collateralized by $3.6 million of FHLB stock owned by the Bank and investmentcertain qualifying loans. At December 31, 2008 the Company had additional borrowing capacity available of approximately $81.1 million at the FHLB. As of December 31, 2008, there were no borrowings outstanding on the FRB and commercial bank lines of credit which totaled $73.9 million. The commercial bank lines are unsecured but generally require the Company to maintain certain standard financial covenants.
As of December 31, 2008, the Company had entered into repurchase agreements with the FHLB, whereby securities available for sale with a faircarrying value of approximately $71.2$31.9 million were pledged to collateralize the borrowings. There were no FHLB repurchase agreements outstanding at December 31, 2006.2007. These transactions are accounted for as secured financings and the obligation to repurchase is reflected as a liability in the Company’s Consolidated Statements of Condition. The dollar amount of securities underlying the agreements is included in securities available for sale in the Company’s Consolidated Statements of Financial Condition. These securities however, are delivered to the FHLB, who may sell, loan or otherwise dispose of these securities to other parties in the normal course of their business, but they agree to resell to us the same securities at the maturity of the agreements. The Company also retains the right of substitution of collateral throughout the terms of the agreements. At December 31, 2006,2008, there were no amounts at risk under repurchase agreements with any individual counterparty or group of related counterparties that exceeded 10% of shareholders’ equity. The amount at risk to the Bank had remaining credit availableCompany is equal to the excess of approximately $31.5 millionthe carrying value (or fair value if greater) of the securities sold under linesagreements to repurchase over the amount of credit with the FHLB. our repurchase liability.
The Bank also had $102.1 millionaggregate maturities of remaining credit available under unsecured linesFHLB advances and repurchase agreements, by year of credit with various other banksmaturity, at December 31, 2006.
The Company also had a credit agreement with another commercial bank and pledged the stock of FSB as collateral for the credit facility. The credit agreement included a $25.0 million term loan facility and a $5.0 million revolving loan facility. At June 30, 2005, the Company was in default of an affirmative financial covenant in the credit agreement and reclassified the borrowing from long-term to short-term. The bank waived the event of default at June 30, 2005. As of September 30, 2005, FII and the bank agreed to modify the covenants in the agreement. FII complied with the modified covenants, therefore the term loan was classified as a long-term borrowing at December 31, 2005. In addition, the interest rate and maturity of the term loan facility were modified. The amended and restated term loan required monthly payments of interest only at a variable interest rate of London Interbank Offered Rate (“LIBOR”) plus 2.00% through the third quarter of 2006. During October 2006, FII repaid the $25.0 million term loan. The debt was scheduled for repayment in equal annual installments of $6.25 million beginning in December 2007. The $5.0 million revolving loan was also modified to accrue interest at a rate of LIBOR plus 1.75% and is scheduled to mature April of 2007. There were no advances outstanding on the revolving loan during the year ended December 31, 2006 and 2005.
At December 31, 2006, the aggregate maturities of long-term borrowings, including maturities of amortizing advances,2008 are as follows:follows (in thousands):
Mature in year ending December 31:
     
(Dollars in thousands)    
2007 $12,321 
2008  5,212 
2009  20,508 
2010  80 
2011  66 
    
     
  $38,187 
    
(10) Junior Subordinated Debentures
     
2009 $508 
2010  20,080 
2011  10,065 
    
  $30,653 
    
In February 2001, the Company established FISIformed Financial Institutions Statutory Trust I (the “Trust”), which is a statutory business trust formed under Connecticut law. The Trust exists for the exclusive purposessole purpose of (i) issuing trust preferred securities. The Company accounts for the Trust in accordance with FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” and, selling 30 year guaranteed preferred beneficial interestsas such, the Trust is not consolidated. The Company’s $502 thousand investment in the trust assets (“trust preferred” or “capital” securities)common equity of the Trust is classified in the aggregate amountconsolidated statements of $16.2financial condition as other assets and $16.7 million atof related debentures are classified as liabilities. In 2001, the Company incurred costs relating to the issuance of the debentures totaling $487 thousand. These costs, which are included in other assets on the consolidated statements of financial condition, were deferred and are being amortized to interest expense using the straight-line method over a twenty year period.
The Company, through the Trust, issued 16,200 fixed rate pooled trust preferred securities with a liquidation preference of 10.20%, (ii) using$1,000 per security. The trust preferred securities represent an interest in the proceeds from the salerelated subordinated debentures of the capital securities to acquire the junior subordinated debentures issuedCompany, which were purchased by the CompanyTrust and (iii) engaging in only those other activities necessary, advisable or incidental thereto.
have substantially the same payment terms as these trust preferred securities. The Company’s junior subordinated debentures are the primaryonly assets of the Trust and accordingly,interest payments underfrom the corporation obligated junior debentures arefinance the sole revenue ofdistributions paid on the Trust. The capital securities of the Trust are non-voting. The Company owns all of the common securities of the Trust. The capital securities qualified as Tier 1 capital under regulatory definitions as of December 31, 2006 and 2005.
The Company’s primary sources of funds to pay interesttrust preferred securities. Distributions on the debentures held byare payable semi-annually at a fixed interest rate of 10.20%.
The trust preferred securities are subject to mandatory redemption at the Trust are current dividends from FSB. Accordingly,liquidation preference, in whole or in part, upon repayment of the Company’s ability to service thesubordinated debentures is dependent upon the ability of FSB to pay dividends to the Company. Since the juniorat maturity or their earlier redemption. The subordinated debentures are classified as debt for financial statement purposes,redeemable prior to the associated tax-deductible expense has been recorded as interest expense inmaturity date of February 1, 2031, at the consolidated statementsoption of income.

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The Company incurred $487,000 in costs to issue the securities and the costs are being amortized over 20 years using the interest method.
As of December 31, 2003, the Company deconsolidated the subsidiary Trust, which had issued trust preferred securities, and replaced the presentation of such instruments with the Company’s junioron or after February 1, 2011, in whole at any time thereafter or in part from time to time thereafter. The subordinated debentures issued to the subsidiary Trust. Such presentation reflects the adoption of FASB Interpretation No. 46 (“FIN 46 R”), “Consolidation of Variable Interest Entities.”
(11) Income Taxes
Total income tax expense (benefit) is allocated as follows for the years ended December 31:
             
(Dollars in thousands) 2006  2005  2004 
 
Income (loss) from continuing operations $6,245  $(1,766) $3,170 
Loss on discontinued operations     1,041   (149)
Additional paid-in capital for stock options exercised  (8)  (129)  (204)
Shareholders’ equity for unrealized loss on securities available for sale  (241)  (6,675)  (2,864)
Shareholders’ equity for unrecognized net periodic defined benefit pension costs  (1,157)      
Shareholders’ equity for unrecognized net periodic postretirement benefit costs  134       
          
 
  $4,973  $(7,529) $(47)
          
Income tax expense (benefit) from continuing operations is as follows for the years ended December 31:
             
(Dollars in thousands) 2006  2005  2004 
 
Current:            
Federal $6,152  $(9,254) $6,161 
State  30   (214)  1,486 
          
Total current tax expense (benefit)  6,182   (9,468)  7,647 
Deferred:            
Federal  (1,498)  7,493   (3,630)
State  1,561   209   (847)
          
Total deferred tax expense (benefit)  63   7,702   (4,477)
          
             
Total income tax expense (benefit) from continuing operations $6,245  $(1,766) $3,170 
          
The following is a reconciliation of the actual and statutory tax rates for income from continuing operations for the years ended December 31:
             
  2006  2005  2004 
   
Statutory rate  34.0%  35.0%  35.0%
Increase (decrease) resulting from:            
Tax exempt interest income  (12.8)  (106.9)  (18.4)
Disallowed interest expense  1.5   10.1   1.4 
State taxes, net of federal income tax benefit  4.4   (0.1)  2.5 
Other  (0.6)     (0.8)
          
             
Total  26.5%  (61.9)%  19.7%
          

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The following table presents the tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilitiesare also redeemable at December 31:
         
(Dollars in thousands) 2006  2005 
 
Deferred tax assets:        
Allowance for loan losses $6,054  $7,441 
Unrealized loss on securities available for sale  4,338   4,097 
Core deposit intangible  675   821 
Interest on nonaccruing loans  996   1,011 
Tax attribute carryforward benefits  2,575   1,374 
Accrued employee benefits  247   412 
Stock compensation  268    
Other  223   148 
       
 
Total gross deferred tax assets  15,376   15,304 
 
Deferred tax liabilities:        
Prepaid pension and postretirement plan costs  45   1,135 
Depreciation and amortization of premises and equipment  1,330   1,617 
Net deferred loan origination costs  1,752   1,310 
Loan servicing assets  453   620 
Other  19   46 
       
 
Total gross deferred tax liabilities  3,599   4,728 
       
 
Net deferred tax assets (included in other assets) at end of year  11,777   10,576 
 
Net deferred tax assets (included in other assets) at beginning of year  10,576   11,603 
       
 
(Increase) decrease in net deferred tax assets  (1,201)  1,027 
 
Change in unrealized loss on securities available for sale  241   6,675 
 
Unrecognized net periodic pension costs  1,157    
 
Unrecognized net periodic postretirement costs  (134)   
       
 
Deferred tax expense $63  $7,702 
       
Realization of the net deferred tax assets is dependentany time, in whole, but not in part, upon the generationoccurrence of future taxable income or the existence of sufficient taxable incomespecific events defined within the carry-back period. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax assets will not be realized. In assessing the need for a valuation allowance, management considers the scheduled reversal of the deferred tax liabilities, the level of historical taxable income and projected future taxable income over the periods in which the temporary differences comprising the deferred tax assets will be deductible. Based on its assessment, management determined that no valuation allowance is necessary at December 31, 2006 and 2005.
trust indenture. The Company has the following tax attribute carryforward benefits available at December 31:
       
      Year(s) of
(Dollars in thousands) 2006  Expiration
       
Federal:      
Net operating loss $208  2021
Tax credits  2,153  None
       
New York State:      
Net operating loss $5,401  2021-2025
Charitable contribution  267  2010
Tax credits  107  None
The federal net operating loss carryforward and $208,000 ofoption to defer distributions on the New York State net operating loss carryforward are subjectsubordinated debentures from time to annual limitations imposed by the Internal Revenue Code (“IRC”). The Company believes the limitations willtime for a period not prevent the carryforward benefits from being utilized.to exceed 20 consecutive quarters.

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(12) CommitmentsFINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and Contingencies2006
Commitments(9.) COMMITMENTS AND CONTINGENCIES
InFinancial Instruments with Off-Balance Sheet Risk
The Company has financial instruments with off-balance sheet risk established in the normal course of business there are various outstandingto meet the financing needs of its customers. These financial instruments include commitments to extend credit that are not reflectedand standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest rate risk extending beyond amounts recognized in the accompanying consolidated financial statements. Loan commitments have off-balance-sheet
The Company’s exposure to credit risk until commitments are fulfilled or expire. The credit risk amounts are equalloss in the event of nonperformance by the other party to the contractual amounts, assumingfinancial instrument for commitments to extend credit and standby letters of credit is essentially the same as that involved with extending loans to customers. The Company uses the amounts are ultimately advancedsame credit underwriting policies in fullmaking commitments and that the collateral or other security is of no value. The Company’s policy generally requires customers to provide collateral, usually in the form of customers’ operating assets or property, prior to the disbursement of approved loans. conditional obligations as for on-balance sheet instruments.
At December 31, 2006, stand-by letters of credit totaling $5.8 million2008 and unused loan2007, the off-balance sheet commitments and lines of credit of $258.6 million were contractually available. Approximately 18%consist of the unused loan commitments and lines offollowing (in thousands):
         
  2008  2007 
Commitments to extend credit $339,454  $273,354 
Standby letters of credit  7,902   7,277 
Commitments to extend credit were at fixed rates at December 31, 2006. There were no significant commitmentsare agreements to lend to nonperforming borrowers at December 31, 2006. Comparable amounts fora customer as long as there is no violation of any condition established in the stand-by letters of credit and commitments at December 31, 2005 were $9.5 million and $231.5 million, respectively.contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected toCommitments may expire without funding,being drawn upon; therefore the total commitment amounts do not necessarily represent future cash requirements. Each customer’s creditworthiness is evaluated on a case-by-case basis. The amount of collateral obtained, if any, is based on management’s credit evaluation of the borrower. Standby letters of credit are conditional lending commitments issued by the Company to guarantee the performance of a customer to a third party. These standby letters of credit are primarily issued to support private borrowing arrangements. The credit risk involved in issuing standby letters of credit is essentially the same as that involved in extending loan facilities to customers.
The Company also extends rate lock agreements to borrowers related to the origination of residential mortgage loans. To mitigate the interest rate risk inherent in these rate lock agreements when the Company intends to sell the related loan, once originated, as well as closed residential mortgage loans held for sale, the Company enters into forward commitments to sell individual mortgage loans.residential mortgages. Rate lock agreements and forward commitments are considered derivatives and are recorded at fair value in accordance with SFAS No. 133. At133,Accounting for Derivative Instruments and Hedging Activities. As of December 31, 20062008 and 2005,2007, the total notional amount of these derivatives (rate lock agreements and forward commitments) held by the Company amounted to $4.5$21.3 million and $8.2$6.3 million, respectively. The fair value of these derivatives in a gain position were recorded as other assets, while the fair value of these derivatives in a loss position were recorded as other liabilities in the consolidated statements of financial condition. In addition, the net change in the fair values of these derivatives was recognized in current earnings as other noninterest income or other noninterest expense in the consolidated statements of income.operations. These fair values and changes in fair values were not significant atas of or for the years ended December 31, 20062008 and 2005.2007.
Lease Obligations
The Company wasis obligated under a number of noncancellable operating leaseslease agreements for land, buildings and equipment. Certain of these leases provide for escalation clauses and contain renewal options calling for increased rentals if the lease is renewed. The futureFuture minimum lease payments on operatingby year and in the aggregate, under the noncancellable leases with initial or remaining terms of one year or more, are as follows at December 31, 2006:2008 (in thousands):
Operating lease payments in year ending December 31:
        
(Dollars in thousands) 
2007 $769 
2008 682 
2009 628  $1,237 
2010 420  1,051 
2011 411  999 
2012 977 
2013 838 
Thereafter 1,779  5,215 
      
  $10,317 
 $4,689    
   
Rent expense relating to these operating leases, included in occupancy and equipment expense in the consolidated statements of income, totaled $761,000, $645,000operations, was $1.1 million, $970 thousand and $646,000 for the years ended December 31,$899 thousand in 2008, 2007 and 2006, 2005 and 2004, respectively.
Contingent Liabilities
In the ordinary course of business there are various threatened and pending legal proceedings against the Company. Based on consultation with outside legal counsel, management believes that the aggregate liability, if any, arising from such litigation would not have a material adverse effect on the Company’s consolidated financial statements.

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(13) RetirementFINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and Postretirement Benefit Plans2006
Adoption of SFAS No. 158(10.) REGULATORY MATTERS
General
The Company adopted SFAS No. 158 effectivesupervision and regulation of financial and bank holding companies and their subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds regulated by the FDIC and the banking system as a whole, and not for the protection of shareholders or creditors of bank holding companies. The various bank regulatory agencies have broad enforcement power over financial holding companies and banks, including the power to impose substantial fines, operational restrictions and other penalties for violations of laws and regulations and for safety and soundness considerations.
Federal Reserve Requirements
The Bank is required to maintain a reserve balance at the Federal Reserve Bank of New York. The reserve requirement for the Bank totaled $1.0 million as of December 31, 2006,2008 and 2007.
Dividend Restrictions
In the ordinary course of business, the Company is dependent upon dividends from Five Star Bank to provide funds for the payment of interest expense on the junior subordinated debentures, dividends to shareholders and to provide for other cash requirements. Banking regulations may limit the amount of dividends that may be paid. Approval by regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. Approval is also required if dividends declared exceed the net profits for that year combined with the retained net profits for the preceding two years. Based upon the financial results for the year ended December 31, 2008, the Bank will be required to obtain approval from the New York State Banking Department for future dividends payments.
In addition, pursuant to the terms of the Treasury’s TARP Capital Purchase Program (see Note 11, Shareholders’ Equity), the Company may not declare or pay any cash dividends on its common stock other than regular quarterly cash dividends of not more than $0.10 without the consent of the U.S. Treasury.
Capital
Banks and financial holding companies are subject to various regulatory capital requirements administered by state and federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material impact on the Company’s consolidated financial statements. Capital adequacy guidelines and, additionally for banks, prompt corrective action regulations, involve quantitative measures of assets, liabilities, and certain off balance-sheet items calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by regulators about components, risk weighting and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios of Total and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average assets (all as defined in the regulations). These minimum amounts and ratios are included in the table below.
The Company’s and the Bank’s Tier 1 capital consists of shareholders’ equity excluding unrealized gains and losses on securities available for sale (except for unrealized losses which required the over-funded or under-funded status of its defined benefit pension and postretirement benefit planshave been determined to be other than temporary and recognized as an asset or liabilityexpense in the consolidated statements of financial condition. Futureoperations), goodwill and other intangible assets and disallowed portions of deferred tax assets. Tier 1 capital for the Company also includes, subject to limitation, $16.7 million of trust preferred securities issued by FISI Statutory Trust I and $37.5 million of preferred stock issued to the U.S. Department of Treasury (the “Treasury”) through the Treasury’s Troubled Asset Relief Program (“TARP”) (see Note 11, Shareholders’ Equity). The Company and the Bank’s total capital are comprised of Tier 1 capital for each entity plus a permissible portion of the allowance for loan losses.
The Tier 1 and total capital ratios are calculated by dividing the respective capital amounts by risk-weighted assets. Risk-weighted assets are calculated based on regulatory requirements and include total assets, excluding goodwill and other intangible assets and disallowed portions of deferred tax assets, allocated by risk weight category and certain off-balance-sheet items (primarily loan commitments). The leverage ratio is calculated by dividing Tier 1 capital by adjusted quarterly average total assets, which exclude goodwill and other intangible assets and disallowed portions of deferred tax assets.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(10.) REGULATORY MATTERS (Continued)
The Company’s and the Bank’s actual and required capital ratios as of December 31, 2008 and 2007 were as follows (dollars in thousands):
                         
          For Capital    
  Actual  Adequacy Purposes  Well Capitalized 
  Amount  Ratio  Amount  Ratio  Amount  Ratio 
December 31, 2008:
                        
Tier 1 leverage:                        
Company $150,426   8.05% $74,764   4.00% $93,456   5.00%
Bank (FSB)  120,484   6.46   74,586   4.00   93,232   5.00 
Tier 1 capital (to risk-weighted assets):                        
Company  150,426   11.83   50,881   4.00   76,322   6.00 
Bank (FSB)  120,484   9.52   50,624   4.00   75,936   6.00 
Total risk-based capital (to risk-weighted assets):                        
Company  166,362   13.08   101,762   8.00   127,203   10.00 
Bank (FSB)  136,340   10.77   101,248   8.00   126,560   10.00 
                         
December 31, 2007:
                        
Tier 1 leverage:                        
Company $172,899   9.35% $73,943   4.00% $92,429   5.00%
Bank (FSB)  157,312   8.54   73,718   4.00   92,148   5.00 
Tier 1 capital (to risk-weighted assets):                        
Company  172,899   15.74   49,939   4.00   65,909   6.00 
Bank (FSB)  157,312   14.40   43,710   4.00   65,565   6.00 
Total risk-based capital (to risk-weighted assets):                        
Company  186,652   16.99   87,878   8.00   109,848   10.00 
Bank (FSB)  170,994   15.65   87,420   8.00   109,275   10.00 
Five Star Bank has been notified by its regulator that, as of its most recent regulatory examination, it is regarded as well capitalized under the regulatory framework for prompt corrective action. Such determination has been made based on the Bank’s Tier 1, total capital, and leverage ratios. There have been no conditions or events since this notification that management believes would change the Bank’s categorization as well capitalized under the aforementioned ratios.
(11.) SHAREHOLDERS’ EQUITY
The Company’s authorized capital stock consists of 50,210,000 shares of capital stock, 50,000,000 of which are common stock, par value $0.01 per share, and 210,000 of which are preferred stock, par value $100.00 per share, which is designated into two classes, Class A of which 10,000 shares are authorized, and Class B of which 200,000 shares are authorized. There are two series of Class A Preferred Stock; Series A 3% Preferred Stock and the Series A Preferred Stock. There is one series of Class B Preferred Stock; Series B-1 8.48% Preferred Stock. As of December 31, 2008, there were 183,259 shares of preferred stock issued and outstanding.
Common Stock
The changes in shares of common stock outstanding were as follows for the funded statusyears ended December 31:
         
  2008  2007 
Shares outstanding at beginning of period  11,011,151   11,342,771 
Restricted stock awards issued  51,500   17,100 
Stock options exercised  2,317   14,776 
Directors’ retainer  5,912   5,319 
Treasury stock purchases  (272,861)  (368,815)
       
         
Shares outstanding at end of period  10,798,019   11,011,151 
       

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(11.) SHAREHOLDERS’ EQUITY (Continued)
Treasury Stock
The Company repurchased 272,861 shares, 368,815 shares, and 20,351 shares of its common stock in open market transactions at an aggregate cost of $4.8 million, $7.2 million and $335 thousand during the years ended December 31, 2008, 2007 and 2006, respectively.
Preferred Stock and Warrant
Series A 3% Preferred Stock.As of December 31, 2008, there were 1,533 shares of Series A 3% Preferred Stock issued and outstanding. Holders of Series A 3% Preferred Stock are entitled to receive an annual dividend of $3.00 per share, which is cumulative and payable quarterly. Holders of Series A 3% Preferred Stock have no pre-emptive right in, or right to purchase or subscribe for, any additional shares of the defined benefitCompany’s capital stock and postretirement planshave no voting rights. Dividend or dissolution payments to the Class A shareholders must be declared and paid, or set apart for payment, before any dividends or dissolution payments can be declared and paid, or set apart for payment, to the holders of Class B Preferred Stock or Common Stock. The Series A 3% Preferred Stock is not convertible into any other of the Company’s securities.
Series A Preferred Stock and Warrant.In December 2008, under the U.S. Department of the Treasury’s (“Treasury”) TARP Capital Purchase Program, the Company entered into a Securities Purchase Agreement—Standard Terms with the U.S. Treasury pursuant to which, among other things, the Company sold to the U.S. Treasury for an aggregate purchase price of $37.5 million, 7,503 shares of fixed rate cumulative perpetual preferred stock, Series A (Series A Preferred Stock) and a warrant to purchase up to 378,175 shares of common stock, par value $0.01 per share (the “Warrant”), of the Company.
The Series A Preferred Stock ranks senior to the Company’s common shares andpari passu, which is at an equal level in the capital structure, with existing preferred shares (Series A 3% Preferred Stock), other than preferred shares which by their terms rank junior to any other existing preferred shares (Series B-1 8.48% Preferred Stock). The Series A Preferred Stock pays a compounding cumulative dividend, in cash, at a rate of 5% per annum through February 15, 2014, and 9% per annum thereafter on the liquidation preference of $5,000 per share. The Company is prohibited from paying any dividend with respect to shares of common stock, other junior securities or preferred stock rankingpari passuwith the Series A Preferred Stock or repurchasing or redeeming any shares of the Company’s common shares, other junior securities or preferred stock rankingpari passuwith the Series A Preferred Stock in any quarter unless all accrued and unpaid dividends are paid on the Series A Preferred Stock for all past dividend periods (including the latest completed dividend period), subject to certain limited exceptions. The Series A Preferred Stock is non-voting, other than class voting rights on matters that could adversely affect the Series A Preferred Stock. The U.S. Treasury may also transfer the Series A Preferred Stock to a third party at any time.
The Company’s Series A Preferred Stock qualifies as Tier 1 capital in accordance with regulatory capital requirements (see Note 10, Regulatory Matters).
The Warrant has a term of 10 years and is exercisable at any time, in whole or in part, at an exercise price of $14.88 per share (subject to certain anti-dilution adjustments). The U.S. Treasury may not exercise the Warrant for, or transfer the Warrant with respect to, more than half of the initial shares of common stock underlying the Warrant prior to the earlier of (i) the date on which the Company receives aggregate gross proceeds of not less than $37.5 million from one or more qualified equity offerings and (ii) December 31, 2009. The number of shares to be delivered upon settlement of the Warrant will be recognizedreduced by 50% if the Company receives aggregate gross proceeds of at least 100% of the aggregate liquidation preference of the Series A Preferred Stock ($37.5 million) from one or more qualified equity offerings prior to December 31, 2009.
Under the original terms of the CPP, the Company could not redeem the Series A Preferred Stock prior to February 15, 2012 except with proceeds from a qualified offering. However, the American Recovery and Reinvestment Act of 2009 (“ARRA”), provides that the Secretary of Treasury shall permit a recipient of funds under TARP, subject to consultation with the recipient’s appropriate Federal banking agency, to repay such assistance without regard to whether the recipient has replaced such funds from any other source or to any waiting period. ARRA further provides that when the recipient repays such assistance, the Secretary of Treasury shall liquidate the warrants associated with the assistance at the current market price. While Treasury has not yet issued implementing regulations, it appears that ARRA will permit the Company, if it so elects and following consultation with the FRB, to redeem the Series A Preferred Stock at any time without restriction.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(11.) SHAREHOLDERS’ EQUITY (Continued)
The $37.5 million in proceeds was allocated to the Series A Preferred Stock and the Warrant based on their relative fair values at issuance ($35.5 million was allocated to the Series A Preferred Stock and $2.0 million to the Warrant). The difference between the initial value allocated to the Series A Preferred Stock of $35.5 million and the liquidation value of $37.5 million will be charged to retained earnings from the issue date through February 15, 2014, which is the commencement of the perpetual dividend, as an adjustment to the dividend yield using the effective yield method. The amount charged to retained earnings will be deducted from the numerator in calculating basic and diluted earnings per share during the related reporting period (see Note 15, (Loss) Earnings per Share).
Series B-1 8.48% Preferred Stock.As of December 31, 2008, there were 174,223 shares of Series B-1 8.48% Preferred Stock issued and outstanding. Holders of Series B-1 8.48% Preferred Stock are entitled to receive an annual dividend of $8.48 per share, which is cumulative and payable quarterly. Holders of Series B-1 8.48% Preferred Stock have no pre-emptive right in, or right to purchase or subscribe for, any additional shares of the Company’s capital stock and have no voting rights. Accumulated dividends on the Series B-1 8.48% Preferred Stock do not bear interest, and the Series B-1 8.48% Preferred Stock is not subject to redemption. Dividend or dissolution payments to the Class B shareholders must be declared and paid, or set apart for payment, before any dividends or dissolution payments are declared and paid, or set apart for payment, to the holders of Common Stock. The Series B-1 8.48% Preferred Stock is not convertible into any other of the Company’s securities.
(12.) OTHER COMPREHENSIVE INCOME (LOSS)
Total comprehensive income (loss) is reported in the yearaccompanying consolidated statements of changes in whichshareholders’ equity. Information related to net other comprehensive income (loss) for the changes occur throughyears ended December 31 was as follows (in thousands):
             
  Pre-tax  Tax Expense  Net-of-tax 
  Amount  (Benefit)  Amount 
2008
            
Securities available for sale:            
Change in net unrealized gain/loss during the period $(61,464) $(23,778) $(37,686)
Reclassification adjustment for gains included in income  (288)  (111)  (177)
Reclassification adjustment for impairment charges included in income  68,215   26,389   41,826 
          
   6,463   2,500   3,963 
Change in net actuarial gain/loss and prior service benefit (cost) on defined benefit pension and post-retirement plans  (14,098)  (5,455)  (8,643)
          
Other comprehensive loss $(7,635) $(2,955) $(4,680)
          
             
2007
            
Securities available for sale:            
Change in net unrealized gain/loss during the period $10,530  $4,103  $6,427 
Reclassification adjustment for gains included in income  (207)  (80)  (127)
          
   10,323   4,023   6,300 
Change in net actuarial gain/loss and prior service benefit (cost) on defined benefit pension and post-retirement plans  4,531   1,760   2,771 
          
Other comprehensive income $14,854  $5,783  $9,071 
          
             
2006
            
Securities available for sale:            
Change in net unrealized gain/loss during the period $(833) $(229) $(604)
Reclassification adjustment for gains included in income  (30)  (12)  (18)
          
Other comprehensive loss $(863) $(241) $(622)
          
The components of accumulated other comprehensive income or loss.(loss), net of tax, as of December 31 were as follows (in thousands):
         
  2008  2007 
Net actuarial gain (loss) and prior service benefit (cost) on defined benefit pension and post-retirement plans $(7,476) $1,167 
Net unrealized gain (loss) on securities available for sale  3,463   (500)
       
  $(4,013) $667 
       

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(13.) SHARE-BASED COMPENSATION
The incremental effectCompany has a Management Stock Incentive Plan and a Director’s Stock Incentive Plan (the “Plans”). Under the Plans, the Company may grant stock options to purchase shares of applying SFAScommon stock, shares of restricted stock or stock appreciation rights to its directors and key employees. Grants under the plans may be made up to 10% of the number of shares of common stock issued, including treasury shares. The exercise price of each option equals the market price of the Company’s stock on the date of the grant. All options have a 10-year term and become fully exercisable over a period of 3 to 5 years from the grant date. When option recipients exercise their options, the Company issues shares from treasury stock and record the proceeds as additions to capital.
The share-based compensation expense included in the Consolidated Statements of Operations for the years ended December 31, 2008, 2007 and 2006 was as follows (in thousands):
             
  2008  2007  2006 
Stock options:            
Management Stock Incentive Plan $378  $571  $522 
Director Stock Incentive Plan  40   220   299 
          
   418   791   821 
Restricted stock awards:            
Management Stock Incentive Plan  215   164   44 
          
Total share-based compensation $633  $955  $865 
          
The restricted stock award expense for 2008 includes $30 thousand of dividends for unearned shares in the restricted stock plan which is accounted for as compensation expense.
The following is a summary of stock option activity for the year ended December 31, 2008 (dollars in thousands, except per share amounts):
                 
          Weighted    
      Weighted  Average    
      Average  Remaining  Aggregate 
  Number of  Exercise  Contractual  Intrinsic 
  Options  Price  Term  Value 
                 
Outstanding at beginning of year  534,987  $19.40         
Granted  61,100   16.98         
Exercised  (2,317)  13.77         
Forfeited  (5,775)  19.03         
Expired  (5,110)  22.18         
                
Outstanding at end of year  582,885  $19.14  5.37 years $59 
                 
Exercisable at end of year  402,357  $19.28  4.02 years $59 
As of December 31, 2008, there was $430 thousand of unrecognized compensation expense related to unvested stock options that is expected to be recognized over a weighted average period of 1.99 years.
The aggregate intrinsic value (the amount by which the market price of the stock on the date of exercise exceeded the market price of the stock on the date of grant) of option exercises for the years ended December 31, 2008, 2007 and 2006 was $10 thousand, $52 thousand, and $54 thousand, respectively. The total cash received as a result of option exercises under stock compensation plans for the years ended December 31, 2008, 2007 and 2006 was $32 thousand, $251 thousand, and $208 thousand, respectively. The tax benefits realized in connection with these stock option exercises were not significant.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(13.) SHARE-BASED COMPENSATION (Continued)
The Company uses the Black-Scholes valuation method to estimate the fair value of its stock option awards. This method is dependent on certain assumption. The following is a summary of the stock options granted for the periods indicated as well as the weighted average assumptions used to compute the fair value of the options:
             
  2008  2007  2006 
             
Options granted  61,100   90,700   99,597 
Grant date weighted average fair value per share $5.09  $7.09  $8.14 
Grant date weighted average share price $16.98  $19.49  $19.73 
Risk-free interest rate  3.40%  4.76%  4.96%
Expected dividend yield  3.48%  2.21%  1.65%
Expected stock price volatility  38.60%  39.36%  41.75%
Expected life (in years)  6.19   5.94   6.19 
In the table above the risk-free interest rate is the U.S. Treasury rate commensurate with the expected life of option on the date of their grant. The expected stock price volatility is based upon historical activity of the Company’s stock over a span of time equal to the expected life of the options. The expected life for options granted subsequent to 2006 is based upon based on historical experience for the Plans. Prior to that, the Company estimated the expected life of the stock options using the simplified method prescribed by SEC Staff Accounting Bulletin (“SAB”) No. 158 on individual line items107.
The following is a summary of restricted stock award activity for the year ended December 31, 2008:
         
      Weighted 
      Average 
      Market 
  Number of  Price at 
  Shares  Grant Date 
         
Outstanding at beginning of year  30,300  $19.56 
Granted  51,500   19.22 
Vested      
Forfeited      
        
Outstanding at end of year  81,800  $19.35 
        
As of December 31, 2008, there was $238 thousand of unrecognized compensation expense related to unvested restricted stock awards that is expected to be recognized over a weighted average period of 1.38 years.
(14.) INCOME TAXES
Total income tax (benefit) expense was allocated as follows for the years ended December 31 (in thousands):
             
  2008  2007  2006 
             
Income tax (benefit) expense $(21,301) $4,800  $6,245 
Shareholder’s equity  (2,955)  5,783   (1,272)
The income tax (benefit) provision for the years ended December 31, 2008, 2007 and 2006 consisted of the following (in thousands):
             
  2008  2007  2006 
             
Current tax expense:            
Federal $2,043  $3,572  $6,152 
State  504   513   30 
          
   2,547   4,085   6,182 
          
             
Deferred tax (benefit) expense:            
Federal  (19,640)  126   (1,498)
State  (4,208)  589   1,561 
          
   (23,848)  715   63 
          
Total income tax (benefit) expense: $(21,301) $4,800  $6,245 
          

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(14.) INCOME TAXES (Continued)
Income tax expense (benefit) differed from the statutory federal income tax rate as follows:
             
  2008  2007  2006 
 
Statutory federal tax rate  (34.0)%  34.0%  34.0%
Increase (decrease) resulting from:            
Tax exempt interest income  (5.2)  (13.6)  (12.8)
Disallowed interest expense  0.5   1.8   1.5 
State taxes, net of federal tax benefit  (5.2)  3.4   4.4 
Non-taxable earnings on company owned life insurance  (0.4)  (2.0)  (0.8)
Dividend received deduction  (0.8)  (1.5)  (0.3)
Other, net  0.2   0.5   0.5 
          
Effective tax rate  (44.9)%  22.6%  26.5%
          
The Company’s net deferred tax asset is included in other assets in the Consolidated Statements of Condition. The tax effects of temporary differences that give rise to the deferred tax assets and deferred tax liabilities at December 31, 2008 and 2007 are as follows (in thousands):
         
  2008  2007 
Deferred tax assets:        
Allowance for loan losses $6,619  $5,435 
Net unrealized loss on securities available for sale     315 
Other than temporary impairment of investment securities  26,389    
Tax attribute carryforward benefits  2,689   2,070 
Accrued pension costs  2,494    
Interest on nonaccruing loans  595   678 
Share-based compensation  794   569 
Core deposit intangible  332   500 
Other  374   318 
       
Gross deferred tax assets  40,286   9,885 
Valuation allowance      
       
Deferred tax assets, net of valuation allowance  40,286   9,885 
Deferred tax liabilities:        
Deferred loan origination costs  4,458   1,873 
Net unrealized gain on securities available for sale  2,185    
Prepaid pension costs     1,288 
Depreciation and amortization  1,342   1,056 
Loan servicing assets  218   380 
Other  2   9 
       
Gross deferred tax liabilities  8,205   4,606 
       
Net deferred tax asset $32,081  $5,279 
       
The Company recognizes deferred income taxes for the estimated future tax effects of differences between the tax and financial statement bases of assets and liabilities considering enacted tax laws. These differences result in deferred tax assets and liabilities, which are included in other assets in the Company’s consolidated statements of condition. The Company also assesses the likelihood that deferred tax assets will be realizable based on, among other considerations, future taxable income and establishes, if necessary, a valuation allowance for those deferred tax assets determined to not likely be realizable. A deferred tax asset valuation allowance is recognized if, based on the weight of available evidence (both positive and negative), it is more likely than not that some portion or all of the deferred tax assets will not be realized. The future realization of deferred tax benefits depends upon the existence of sufficient taxable income within the carry-back and carry-forward periods. Management judgment is required in determining the appropriate recognition of deferred tax assets and liabilities, including projections of future taxable income.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(14.) INCOME TAXES (Continued)
The following are examples of certain evidence that management considered in evaluating its ability to realize its deferred tax assets at December 31, 2008:
While current and anticipated banking industry conditions are challenging, the Company remains well capitalized.
The Company sustained a strong earnings history for many years prior to 2008.
The cumulative three-year loss (based on pre-tax income for financial conditionreporting purposes) of approximately $2.6 million includes an impairment charge of $68.2 million related to the OTTI charge on certain securities. The Company would have been profitable for the three-year period without this charge.
The Company’s cumulative loss in recent years includes only one year (2008) with a pre-tax loss. Notwithstanding the loss, the Company’s estimated 2008 taxable income for federal income tax return purposes is approximately $4.0 million.
There are prudent and feasible tax planning strategies available to sustain the recognition of certain tax assets, such as followsthe strategy of holding temporarily impaired securities until a market recovery, which may be until maturity, the timing of contributions to the defined benefit pension plan and the de-emphasis on tax-exempt interest income, among other things.
Taxes paid within the Company’s two year federal tax loss carry-back period were approximately $5.6 million.
Taxable temporary differences related to deferred tax liabilities of approximately $8.2 million are scheduled to reverse and offset deductible temporary differences in the future.
Based upon the Company’s historical and projected future levels of pre-tax and taxable income, the scheduled reversals of taxable temporary differences to offset future deductible amounts, and prudent and feasible tax planning strategies, management believes it is more likely than not that the deferred tax assets will be realized.
The Company and its subsidiaries are subject to federal and New York State (“NYS”) income taxes. The federal and NYS income tax years currently open for audit are 2006 through 2008.
At December 31, 2008, the Company has federal and NYS net operating loss carryforwards of approximately $58 thousand and $86 thousand, respectively. The federal and NYS net operating loss carryforwards begin to expire in 2021. The Company also has federal and NYS tax credits of approximately $2.7 million and $8 thousand, respectively, which have an unlimited carryforward period. The federal and NYS net operating loss carryforwards are subject to annual limitations imposed by the Internal Revenue Code (“IRC”). The Company believes the limitations will not prevent the carryforward benefits from being utilized.
As of December 31, 2007, the Company’s unrecognized tax benefits totaled $50 thousand. The unrecognized tax benefits were associated with a NYS examination of the Company’s 2002 through 2005 tax years that remained in process as of December 31:31, 2007. In 2008 the NYS examination was concluded and the unrecognized tax benefits were recognized. The Company had no unrecognized tax benefits at December 31, 2008 and does not expect unrecognized tax benefits to significantly increase or decrease in the next twelve months. There were no interest or penalties recorded in the income statement in income tax expense for the year ended December 31, 2008. As of December 31, 2008, there were no amounts accrued for interest or penalties related to uncertain tax positions.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
             
  2006
  Before     After
(Dollars in thousands) Adoption Adjustment Adoption
 
Prepaid pension asset, included in other assets $3,086  $(2,971) $115 
Net deferred tax assets, include in other assets  10,754   1,023   11,777 
Accrued postretirement liability, included in other liabilities  791   (344)  447 
Accumulated other comprehensive income (loss)  (6,800)  (1,604)  (8,404)
(15.) (LOSS) EARNINGS PER SHARE
Basic (loss) earnings per share represents income applicable to common shareholders divided by the weighted-average number of common shares outstanding during the period excluding unvested restricted stock. Diluted earnings per share reflects additional common shares (common stock equivalents) that would have been outstanding if dilutive potential common shares had been issued. Potential common shares that may be issued by the Company relate to outstanding stock-based awards and a warrant to purchase stock and are determined using the treasury stock method. Assumed conversion of the outstanding dilutive stock-based awards and the warrant to purchase stock would increase the shares outstanding but would not require an adjustment to income as a result of the conversion.
Earnings per common share have been computed based on the following for the years ended December 31, (dollars and shares in thousands, except per share amounts):
             
  2008  2007  2006 
 
Net (loss) income applicable to common shareholders $(27,696) $14,926  $15,876 
          
Weighted average number of common shares used to calculate basic (loss) earnings per common share  10,818   11,154   11,328 
Add: Effect of common stock equivalents     30   36 
          
Weighted average number of common shares used to calculate diluted (loss) earnings per common share  10,818   11,184   11,364 
          
             
(Loss) earnings per common share:            
Basic $(2.56) $1.34  $1.40 
Diluted $(2.56) $1.33  $1.40 
Due to the loss applicable to common shareholders reported for the year ended December 31, 2008, the effect of all share-based awards and the warrant were anti-dilutive and therefore are not included in the calculation of diluted earnings per share. There were approximately 384,000 and 251,000 weighted average common stock equivalents for the years ended December 31, 2007 and 2006, respectively, that were not considered in the calculation of diluted earnings per share since their effect would have been anti-dilutive.
(16.) EMPLOYEE BENEFIT PLANS
Defined Benefit Pension Plan
The Company participates in The New York State Bankers Retirement System (the “System”), which is a defined benefit pension plan covering substantially all employees.employees, subject to the limitations related to the plan closure effective December 31, 2006. The benefits are based on years of service and the employee’s highest average compensation during five consecutive years of employment.
The defined benefit plan was closed to new participants effective December 31, 2006. Only employees hired on or before December 31, 2006 and who meetmet participation requirements on or before January 1, 2008 shall beare eligible to receive benefits.
The following table sets forth the defined benefit pension plan’s change in benefit obligation and change in plan assets using the most recent actuarial data at September 30 (measurement date for plan accounting and disclosure):

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(Dollars in thousands) 2006  2005  2004 
 
Change in benefit obligation:            
Benefit obligation at beginning of year $(25,966) $(22,704) $(20,080)
Service cost  (1,725)  (1,578)  (1,374)
Interest cost  (1,341)  (1,285)  (1,186)
Actuarial gain (loss)  1,928   (1,354)  (968)
Benefits paid  1,093   765   747 
Plan expenses  205   190   157 
          
Benefit obligation at end of year  (25,806)  (25,966)  (22,704)
             
Change in plan assets:            
Fair value of plan assets at beginning of year  22,953   19,962   17,560 
Actual return on plan assets  2,698   2,367   1,900 
Employer contributions  1,568   1,579   1,406 
Benefits paid  (1,093)  (765)  (747)
Plan expenses  (205)  (190)  (157)
          
Fair value of plan assets at end of year  25,921   22,953   19,962 
          
             
Unfunded status  115   (3,013)  (2,742)
Unamortized net asset at transition     (26)  (64)
Unrecognized net loss subsequent to transition     6,050   5,648 
Unamortized prior service cost     195   213 
          
             
Prepaid pension asset, included in other assets $115  $3,206  $3,055 
          
The accumulated benefit obligation was $21.8 million at September 30, 2006 and 2005, respectively.
Net periodic pension cost consists of the following components for the years ended September 30:
             
(Dollars in thousands) 2006  2005  2004 
 
Service cost $1,725  $1,578  $1,374 
Interest cost on projected benefit obligation  1,341   1,285   1,186 
Expected return on plan assets  (1,866)  (1,632)  (1,436)
Amortization of net transition asset  (26)  (38)  (38)
Amortization of unrecognized loss  223   218   219 
Amortization of unrecognized prior service cost  14   18   18 
          
             
Net periodic pension cost $1,411  $1,429  $1,323 
          
The actuarial assumptions used to determine the net periodic pension cost were as follows:
             
  2006  2005  2004 
   
Weighted average discount rate  5.25%  5.75%  6.00%
Expected long-term rate of return  7.50%  8.00%  8.00%
Rate of compensation increase  3.50%  3.00%  3.00%
The actuarial assumptions used to determine the accumulated benefit obligation were as follows:
             
  2006  2005  2004 
   
Weighted average discount rate  5.82%  5.25%  5.75%
Expected long-term rate of return  7.50%  8.00%  8.00%
The weighted average discount rate was derived using an actuarial discount rate model based on expected cash outflows from the plan.
The expected long-term rate-of-return on plan assets reflects long-term earnings expectations on existing plan assets and those contributions expected to be received during the current plan year. In estimating that rate,

77


appropriate consideration was given to historical returns earned by plan assets in the fund and the rates of return expected to be available for reinvestment. Average rates of return over the past 1,3,5 and 10 year periods were determined and subsequently adjusted to reflect current capital market assumptions and changes in investment allocations.
The estimated amounts that will be amortized from accumulated other comprehensive income (loss) into net periodic benefit cost in 2007 are as follows:
     
(Dollars in thousands) 2007 
 
Unrecognized loss $31 
Prior service cost  11 
    
     
Total $42 
    
The pension plan weighted average asset allocations by asset category are as follows at September 30:
         
(Dollars in thousands) 2006  2005 
 
Asset category:        
Equity securities  59.8%  58.8%
Debt securities  39.9   41.2 
Other  0.3    
       
         
Total  100.0%  100.0%
       
The New York State Bankers Retirement System (the “System”) was established in 1938 to provide for the payment of benefits to employees of participating banks. The Systembanks and is overseen by a Board of Trustees who meet quarterly to set the investment policy guidelines.
The System utilizes two investment management firms each investingwhere one firm is managing approximately 50%68% of the totalportfolio and the second firm is managing approximately 32% of the portfolio. The System’s investment objective is to exceed the investment benchmarks in each asset category. Each firm operates under a separate written investment policy approved by the Trustees and designed to achieve an allocation approximating 60% (may vary from 50%-70%) invested in equity securities and 40% (may vary from 30%-50%) invested in debt securities. Each firm reports at least quarterly to the Investment Committee and semi-annually to the Board.
In September 2006, the FASB issued SFAS 158, which requires the recognition of the overfunded or underfunded status of a defined benefit postretirement plan in the Company’s Consolidated Statements of Condition. This portion of the new guidance was adopted by the Company on December 31, 2006. Additionally, the pronouncement eliminates the option for the Company to use a measurement date prior to the Company’s fiscal year-end effective December 31, 2008. SFAS 158 provides two approaches to transition to a fiscal year-end measurement date, both of which are to be applied prospectively. The Company elected to apply the transition option under which a 15-month measurement was determined as of September 30, 2007 that covered the period until the fiscal year-end measurement was required on December 31, 2008. The effect of changing the measurement date resulted in a $43 thousand increase to retained earnings.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(16.) EMPLOYEE BENEFIT PLANS (Continued)
The following table provides a reconciliation of the changes in the plan’s benefit obligations, fair value of assets and a statement of the funded status at their respective measurement dates (in thousands):
         
  December 31,  September 30, 
  2008(a)  2007 
Change in projected benefit obligation:        
Projected benefit obligation at of beginning of period $(25,102) $(25,806)
Service cost  (1,820)  (1,498)
Interest cost  (1,953)  (1,473)
Actuarial (loss) gain  (3,767)  2,310 
Benefits paid and plan expenses  1,764   1,365 
       
Projected benefit obligation as of end of period  (30,878)  (25,102)
       
Change in plan assets:        
Fair value of plan assets as of beginning of period  28,431   25,921 
Actual (loss) return on plan assets  (7,436)  3,875 
Employer contributions  5,200    
Benefits paid and plan expenses  (1,764)  (1,365)
       
Fair value of plan assets as of end of period  24,431   28,431 
       
(Unfunded) funded status at end of period $(6,447) $3,329 
       
(a)The measurement date for 2008 and 2007 is December 31 and September 30, respectively. As a result, 2008 includes 15 months of activity.
The accumulated benefit obligation was $27.1 million and $22.0 million at December 31, 2008 and 2007, respectively.
Net periodic pension cost consists of the following components for the years ended December 31 (in thousands):
             
  2008  2007  2006 
             
Service cost $1,456  $1,498  $1,725 
Interest cost on projected benefit obligation  1,562   1,473   1,341 
Expected return on plan assets  (2,094)  (1,907)  (1,866)
Amortization of net transition asset        (26)
Amortization of unrecognized loss     31   223 
Amortization of unrecognized prior service cost  11   11   14 
          
Net periodic pension cost $935  $1,106  $1,411 
          
The actuarial assumptions used to determine the net periodic pension cost were as follows:
             
  2008  2007  2006 
             
Weighted average discount rate  6.35%  5.82%  5.25%
Rate of compensation increase  3.50%  3.50%  3.50%
Expected long-term rate of return  7.50%  7.50%  7.50%
The actuarial assumptions used to determine the projected benefit obligation were as follows:
             
  2008  2007  2006 
             
Weighted average discount rate  6.03%  6.35%  5.82%
Rate of compensation increase  3.50%  3.50%  3.50%
The weighted average discount rate was based upon the projected benefit cash flows and the market yields of high grade corporate bonds that are available to pay such cash flows.

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(16.) EMPLOYEE BENEFIT PLANS (Continued)
The expected long-term rate-of-return on plan assets reflects long-term earnings expectations on existing plan assets and those contributions expected to be received during the current plan year. In estimating that rate, appropriate consideration was given to historical returns earned by plan assets in the fund and the rates of return expected to be available for reinvestment.
The Company’s funding policy is to contribute, at a minimum, an actuarially determined amount that will satisfy the minimum funding requirements determined under the appropriate sections of Internal Revenue Code. The Company expects to make the minimum required contribution is zero forof $1.6 million to its pension plan in fiscal year 2009, however a greater amount may be contributed, especially if the year ended December 31, 2007, however the Company is considering making a discretionary contribution tocurrent market disruption continues or worsens.
Estimated benefit payments under the pension plan during 2007.over the next ten years at December 31, 2008 are as follows (in thousands):
     
2009 $1,160 
2010  1,222 
2011  1,348 
2012  1,451 
2013  1,521 
2014 – 2018  10,037 
The future benefit payments that reflect expected future service,pension plan asset allocations by asset category are as appropriate, are expected to be paidfollows as follows:of December 31 (in thousands):
Future pension benefit payments in year ending December 31:
     
(Dollars in thousands)    
 
2007 $1,019 
2008  1,022 
2009  1,045 
2010  1,091 
2011  1,166 
2012-2016  7,943 
         
  2008  2007 
         
Asset category:        
Equity securities $50% $54%
Debt securities  43   40 
Other  7   6 
       
Total $100% $100%
       
Postretirement Benefit Plan
Prior to December 31, 2001, BNBan entity acquired by the Company provided health and dental care benefits to retired employees who met specified age and service requirements through a postretirement health and dental care plan in which both BNBthe acquired entity and the retireeretirees shared the cost. The plan provided for substantially the same medical insurance coverage as for active employees until their death and was integrated with Medicare for those retirees aged 65 or older. In 2001, the plan’s eligibility requirements were amended to curtail eligible benefit payments to only retired employees

78


and active participants who were fully vested under the Plan. In 2003, retirees under age 65 began contributing to health coverage at the same cost-sharing level as that of active employees. The retirees aged 65 or older were offered new Medicare supplemental plans as alternatives to the plan historically offered. The cost sharing of medical coverage was standardized throughout the group of retirees aged 65 or older. In addition, to be consistent with the administration of the Company’s dental plan for active employees, all retirees who continued dental coverage began paying the full monthly premium. The accrued liability included in other liabilities in the consolidated statements of financial condition related to this plan amounted to $447,000$144 thousand and $806,000$207 thousand as of December 31, 2008 and 2007, respectively. The postretirement expense for the plan that was included in salaries and employee benefits in the consolidated statements of operations was not significant for the years ended December 31, 2008, 2007 and 2006. The plan is not funded.
The components of accumulated other comprehensive income (loss) related to the defined benefit plan and postretirement benefit plan, on a pre-tax basis at December 31, are summarized below (in thousands):
         
  2008  2007 
Defined benefit plan:
        
Net actuarial gain (loss) $(12,579) $1,518 
Prior service (cost) benefit  (155)  (169)
       
   (12,734)  1,349 
       
Postretirement benefit plan:
        
Net actuarial gain (loss)  (238)  (308)
Prior service (cost) benefit  778   863 
       
   540   555 
       
Total recognized in accumulated other comprehensive income (loss) $(12,194) $1,904 
       

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(16.) EMPLOYEE BENEFIT PLANS (Continued)
Changes in plan assets and benefit obligations recognized in other comprehensive income (loss) on a pre-tax basis during the years ended December 31 are as follows (in thousands):
         
  2008  2007 
Defined benefit plan:
        
Net actuarial gain (loss) $(14,097) $4,308 
Prior service (cost) benefit  14   12 
       
   (14,083)  4,320 
       
Postretirement benefit plan:
        
Net actuarial gain (loss)  70   85 
Prior service (cost) benefit  (85)  126 
       
   (15)  211 
       
Total recognized in other comprehensive income (loss) $(14,098) $4,531 
       
For the year ending December 31, 2009, the estimated amount of prior service cost that will be amortized from accumulated other comprehensive income into net periodic benefit cost is $12 thousand.
Defined Contribution Plan
Employees that meet certain age and service requirements are eligible to participate in the Company sponsored 401(k) plan. Under the plan, participants may make contributions, in the form of salary deferrals, up to the maximum Internal Revenue Code limit. The Company matches a participant’s contributions up to 4.5% of compensation, calculated as 100% of the first 3% of compensation and 50% of the next 3% of compensation deferred by the participant. In 2006, and 2005, respectively.the Company matched 25% of the first 8% of participant compensation deferral. The Company may also make additional discretionary matching contributions, although no such additional discretionary contributions were made in 2008, 2007 or 2006. The expense included in salaries and employee benefits in the consolidated statements of income for this plan was not significant for the years ended December 31, 2006, 2005 and 2004.
Defined Contribution Plan
The Company also sponsors a defined contribution profit sharing (401(k)) plan covering substantially all employees. The Company matches certain percentages of each eligible employee’s contribution to the plan. The expense included in salaries and employee benefits in the consolidated statements of incomeoperations for this plan amounted to $553,000, $301,000$993 thousand, $869 thousand and $1.1 million$553 thousand in 2006, 20052008, 2007 and 2004,2006, respectively.
(14) Stock CompensationSupplemental Executive Retirement Plans
During 2008, the Company maintains a non-qualified supplemental executive retirement plan (“SERP”) for two active executives. The Company has accrued a Management Stock Incentive Planliability, all of which is unfunded, and a Director’s Stock Incentive Plan (the “Plans”). Under the Plans, the Company may grant stock options to purchase sharesrecorded expense of common stock, shares of restricted stock or stock appreciation rights to its directors$309 thousand at and key employees. The Company had previously only granted stock options to purchase shares of common stock under the Plans, but during the third quarter of 2006, restricted stock awards were granted to certain Executives and Senior Officers of the Management team. Grants under the plans may be made up to 10% of the number of shares of common stock issued, including treasury shares. The exercise price of each option equals the market price of the Company’s stock on the date of the grant. The maximum term of each option is ten years and the vesting period generally ranges between three and five years.
Prior to January 1, 2006, the Company applied Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for stock-based compensation. No stock-based compensation expense was recognized in the consolidated statements of income prior to 2006 for stock options, as the exercise price was equal to the market price of the common stock on the date of all grants made by the Company.
Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payment”, requiring the Company to recognize expense related to the fair value of the stock-based compensation awards. The Company elected the modified prospective transition method as permitted by SFAS No. 123(R); accordingly, results from prior periods have not been restated. Under the transition method, stock-based compensation expense for the year ended December 31, 2006 includes:
(a)compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”; and
(b)compensation expense for all stock-based compensation awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123(R).
Historically, SFAS No. 123 required pro forma disclosure of stock-based compensation expense and the Company has recognized pro forma compensation expense2008. There were no amounts recorded for stock option awards on a straight-line basis over the applicable vesting periods. This policy differs from the policy required to be applied to awards granted after the adoption of SFAS No. 123(R), which requires that compensation expense be recognized for awards over the requisite service period of the award or to an employee’s eligible retirement date, if earlier. The Company will recognize compensation expense over the remaining vesting periods for awards grantedthese SERPs prior to adoption of SFAS No. 123(R), and for all awards after December 31, 2005, compensation expense will be recognized over the award’s requisite service period or over a period ending with an employee’s eligible retirement date, if earlier.2008.

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The expense associated with the amortization of unvested stock compensation included in the consolidated statements of income for the year ended December 31, 2006 is as follows:
     
(Dollars in thousands) 2006 
 
Stock options:    
Management Stock Incentive Plan (1) $522 
Director Stock Incentive Plan (2)  299 
    
     
Total amortization of unvested stock options  821 
     
Restricted stock awards:    
Management Stock Incentive Plan (1)  44 
    
     
Total amortization of unvested restricted stock awards  44 
    
     
Total amortization of unvested stock compensation $865 
    
(1)Included in salaries and employee benefits in the consolidated statements of income.
(2)Included in other noninterest expense in the consolidated statements of income.
The following table summarizes the stock option activity for the year ended December 31, 2006:
                 
          Weighted    
      Weighted  Average    
      Average  Remaining    
      Exercise  Contractual  Aggregate 
      Price  Term  Intrinsic 
(Dollars in thousands, except per share amounts) Options  per Share  (in Years)  Value 
 
Outstanding at December 31, 2005  426,238  $19.58         
Granted  99,597   19.73         
Exercised  (10,355)  18.90         
Forfeited  (5,298)  21.24         
Expired  (11,250)  22.82         
               
Outstanding at December 31, 2006  498,932  $19.54   5.78  $1,975 
                 
Vested and expected to vest at December 31, 2006  473,320  $19.49   5.63  $1,910 
                 
Exercisable at December 31, 2006  309,649  $18.94   3.99  $1,481 
As of December 31, 2006, there was $734,000 of unrecognized compensation expense related to unvested stock options that is expected to be recognized over a weighted average period of 2.13 years.
The weighted average grant date fair value and Black-Scholes option valuation assumptions used for the stock option grants totaling 99,597, 143,263 and 104,234 for the years ended December 31, 2006, 2005 and 2004, respectively were as follows:
             
  2006  2005  2004 
 
Fair value of stock options granted $8.14  $6.35  $9.25 
Risk-free interest rate  4.96%(1)  4.17%  4.20%
Expected dividend yield  1.65%  1.94%  2.69%
Expected stock price volatility  41.75%(2)  26.79%  35.70%
Expected term of stock options (in years) 6.19 yrs (3) 6.22 yrs  10.00 yrs 
(1)Based on the average of the five and seven year Treasury constant maturity (“TCM”) interest rates that is consistent with the expected term of the stock options.
(2)Expected stock price volatility is based on actual experience using a historical period that is consistent with the expected term of the stock options.
(3)The Company estimated the expected term of the stock options using the simplified method prescribed by SEC Staff Accounting Bulletin (“SAB”) No. 107.

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The aggregate intrinsic value of option (the amount by which the market price of the stock on the date of exercise exceeded the market price of the stock on the date of grant) exercises for the years ended December 31, 2006, 2005 and 2004 was $54,000, $322,000 and $511,000, respectively. The total cash received as a result of option exercises under stock compensation plans for the years ended December 31, 2006, 2005 and 2004 was $196,000, $940,000 and $1.1 million, respectively. In connection with these option exercises, the tax benefits realized from stock compensation plans were $22,000, $129,000 and $204,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
The following table summarizes the restricted stock award activity for the year ended December 31, 2006:
         
      Weighted Average 
      Market Price 
  Shares  at Grant Date 
 
Outstanding at December 31, 2005    $ 
Awarded  13,200   19.75 
Vested      
Forfeited      
       
Outstanding at December 31, 2006  13,200  $19.75 
As of December 31, 2006, there was $217,000 of unrecognized compensation expense related to unvested restricted stock awards that is expected to be recognized over a weighted average period of 2.41 years.
(15) Earnings Per Common Share
Basic earnings per share, after giving effect to preferred stock dividends, has been computed using weighted average common shares outstanding. Diluted earnings per share reflect the effects, if any, of incremental common shares issuable upon exercise of dilutive stock options.
Earnings per common share have been computed based on the following for the years ended December 31:
             
(Dollars in thousands) 2006  2005  2004 
 
Income from continuing operations $17,362  $4,618  $12,943 
             
Less: Preferred stock dividends  1,486   1,488   1,495 
          
             
Income from continuing operations available to common shareholders  15,876   3,130   11,448 
             
Loss on discontinued operations, net of tax     (2,452)  (450)
          
             
Net income available to common shareholders $15,876  $678  $10,998 
          
             
Weighted average number of common shares used to calculate basic earnings per common share  11,328   11,303   11,192 
             
Add: Effect of common stock equivalents  36   31   48 
          
             
Weighted average number of common shares used to calculate diluted earnings per common share  11,364   11,334   11,240 
          
There were approximately 251,000, 354,000 and 229,000 weighted average common stock equivalents from outstanding stock options for the years ended December 31, 2006, 2005 and 2004, respectively that were not considered in the calculation of diluted earnings per share since their effect would have been anti-dilutive.
(16) Supervision and Regulation
The supervision and regulation of financial and bank holding companies and their subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds regulated by the FDIC and the banking system as a whole, and not for the protection of shareholders or creditors of bank holding companies. The various bank regulatory agencies have broad enforcement power over bank holding companies and banks, including the

81


power to impose substantial fines, operational restrictions and other penalties for violations of laws and regulations.
The Bank is required to maintain a reserve balance at the Federal Reserve Bank of New York. The reserve requirements for the Bank totaled $1.2 million and $1.0 million at December 31, 2006 and 2005, respectively.
The Company is also subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material impact on the Company’s consolidated financial statements.
For evaluating regulatory capital adequacy, companies are required to determine capital and assets under regulatory accounting practices. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios. The leverage ratio requirement is based on period-end capital to average adjusted total assets during the previous three months. Compliance with risk-based capital requirements is determined by dividing regulatory capital by the sum of a company’s weighted asset values. Risk weightings are established by the regulators for each asset category according to the perceived degree of risk. As of December 31, 2006 and 2005, the Company and FSB met all capital adequacy requirements to which they are subject.
The Bank must pay assessments to the Federal Deposit Insurance Corporation (“FDIC”) for federal deposit insurance protection. The FDIC has adopted a risk-based assessment system as required by the FDIC Improvement Act. Under this system, FDIC-insured depository institutions pay insurance premiums at rates based on their risk classification. Institutions assigned to higher risk classifications (that is, institutions that pose a greater risk of loss to their respective deposit insurance funds) pay assessments at higher rates than institutions that pose a lower risk. An institution’s risk classification is assigned based on its capital levels and the level of supervisory concern the institution poses to the regulators. In addition, the FDIC can impose special assessments in certain instances.
Prior to the Company’s restructuring in December 2005, the Company’s former bank subsidiaries NBG and BNB were operating under formal agreements with the Office of the Comptroller of the Currency (“OCC”), which resulted in a higher FDIC risk classification and the Company experienced an increase in FDIC insurance premiums in 2005. As a result of the merger of the Company’s subsidiary banks and the lower risk classification for FSB, the FDIC insurance premiums decreased in 2006. FDIC insurance premiums, included in other noninterest expense in the consolidated statements of income, amounted to $215,000, $1,368,000 and $566,000 for the years ended December 31, 2006, 2005 and 2004, respectively.
Payments of dividends by the subsidiary Bank to FII are limited or restricted in certain circumstances under banking regulations. During September 2006, FII requested approval from the NYS Banking Department to pay a $25.0 million cash dividend from FSB to FII. Regulatory approval was necessary as the requested dividend amount exceeded the amount allowable under regulations. During October 2006, FSB received regulatory approval and paid the $25.0 million dividend to FII. FSB will be required to obtain approval from the NYS Banking Department for any future dividend that exceeds the sum of the current year’s net income plus the retained profits for the preceding two years. FII used the dividend proceeds to repay a $25.0 million term loan with another commercial bank during October 2006.
The following is a summary of the actual capital amounts and ratios for the Company and the Bank(s) as of December 31:

82


                         
(Dollars in thousands) 2006
  Actual Regulatory    
  Capital Minimum Requirements Well-Capitalized
  Amount Ratio Amount Ratio Amount Ratio
 
Leverage capital (Tier 1) as percent of three-month average assets:                        
Company $168,729   8.91% $75,784   4.00% $94,731   5.00%
FSB  152,328   8.06   75,584   4.00   94,480   5.00 
                         
As percent of risk-weighted, period-end assets:                        
Core capital (Tier 1):                        
Company  168,729   15.85   42,587   4.00   63,881   6.00 
FSB  152,328   14.35   42,446   4.00   63,669   6.00 
                         
Total capital (Tiers 1 and 2):                        
Company  182,084   17.10   85,175   8.00   106,469   10.00 
FSB  165,639   15.61   84,892   8.00   106,115   10.00 
                         
(Dollars in thousands) 2005
  Actual Regulatory    
  Capital Minimum Requirements Well-Capitalized
  Amount Ratio Amount Ratio Amount Ratio
 
Leverage capital (Tier 1) as percent of three-month average assets:                        
Company $155,296   7.60% $81,709   4.00% $102,137   5.00%
FSB  166,989   8.20   81,477   4.00   101,846   5.00 
                         
As percent of risk-weighted, period-end assets:                        
Core capital (Tier 1):                        
Company  155,296   13.75   45,171   4.00   67,757   6.00 
FSB  166,989   14.87   44,923   4.00   67,385   6.00 
                         
Total capital (Tiers 1 and 2):                        
Company  169,487   15.01   90,342   8.00   112,928   10.00 
FSB  181,104   16.13   89,847   8.00   112,309   10.00 

83- 94 -


(17)FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(17.)
FAIR VALUE MEASUREMENTS
Determination of Fair Value of Financial Instruments— Assets Measured at Fair Value on a Recurring and Nonrecurring Basis
The “fair value” of a financial instrument is definedValuation Hierarchy
SFAS 157 defines fair value as the exchange price that would be received for an asset or paid to transfer a willing buyerliability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. For SFAS 157 disclosures, SFAS 157 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three levels.
Level 1— Unadjusted quoted prices in active markets for assets or liabilities identical to those to be reported at fair value. An active market is a market in which transactions occur for the item to be fair valued with sufficient frequency and a willing seller wouldvolume to provide pricing information on an ongoing basis. The Company’s Level 1 assets primarily include exchange intraded equity securities.
Level 2— Inputs other than a distressedquoted prices included within Level 1 inputs that are observable for the asset or liability, either directly or indirectly. These inputs include: (a) quoted prices for similar assets or liabilities in active markets; (b) quoted prices for identical or similar assets or liabilities in markets that are not active, such as when there are few transactions for the asset or liability, the prices are not current, price quotations vary substantially over time or in which little information is released publicly; (c) inputs other than quoted prices that are observable for the asset or liability; and (d) inputs that are derived principally from or corroborated by observable market data by correlation or other means. The Company’s Level 2 assets primarily include debt securities classified as available for sale situation.and not included in Level 3.
Level 3— Significant unobservable inputs for the asset or liability. These inputs should be used to determine fair value only when observable inputs are not available. Unobservable inputs should be developed based on the best information available in the circumstances, which might include internally generated data and assumptions being used to price the asset or liability. The following table presents the carrying amounts and estimated fairCompany’s Level 3 assets primarily include pooled trust preferred securities.
Investment Securities.Fair values of the Company’s financial instruments at December 31:
                 
(Dollars in thousands) 2006  2005 
  Carrying  Fair  Carrying  Fair 
  Amount  Value  Amount  Value 
 
Financial Assets                
Cash and cash equivalents $109,772  $109,772  $91,940  $91,940 
Securities available for sale  735,148   735,148   790,855   790,855 
Securities held to maturity  40,388   40,421   42,593   42,898 
Loans held for sale  992   993   1,253   1,261 
Loans, net  909,434   907,435   972,090   970,361 
Accrued interest receivable  9,160   9,160   8,822   8,822 
FHLB and FRB stock  6,485   6,485   7,158   7,158 
                 
Financial Liabilities                
Deposits:                
Noninterest-bearing demand  273,783   273,783   284,958   284,958 
Interest-bearing:                
Savings and interest-bearing demand  674,224   674,224   755,229   755,229 
Certificates of deposit  669,688   669,688   677,074   677,074 
             
Total deposits  1,617,695   1,617,695   1,717,261   1,717,261 
Short-term borrowings  32,310   32,310   20,106   20,106 
Long-term borrowings  38,187   37,037   78,391   74,316 
Junior subordinated debentures  16,702   17,533   16,702   18,048 
Accrued interest payable  13,132   13,132   11,966   11,966 
The following methods and assumptions were used to estimate the fair value of each class of financial instruments.
Cash and cash equivalents:The carrying amounts reported in the consolidated statements of financial condition for cash, due from banks, federal funds sold and interest-bearing deposits approximate the fair value of those assets.
Securities:Fair value is based on quoted market prices, whereequity securities are determined using public quotations, when available. Where quoted market prices are not available, fair values may be estimated based on dealer quotes, pricing models, discounted cash flow methodologies, or similar techniques for which the determination of fair value may require significant judgment or estimation. Fair values of public bonds and those private securities that are actively traded in the secondary market have been determined through the use of third-party pricing services using market observable inputs. Private placement securities and other securities where the Company does not receive a public quotation are valued by discounting the expected cash flows. Market rates used are applicable to the yield, credit quality and average maturity of each security. Private equity securities may also utilize internal valuation methodologies appropriate for the specific asset. Fair values might also be determined using broker quotes or through the use of internal models or analysis.
Assets Measured at Fair Value on a Recurring Basis
Assets measured and recorded at fair value on a recurring basis as of December 31, 2008 are summarized as follows (in thousands):
                 
  Assets Measured and Recorded at Fair Value 
  Total  Level 1  Level 2  Level 3 
                 
Securities available for sale $547,506  $624  $543,110  $3,772 
Changes in Level 3 Fair Value Measurements
The reconciliation for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level 3) for the year ended December 31, 2008, is as follows (in thousands):
     
Securities available for sale (Level 3), beginning of year $ 
Transfers into Level 3  33,307 
Impairment charges included in earnings  (29,429)
Principal paydowns and amortization of premiums  (106)
    
Securities available for sale (Level 3), end of year $3,772 
    

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FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(17.) FAIR VALUE MEASUREMENTS (Continued)
Assets Measured at Fair Value on a Nonrecurring Basis
The Company measures or monitors certain of its assets on a nonrecurring fair value basis. Examples of these nonrecurring uses of fair value include: loans held for sale, mortgage servicing assets and collateral dependent impaired loans.
Collateral dependent impaired loans totaling $599 thousand were recorded at fair value on a nonrecurring basis as of December 31, 2008, resulting in a charge of $109 thousand included in the provision for loan losses for the year ended December 31, 2008. The collateral dependent impaired loans are a Level 2 fair measurement, as fair value is determined based upon estimates of the fair value of the collateral underlying the impaired loans typically using appraisals of comparable property or valuation guides.
Mortgage servicing rights were written down to fair value of $563 thousand at December 31, 2008, resulting in a charge of $343 thousand that was recorded in noninterest income. The mortgage servicing rights are a Level 3 fair value measurement, as fair value is determined by calculating the present value of the future servicing cash flows from the underlying mortgage loans.
Fair Value of Financial Instruments
The Company uses fair value measurements to record fair value of certain assets and to estimate fair value of financial instruments not recorded at fair value but required to be disclosed at fair value under SFAS No. 107, “Disclosure About Fair Value of Financial Instruments” (“SFAS 107”).
The following discussion describes the valuation methodologies used for assets and liabilities measured or disclosed at fair value. The techniques utilized in estimating the fair values of financial instruments are reliant on the assumptions used, including discount rates and estimates of the amount and timing of future cash flows. Care should be exercised in deriving conclusions about our business, its value or financial position based on quotedthe fair value information of financial instruments presented below.
Fair value estimates are made at a specific point in time, based on available market pricesinformation and judgments about the financial instrument, including estimates of comparable instruments.timing, amount of expected future cash flows and the credit standing of the issuer. Such estimates do not consider the tax impact of the realization of unrealized gains or losses. In some cases, the fair value estimates cannot be substantiated by comparison to independent markets. In addition, the disclosed fair value may not be realized in the immediate settlement of the financial instrument.
The estimated fair value approximates carrying value for cash and cash equivalents, FHLB and FRB stock, company owned life insurance, accrued interest receivable, short-term borrowings and accrued interest payable. Fair value estimates for other financial instruments are discussed below.
Loans held for sale:sale.The fair value of loans held for sale is based on estimates, quoted market prices and investor commitments.
Loans, net:Loans.For variable rate loans that re-price frequently, fair value approximates carrying amount. The fair value for fixed rate loans is estimated through discounted cash flow analysis using interest rates currently being offered on loans with similar terms and credit quality. For criticized and classified loans, fair value is estimated by discounting expected cash flows at a rate commensurate with the risk associated with the estimated cash flows, or estimates of fair value discounts based on observable market information.
Accrued interest receivable/payable:Deposits.The carrying amounts of accrued interest receivable and accrued interest payable approximate their fair values because of the relatively short time period between the accrual period and the expected receipt or payment due date.
FHLB and FRB stock:The carrying amounts, which represent par value or cost, reported in the consolidated statements of financial condition for the non-marketable investments in FHLB and FRB stock approximate the fair value of those assets.
Deposits:The fair value for savings, interest-bearing and noninterest-bearing demand accounts, ismoney market and savings deposits are equal to thetheir carrying amount because of the customer’s ability to withdraw funds immediately.amounts. The fair values of certificates

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of deposit are estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments. The unrealized gains on certificates of deposit are limited to the amount of prepayment penalties, if any. Fair value can only exceed the carrying amount to the extent of withdrawal fees.
Short-term Borrowings:Carrying value approximates fair value for short-term borrowings.
Long-term Borrowings:borrowings (excluding junior subordinated debentures).The fair value for long-term borrowings is estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments.
Junior subordinated debentures and trust preferred securities:debentures.The fair value for the junior subordinated debentures is estimated using a discounted cash flow approach that applies prevailing market interest rates for similar maturity instruments.
Off-Balance Sheet Financial Instruments:The fair value of stand-by letters of credit and commitments to extend credita financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the fees currently charged to enter into similar agreements.assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. The accounting guidelines exclude certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented at December 31, 2008 and 2007 may not necessarily represent the underlying fair value of these fees is not significant.the Company.

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(18) Condensed Parent Company Only Financial StatementsFINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008, 2007 and 2006
(17.) FAIR VALUE MEASUREMENTS (Continued)
The carrying values and fair values of financial instruments at December 31, 2008 and 2007 are as follows (in thousands):
                 
  2008  2007 
  Carrying  Fair  Carrying  Fair 
  Amount  Value  Amount  Value 
Financial assets:
                
Cash and cash equivalents $55,187  $55,187  $46,673  $46,673 
Securities held to maturity  58,532   59,147   59,479   59,902 
Loans held for sale  1,013   1,032   906   914 
Loans  1,102,330   1,169,660   948,652   963,022 
Company owned life insurance  23,692   23,692   3,017   3,017 
Accrued interest receivable  7,556   7,556   9,170   9,170 
FHLB and FRB stock  6,035   6,035   5,972   5,972 
                 
Financial liabilities:
                
Demand, savings and money market deposits  985,796   985,796   968,315   968,315 
Time deposits  647,467   654,334   607,656   607,656 
Short-term borrowings  23,465   23,465   25,643   25,643 
Long-term borrowings (excluding junior subordinated debentures)  30,653   32,005   25,865   26,446 
Junior subordinated debentures  16,702   12,232   16,702   17,258 
Accrued interest payable  7,041   7,041   10,584   10,584 
(18.) PARENT COMPANY FINANCIAL INFORMATION
The following are the condensed financial statements of FIIcondition of the Company as of December 31, 2008 and 2007 and the related condensed statements of operations and cash flows for the years ended December 31:2008, 2007 and 2006 should be read in conjunction with Consolidated Financial Statements and related notes (in thousands):
Condensed Statements of Condition
         
(Dollars in thousands) 2006  2005 
 
Assets:        
Cash and due from subsidiaries $15,631  $11,417 
Securities available for sale, at fair value  1,087   1,034 
Note receivable  300   300 
Investment in and receivables due from subsidiaries and associated companies  182,467   199,743 
Other assets  4,340   5,251 
       
         
Total assets $203,825  $217,745 
       
         
Liabilities and shareholders’ equity        
Long-term borrowings $  $25,000 
Junior subordinated debentures  16,702   16,702 
Other liabilities  4,735   4,286 
Shareholders’ equity  182,388   171,757 
       
         
Total liabilities and shareholders’ equity $203,825  $217,745 
       
Condensed Statements of Income
             
         
(Dollars in thousands) 2006  2005  2004 
 
Dividends from subsidiaries and associated companies $35,455  $5,872  $5,601 
Management and service fees from subsidiaries  643   15,433   13,763 
Other income  427   75   143 
          
Total income  36,525   21,380   19,507 
             
Operating expenses  6,319   20,325   16,721 
          
             
Income before income tax benefit and (distributions in excess of earnings) equity in undistributed earnings of subsidiaries  30,206   1,055   2,786 
             
Income tax benefit  2,164   1,904   1,164 
          
             
Income before (distributions in excess of earnings) equity in undistributed earnings of subsidiaries  32,370   2,959   3,950 
             
(Distributions in excess of earnings) equity in undistributed earnings of subsidiaries  (15,008)  (793)  8,543 
          
             
Net income $17,362  $2,166  $12,493 
          
         
Condensed Statements of Condition 2008  2007 
Assets:        
Cash and due from subsidiaries $27,163  $13,228 
Securities available for sale, at fair value  624   780 
Note receivable  300   300 
Investment in and receivables due from subsidiaries  176,780   196,449 
Other assets  4,585   4,010 
       
Total assets $209,452  $214,767 
       
Liabilities and shareholders’ equity:        
Junior subordinated debentures $16,702  $16,702 
Other liabilities  2,450   2,743 
Shareholders’ equity  190,300   195,322 
       
Total liabilities and shareholders’ equity $209,452  $214,767 
       

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Condensed Statements of Cash Flows
             
         
(Dollars in thousands) 2006  2005  2004 
 
Cash flows from operating activities:            
Net income $17,362  $2,166  $12,493 
Adjustments to reconcile net income to net cash provided by operating activities:            
Depreciation and amortization  642   756   782 
Distributions in excess of earnings (equity in undistributed earnings) of subsidiaries  15,008   793   (8,543)
Increase in other assets  (211)  (852)  (2,609)
Increase (decrease) in other liabilities  1,120   (922)  1,423 
          
             
Net cash provided by operating activities  33,921   1,941   3,546 
          
             
Cash flows from investing activities:            
Proceeds from sale of securities  21      500 
Increase in note receivable        (300)
Proceeds from sale of equity investment in Mercantile Adjustment Bureau        2,400 
Net proceeds from sale of discontinued subsidiary     4,538    
Equity investment in subsidiaries     (512)  (150)
Purchase of premises and equipment, net  528   (388)  (261)
          
             
Net cash provided by investing activities  549   3,638   2,189 
          
             
Cash flows from financing activities:            
Repayment on long-term borrowings  (25,000)      
Purchase of preferred and common shares  (346)  (178)  (43)
Issuance of common shares  112   57   52 
Stock options exercised  196   940   1,131 
Excess tax benefit from stock options exercised  8       
Dividends paid  (5,226)  (6,902)  (8,652)
          
             
Net used in financing activities  (30,256)  (6,083)  (7,512)
          
             
Net increase (decrease) in cash and cash equivalents  4,214   (504)  (1,777)
             
Cash and cash equivalents at the beginning of year  11,417   11,921   13,698 
          
             
Cash and cash equivalents at the end of the year $15,631  $11,417  $11,921 
          

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Selected Quarterly Financial Information (Unaudited)
                 
  First  Second  Third  Fourth 
(Dollars in thousands, except per share data) Quarter  Quarter  Quarter  Quarter 
 
2006
                
Results of operations data:                
Interest income $25,275  $25,750  $25,823  $26,222 
Interest expense  9,796   10,738   11,141   11,929 
             
Net interest income  15,479   15,012   14,682   14,293 
Provision (credit) for loan losses  250   (1,601)  (491)   
             
Net interest income after provision (credit) for loan losses  15,229   16,613   15,173   14,293 
Noninterest income  4,956   5,181   6,979   4,795 
Noninterest expense  15,275   14,581   14,593   15,163 
             
Income before income taxes  4,910   7,213   7,559   3,925 
Income taxes  1,171   1,839   2,314   921 
             
Net income $3,739  $5,374  $5,245  $3,004 
             
                 
Per common share data:                
Net income — basic $0.30  $0.44  $0.43  $0.23 
Net income — diluted  0.30   0.44   0.43   0.23 
Cash dividends declared  0.08   0.08   0.09   0.09 
                 
2005
                
Results of operations data:                
Interest income $26,420  $25,818  $25,495  $26,154 
Interest expense  8,051   8,960   9,238   10,146 
             
Net interest income  18,369   16,858   16,257   16,008 
Provision for loan losses  3,692   21,889   1,529   1,422 
             
Net interest income (loss) after provision for loan losses  14,677   (5,031)  14,728   14,586 
Noninterest income  4,907   4,791   14,749   4,937 
Noninterest expense  16,418   16,592   16,312   16,170 
             
Income (loss) from continuing operations before income taxes  3,166   (16,832)  13,165   3,353 
Income taxes from continuing operations  781   (7,264)  4,205   512 
             
Income (loss) from continuing operations  2,385   (9,568)  8,960   2,841 
(Loss) income from discontinued operation, net of income taxes  (96)  (2,397)  11   30 
             
Net income (loss) $2,289  $(11,965) $8,971  $2,871 
             
                 
Per common share data:                
Basic:                
Income (loss) from continuing operations $0.18  $(0.88) $0.76  $0.22 
Net income (loss)  0.17   (1.09)  0.76   0.22 
Diluted:                
Income (loss) from continuing operations  0.18   (0.88)  0.76   0.22 
Net income (loss)  0.17   (1.09)  0.76   0.22 
Cash dividends declared  0.16   0.08   0.08   0.08 

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Report of Independent Registered Public Accounting Firm
The Board of Directors ofFINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES
Financial Institutions, Inc.:
We have audited the accompanying consolidated statements of financial condition of Financial Institutions, Inc. and subsidiaries (the Company) as of NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 20062008, 2007 and 2005, and the related consolidated statements of income, changes in shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.2006
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
(18.)
PARENT COMPANY FINANCIAL INFORMATION (Continued)
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Company and subsidiaries as of December 31, 2006 and 2005, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2006, in conformity with U.S. generally accepted accounting principles.
             
Condensed Statements of Operations 2008  2007  2006 
Dividends from subsidiaries and associated companies $11,251  $14,151  $35,455 
Management and service fees from subsidiaries  418   631   643 
Other income  74   94   427 
          
Total income  11,743   14,876   36,525 
Operating expenses  4,363   4,684   6,319 
          
Income before income tax benefit and equity in undistributed earnings (distributions in excess of earnings) of subsidiaries  7,380   10,192   30,206 
Income tax benefit  1,499   1,491   2,164 
          
Income before equity in undistributed earnings (distributions in excess of earnings) of subsidiaries  8,879   11,683   32,370 
(Distributions in excess of earnings) equity in undistributed earnings of subsidiaries  (35,037)  4,726   (15,008)
          
Net (loss) income $(26,158) $16,409  $17,362 
          
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of the Company’s internal control over financial reporting as of December 31, 2006, based on criteria established inInternal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO),and our report dated March 13, 2007 expressed an unqualified opinion on management’s assessment of, and the effective operation of, internal control over financial reporting.
As discussed in Note 1 to the consolidated financial statements, the Company adopted the provisions of SFAS No. 123(R), “Share Based Payments” and SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans” for the year ended December 31, 2006.
KPMG LLP
Buffalo, New York
March 13, 2007
             
Condensed Statements of Cash Flows 2008  2007  2006 
Cash flows from operating activities:            
Net (loss) income $(26,158) $16,409  $17,362 
Adjustments to reconcile net (loss) income to net cash provided by operating activities:            
Distributions in excess of earnings (equity in undistributed earnings) of subsidiaries  35,037   (4,726)  15,008 
Depreciation and amortization  427   521   642 
Share-based compensation  633   955   865 
Increase in other assets  (763)  (242)  (1,076)
(Decrease) increase in other liabilities  (258)  (2,421)  1,120 
          
Net cash provided by operating activities  8,918   10,496   33,921 
Cash flows from investing activities:            
(Purchase) sale of securities available for sale  (27)     21 
Purchase of premises and equipment, net of disposals  (72)  189   528 
Capital investment in subsidiary bank  (20,000)      
          
Net cash (used in) provided by investing activities  (20,099)  189   549 
Cash flows from financing activities:            
Repayment on long-term borrowings        (25,000)
Purchase of preferred and common shares  (4,821)  (7,245)  (346)
Proceeds from issuance of preferred and common shares  35,602   105   112 
Proceeds from issuance of common stock warrant  2,025       
Proceeds from stock options exercised  32   251   204 
Dividends paid  (7,722)  (6,199)  (5,226)
          
Net cash provided by (used in) financing activities  25,116   (13,088)  (30,256)
Net (decrease) increase in cash and cash equivalents  13,935   (2,403)  4,214 
Cash and cash equivalents as of beginning of year  13,228   15,631   11,417 
          
Cash and cash equivalents as of end of the year $27,163  $13,228  $15,631 
          

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Item
ITEM 9. Changes in and Disagreements With Accountants on Accounting and Financial Disclosure
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ItemITEM 9A. CONTROLS AND PROCEDURES
Effectiveness of Controls and Procedures
a) As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15(b), as adopted by the Securities and Exchange Commission (“SEC”) under the Securities Exchange Act of 1934 (“Exchange Act”). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective as of the end of the period covered by this annual report.
Disclosure controls and procedures are the controls and other procedures that are designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed in the reports that the Company files or submits under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
b) All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined effective can provide only reasonable assurance with respect to financial statement preparation and presentation.
Management Report on Internal Control over Financial Reporting and Attestation Report of Independent Registered Public Accounting Firm
Management of Financial Institutions, Inc. (the Company) is responsible for establishing and maintaining adequate internal control over financial reporting. Management assessed the Company’s internal control over financial reporting based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this assessment, management has concluded that, as of December 31, 2006,2008, the Company maintained effective internal control over financial reporting.
All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined effective can provide only reasonable assurance with respect to financial statement preparation Management’s Report on Internal Control over Financial Reporting is included under Item 8 “Financial Statements and presentation.Supplementary Data” in Part II of this Form 10-K.
KPMG LLP, a registered public accounting firm, has audited the consolidated financial statements included in the annual report, and has issued an attestation report on management’s assessmentthe effectiveness of the Company’s internal control over financial reporting. The Report of Independent Registered Public Accounting Firm that attests the effectiveness of internal control over financial reporting is included under Item 8 “Financial Statements and Supplementary Data” in Part II of this Form 10-K.
c) Changes toin Internal Control Overover Financial Reporting
There were no changes in the Company’s internal control over financial reporting that occurred during the quarter ended December 31, 20062008 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.
d) Report of Independent Registered Public Accounting Firm
The Board of Directors of
Financial Institutions, Inc.:
We have audited management’s assessment, included in the accompanyingManagement’s Report on Internal Control Over Financial Reporting,that Financial Institutions, Inc. (the Company) maintained effective internal control over financial reporting as of December 31, 2006, based on criteria established inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our

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responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in a reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Financial Institutions, Inc. maintained effective internal control over financial reporting as of December 31, 2006, is fairly stated, in all material respects, based on criteria established inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Also, in our opinion, the Company maintained, in all material respects, effective internal control over financial reporting as of December 31, 2006, based on criteria established inInternal Control – Integrated Frameworkissued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of Financial Institutions, Inc. and subsidiaries as of December 31, 2006 and 2005, and the related consolidated statements of income, changes in shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended December 31, 2006, and our report dated March 13, 2007 expressed an unqualified opinion on those financial statements.
KPMG LLP
Buffalo, New York
March 13, 2007

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ItemITEM 9B. Other InformationOTHER INFORMATION
None.Not applicable.

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PART III
ItemITEM 10. Directors, Executive Officers and Corporate GovernanceDIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
TheIn response to this Item, the information set forth in the Company’s Proxy Statement for its 2009 Annual Meeting of Shareholders (the “2009 Proxy Statement”) to be filed within 120 days following the end of the Company’s fiscal year, under the headings “Election of Directors and Information with Respect to Board of Directors”Directors,” and “Corporate Governance Information”, which includes identifying the “audit committee financial expert” who serves on the Audit Committee of the Company’s Board of Directors and the information under the heading “Section 16(a) Beneficial Ownership Reporting Compliance” areis incorporated herein by reference from the Company’s Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the SEC within 120 days following the end of the Company’s fiscal year. reference.
The information under the heading “Executive Officers and Other Significant Employees of the Registrant” in Part I, Item 1 of this Form 10-K is also incorporated herein by referencereference.
Information concerning the Company’s Audit Committee and the Audit Committee’s financial expert is set forth under the caption “Corporate Governance Information” in this section.the 2009 Proxy Statement and is incorporated herein by reference.
The Company has adopted a Code of Business Conduct and Ethics that applies to its principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. The Code of Business Conduct and Ethics is posted on the Company’s internet website at www.fiiwarsaw.com. In addition, the Company will provide a copy of the Code of Business Conduct and Ethics to anyone, without charge, upon request addressed to Director of Human Resources at Financial Institutions, Inc., 220 Liberty Street, Warsaw, NY 14569. The Company intends to disclose any amendment to, or waiver from, a provision of its Code of Business Conduct and Ethics that applies to the Company’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions, and that relates to any element of the Code of Business Conduct and Ethics, by posting such information on the Company’s website.
ItemITEM 11. Executive CompensationEXECUTIVE COMPENSATION
TheIn response to this Item, the information set forth in the 2009 Proxy Statement under the heading “Executive Compensation” is incorporated herein by reference to the Registrant’s Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the SEC within 120 days following the end of the Company’s fiscal year.reference.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
In response to this Item, 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Informationthe information set forth in the 2009 Proxy Statement under the heading “Stock Ownership” is incorporated herein by reference toreference. The information under the Registrant’s Proxy Statement for its 2007 Annual Meetingheading “Equity Compensation Plan Information” in Part II, Item 5 of Shareholders to be filed with the SEC within 120 days following the end of the Company’s fiscal year.this Form 10-K is also incorporated herein by reference.
The following table provides information as of December 31, 2006, regarding the Company’s equity compensation plans.
             
      Weighted Average Number of Securities
  Number of Securities to be Exercise Price of Remaining Available for
  Issued Upon Exercise of Outstanding Future Issuance Under
  Outstanding Options, Options, Warrants Equity Compensation
Plan Category Warrants and Rights and Rights Plans
Equity Compensation Plans Approved by Shareholders  498,932  $19.54   933,024 
             
Equity Compensation Plans not Approved by Shareholders         

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ItemITEM 13. Certain Relationships and Related Transactions, and Director IndependenceCERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
InformationIn response to this Item, the information set forth in the 2009 Proxy Statement under the headings “Certain Relationships and Related Party Transactions” and “Corporate Governance Information” is incorporated herein by reference to the Registrant’s Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the SEC within 120 days following the end of the Company’s fiscal year.reference.
ItemITEM 14. Principal Accountant Fees and ServicesPRINCIPAL ACCOUNTANT FEES AND SERVICES
InformationIn response to this Item, the information set forth in the 2009 Proxy Statement under the headings “Audit Committee Report and “Independent Auditors” is incorporated herein by reference to the Registrant’s Proxy Statement for its 2007 Annual Meeting of Shareholders to be filed with the SEC within 120 days following the end of the Company’s fiscal year.reference.

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PART IV
ItemITEM 15. Exhibits and Financial Statement SchedulesEXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a)List of Documents Filed as Part of this Report
(a)FINANCIAL STATEMENTS
(1)Financial Statements.
The financial statements listed below andReference is made to the Report of the Independent Registered Public Accounting Firm are included in this Annual Report on Form 10-K:
Report of Independent Registered Public Accounting Firm
Index to Consolidated Financial Statements of Financial Condition asInstitutions, Inc. and Subsidiaries under Item 8 “Financial Statements and Supplementary Data” in Part II of December 31, 2006 and 2005this Form 10-K.
Consolidated Statements of Income for the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income for the years ended December 31, 2006, 2005 and 2004
Consolidated Statements of Cash Flows the years ended December 31, 2006, 2005 and 2004
Notes to Consolidated Financial Statements
(2)Schedules.
All schedules are omitted since the required information is either not applicable, not required, or is contained in the respective financial statements or in the notes thereto.

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(3)Exhibits.
(b)EXHIBITS
The following is a list of all exhibits filed or incorporated by reference as part of this Report.
     
Exhibit No.
Number Description Location
 
3.1 Amended and Restated Certificate of Incorporation of the Company Incorporated by reference to Exhibit 3.1 of the Registrant’s Registration Statement on Form S-1 dated June 25, 1999 (File No. 333-76865) (The “S-1 Registration Statement”)Filed Herewith
     
3.2Amended and Restated Bylaws dated May 23, 2001 Incorporated by referenceCertificate of Amendment to Exhibit 3.2the Certificate of Incorporation of the Form 10-K forCompany relating to the year ended December 31, 2001, dated March 11, 2002Series A Preferred StockFiled Herewith
     
3.3Amended and Restated Bylaws dated February 18, 2004 Incorporated by referenceCertificate of Amendment to Exhibit 3.3the Certificate of Incorporation of the Form 10-K forCompany relating to the year ended December 31, 2003, dated March 12, 2004Series A 3% Preferred StockFiled Herewith
     
3.4 Amended and Restated Bylaws of the CompanyFiled Herewith
4.1Warrant to Purchase Common Stock, dated February 22, 2006December 23, 2008 issued by the Registrant to the United States Department of the Treasury Incorporated by reference to Exhibit 3.44.2 of the Form 10-K for the year ended8-K, dated December 31, 2005, dated March 15, 200619, 2008
     
10.1 1999 Management Stock Incentive Plan Incorporated by reference to Exhibit 10.1 of the S-1 Registration Statement
     
10.2 Amendment Number One to the FII 1999 Management Stock Incentive Plan Incorporated by reference to Exhibit 10.1 of the Form 8-K, dated July 28, 2006
     
10.3 Form of Non-Qualified Stock Option Agreement Pursuant to the FII 1999 Management Stock Incentive Plan Incorporated by reference to Exhibit 10.2 of the Form 8-K, dated July 28, 2006
     
10.4 Form of Restricted Stock Award Agreement Pursuant to the FII 1999 Management Stock Incentive Plan Incorporated by reference to Exhibit 10.3 of the Form 8-K, dated July 28, 2006
     
10.5Form of Restricted Stock Award Agreement Pursuant to the FII 1999 Management Stock Incentive PlanIncorporated by reference to Exhibit 10.1 of the Form 8-K, dated January 23, 2008
10.6 1999 Directors Stock Incentive Plan Incorporated by reference to Exhibit 10.2 of the S-1 Registration Statement
     
10.610.7 Amendment to the 1999 Director Stock Incentive PlanFiled Herewith
10.8Amended Stock Ownership Requirements, (effective January 1, 2005)dated December 14, 2005 Incorporated by reference to Exhibit 10.410.19 of the Form 10-K for the year ended December 31, 2004,2005, dated March 16, 200515, 2006
     
10.710.9 Executive Agreement with Peter G. Humphrey Incorporated by reference to Exhibit 10.1 of the Form 8-K, dated JuneSeptember 30, 2005
     
10.810.10 Executive Agreement with James T. Rudgers Incorporated by reference to Exhibit 10.2 of the Form 8-K, dated JuneSeptember 30, 2005

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10.9Exhibit
NumberDescriptionLocation
10.11 Executive Agreement with Ronald A. Miller Incorporated by reference to Exhibit 10.3 of the Form 8-K, dated JuneSeptember 30, 2005
     
10.1010.12 Executive Agreement with Martin K. BirminghBirmingham am Incorporated by reference to Exhibit 10.4 of the Form 8-K, dated JuneSeptember 30, 2005
     
10.1110.13 Agreement with Peter G. Humphrey Incorporated by reference to Exhibit 10.6 of the Form 8-K, dated JuneSeptember 30, 2005
     
10.1210.14 Executive Agreement with John J. Witkowski Incorporated by reference to Exhibit 10.7 of the Form 8-K, dated September 14, 2005
     
10.1310.15 Executive Agreement with George D. Hagi Incorporated by reference to Exhibit 10.7 of the Form 8-K, dated February 2, 2006

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Exhibit No.DescriptionLocation
10.14Term and Revolving Credit Loan Agreements between FII and M&T Bank, dated December 15, 2003Incorporated by reference to Exhibit 1.1 of the Form 10-K for the year ended December 31, 2003, dated March 12, 2004
10.15Second Amendment to Term Loan Credit Agreement between FI and M&T Bank, dated September 30, 2005Incorporated by reference to Exhibit 10.17 of the Form10-Q for the quarterly period ended September 30, 2005, dated November 4, 2005
    
10.16Fourth Amendment to Revolving Credit Agreement between FII and M&T Bank, dated September 30, 2005 Incorporated by reference to Exhibit 10.17 of the Form10-Q for the quarterly period ended September 30, 2005, dated November 4, 2005
10.17Amended Stock Ownership Requirements, dated December 14, 2005Incorporated by reference to Exhibit 10.19 of the Form10-K for the year ended December 31, 2005, dated March 15, 2006
10.182006 Annual Incentive Plan, dated March 13, 2006Incorporated by reference to Exhibit 10.20 of the Form10-K for the year ended December 31, 2005, dated March 15, 2006
10.19Executive Enhanced Incentive Plan dated January 25, 2006Incorporated by reference to Exhibit 10.21 of the Form10-K for the year ended December 31, 2005, dated March 15, 2006
10.20Trust CompanyVoluntary Retirement Agreement and Plan of Mergerwith James T. Rudgers Incorporated by reference to Exhibit 10.1 of the Form 8-K, dated April 3, 2006September 24, 2008
     
10.2110.17 2007 Annual Incentive Plan, dated March 13, 2007Voluntary Retirement Agreement with Ronald A. Miller Filed HerewithIncorporated by reference to Exhibit 10.2 of the Form 8-K, dated September 24, 2008
     
10.2210.18 2007 Director (Non-Management) CompensationLetter Agreement, dated December 23, 2008, including the Securities Purchase Agreement-Standard Terms attached thereto, by and between the Company and the United States Department of the Treasury Filed HerewithIncorporated by reference to Exhibit 10.1 of the Form 8-K, dated December 19, 2008
     
11.1 Statement of Computation of Per Share Earnings Incorporated by reference to Note 15 of the Registrant’s unaudited consolidated financial statements under Item 8 filed herewith.
     
12Ratio of Earnings to Fixed Charges and Preferred DividendsFiled Herewith
21 Subsidiaries of Financial Institutions, Inc. Filed Herewith
     
23
Consent of Independent Registered Public Accounting
Firm
 Filed Herewith
     
31.1 Certification of Annual Report on Form 10-K pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 -CEO— Principal Executive Officer Filed Herewith
     
31.2 Certification of Annual Report on Form 10-K pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 -CFO— Principal Financial Officer Filed Herewith
     
32.132 Certification of Annual Report on Form 10-Kpursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -CEOFiled Herewith
32.2Certification of Annual Report on Form 10-K pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -CFO Filed Herewith

95

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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act, of 1934, the Registrant has dulyregistrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
     
 FINANCIAL INSTITUTIONS, INC.
March 12, 2009 /s/ Peter G. Humphrey   
 
Date: March 13, 2007By:Peter G. Humphrey  
 President & Chief Executive Officer  
Peter G. Humphrey
President and Chief Executive Officer
(Principal Executive Officer)
By:Ronald A. Miller
Ronald A. Miller
Executive Vice President and Chief Financial Officer
(Principal Accounting Officer)
Pursuant to the requirements of the Securities Exchange Act of 1934, the following persons on behalf of the Registrant and in the capacities and on the date indicated have signed this report below.
     
Signatures Title Date
 
Erland E. Kailbourne/s/ Peter G. Humphrey
 
Erland E. KailbournePeter G. Humphrey
 Chairman of the Board of Directors Director, President and Chief Executive Officer
(Principal Executive Officer)
 March 13, 200712, 2009
     
Peter G. Humphrey/s/ Ronald A. Miler
 
Peter G. HumphreyRonald A. Miler
 Executive Vice President and Chief ExecutiveFinancial Officer
(Principal Financial and DirectorAccounting Officer)
 March 13, 200712, 2009
     
/s/ Karl V. Anderson, Jr.
 
Karl V. Anderson, Jr.
 Director  March 13, 200712, 2009
     
/s/ John E. Benjamin
 
John E. Benjamin
 Director  March 13, 200712, 2009
     
/s/ Thomas P. Connolly
 
Thomas P. Connolly
 Director  March 13, 200712, 2009
     
/s/ Barton P. Dambra
 
Barton P. Dambra
 Director  March 13, 200712, 2009
     
/s/ Samuel M. Gullo
 
Samuel M. Gullo
 Director  March 13, 200712, 2009
     
/s/ Susan R. Holliday
 
Susan R. Holliday
 Director  March 13, 200712, 2009
     
Joseph F. Hurley/s/ Erland E. Kailbourne
 
Joseph F. HurleyErland E. Kailbourne
 Director, Chairman  March 13, 200712, 2009
     
/s/ Robert N. Latella
 
Robert N. Latella
 Director  March 13, 200712, 2009
     
/s/ James L. Robinson
James L. Robinson
Director March 12, 2009
/s/ John R. Tyler, Jr.
 
John R. Tyler, Jr.
 Director  March 13, 200712, 2009
     
/s/ James H. Wyckoff
 
James H. Wyckoff
 Director  March 13, 200712, 2009

96

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EXHIBIT INDEX
Exhibit
NumberDescriptionLocation
3.1Amended and Restated Certificate of Incorporation of the CompanyFiled Herewith
3.2Certificate of Amendment to the Certificate of Incorporation of the Company relating to the Series A Preferred StockFiled Herewith
3.3Certificate of Amendment to the Certificate of Incorporation of the Company relating to the Series A 3% Preferred StockFiled Herewith
3.4Amended and Restated Bylaws of the CompanyFiled Herewith
4.1Warrant to Purchase Common Stock, dated December 23, 2008 issued by the Registrant to the United States Department of the TreasuryIncorporated by reference to Exhibit 4.2 of the Form 8-K, dated December 19, 2008
10.11999 Management Stock Incentive PlanIncorporated by reference to Exhibit 10.1 of the S-1 Registration Statement
10.2Amendment Number One to the FII 1999 Management Stock Incentive PlanIncorporated by reference to Exhibit 10.1 of the Form 8-K, dated July 28, 2006
10.3Form of Non-Qualified Stock Option Agreement Pursuant to the FII 1999 Management Stock Incentive PlanIncorporated by reference to Exhibit 10.2 of the Form 8-K, dated July 28, 2006
10.4Form of Restricted Stock Award Agreement Pursuant to the FII 1999 Management Stock Incentive PlanIncorporated by reference to Exhibit 10.3 of the Form 8-K, dated July 28, 2006
10.5Form of Restricted Stock Award Agreement Pursuant to the FII 1999 Management Stock Incentive PlanIncorporated by reference to Exhibit 10.1 of the Form 8-K, dated January 23, 2008
10.61999 Directors Stock Incentive PlanIncorporated by reference to Exhibit 10.2 of the S-1 Registration Statement
10.7Amendment to the 1999 Director Stock Incentive PlanFiled Herewith
10.8Amended Stock Ownership Requirements, dated December 14, 2005Incorporated by reference to Exhibit 10.19 of the Form 10-K for the year ended December 31, 2005, dated March 15, 2006
10.9Executive Agreement with Peter G. HumphreyIncorporated by reference to Exhibit 10.1 of the Form 8-K, dated September 30, 2005
10.10Executive Agreement with James T. RudgersIncorporated by reference to Exhibit 10.2 of the Form 8-K, dated September 30, 2005
10.11Executive Agreement with Ronald A. MillerIncorporated by reference to Exhibit 10.3 of the Form 8-K, dated September 30, 2005
10.12Executive Agreement with Martin K. BirminghamIncorporated by reference to Exhibit 10.4 of the Form 8-K, dated September 30, 2005
10.13Agreement with Peter G. HumphreyIncorporated by reference to Exhibit 10.6 of the Form 8-K, dated September 30, 2005
10.14Executive Agreement with John J. WitkowskiIncorporated by reference to Exhibit 10.7 of the Form 8-K, dated September 14, 2005

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Exhibit
NumberDescriptionLocation
10.15Executive Agreement with George D. HagiIncorporated by reference to Exhibit 10.7 of the Form 8-K, dated February 2, 2006
10.16Voluntary Retirement Agreement with James T. RudgersIncorporated by reference to Exhibit 10.1 of the Form 8-K, dated September 24, 2008
10.17Voluntary Retirement Agreement with Ronald A. MillerIncorporated by reference to Exhibit 10.2 of the Form 8-K, dated September 24, 2008
10.18Letter Agreement, dated December 23, 2008, including the Securities Purchase Agreement-Standard Terms attached thereto, by and between the Company and the United States Department of the TreasuryIncorporated by reference to Exhibit 10.1 of the Form 8-K, dated December 19, 2008
11.1Statement of Computation of Per Share EarningsIncorporated by reference to Note 15 of the Registrant’s unaudited consolidated financial statements under Item 8 filed herewith.
12Ratio of Earnings to Fixed Charges and Preferred DividendsFiled Herewith
21Subsidiaries of Financial Institutions, Inc.Filed Herewith
23
Consent of Independent Registered Public Accounting
Firm
Filed Herewith
31.1Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 — Principal Executive OfficerFiled Herewith
31.2Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 — Principal Financial OfficerFiled Herewith
32Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002Filed Herewith

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