Chemung Financial 10Q 2012 Q2 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON D.C. 20549 FORM 10-Q
[X]	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For Quarterly period ended June 30, 2012
Or
[ ]	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

Commission File No. 0-13888

CHEMUNG FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

New York				16-1237038
(State or other jurisdiction of incorporation or organization)				I.R.S. Employer Identification No.

One Chemung Canal Plaza, P.O. Box 1522, Elmira, NY				14902
(Address of principal executive offices)				(Zip Code)


(607) 737-3711 or (800) 836-3711
(Registrant's telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.
YES: X NO:____

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
YES: X NO:____

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

Large accelerated filer		[ ]	Non-accelerated filer		[ ]
Accelerated filer		[ ]	Smaller reporting company		[X]


Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act):
YES: NO: X

The number of shares of the registrant's common stock, $.01 par value, outstanding on August 10, 2012 was 4,578,012.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

INDEX

PART I.	FINANCIAL INFORMATION	PAGE

Item 1:	Financial Statements – Unaudited

	Consolidated Balance Sheet	3
	Consolidated Statements of Income	4
	Consolidated Statements of Comprehensive Income	5
	Consolidated Statements of Shareholders’ Equity	6
	Consolidated Statements of Cash Flows	7

	Notes to Unaudited Consolidated Financial Statements	9

Item 2:	Management's Discussion and Analysis of Financial Condition and Results of Operations	39

Item 3:	Quantitative and Qualitative Disclosures About Market Risk	56

Item 4:	Controls and Procedures	56

PART II.	OTHER INFORMATION	56

Item 1A:	Risk Factors	56

Item 2:	Unregistered Sales of Equity Securities and Use of Proceeds	56

Item 6:	Exhibits	57

SIGNATURES		58

INDEX TO EXHIBITS

PART I. FINANCIAL INFORMATION

Item 1: Financial Statements

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

	JUNE 30, 2012			DECEMBER, 31, 2011
ASSETS
Cash and due from financial institutions	$	33,673,471		$	28,204,699
Interest-bearing deposits in other financial institutions		40,501,795			24,697,154
Total cash and cash equivalents		74,175,266			52,901,853

Trading assets, at fair value		252,105			294,381
Securities available for sale, at estimated fair value		260,941,446			280,869,810
Securities held to maturity, estimated fair value of $7,098,146 at June 30, 2012 and $9,175,956 at December 31, 2011		6,334,331			8,311,921
Federal Home Loan Bank and Federal Reserve Bank Stock, at cost		5,358,700			5,509,350
Loans, net of deferred origination fees and costs, and unearned income		855,947,252			796,915,177
Allowance for loan losses		(10,392,572	)		(9,659,320	)
Loans, net		845,554,680			787,255,857

Loans held for sale		482,344			395,427
Premises and equipment, net		24,717,442			24,762,405
Goodwill		21,824,443			21,983,617
Other intangible assets, net		5,642,350			6,190,540
Bank owned life insurance		2,668,373			2,625,104
Other assets		19,507,617			25,159,322

Total assets	$	1,267,459,097		$	1,216,259,587

LIABILITIES AND SHAREHOLDERS' EQUITY
Deposits:
Non-interest-bearing	$	297,412,952		$	258,835,961
Interest-bearing		756,265,757			739,656,878
Total deposits		1,053,678,709			998,492,839

Securities sold under agreements to repurchase		31,750,428			37,106,842
Federal Home Loan Bank term advances		41,127,794			43,343,918
Accrued interest payable		655,923			800,148
Dividends payable		1,142,082			1,141,081
Other liabilities		8,895,360			9,445,319
Total liabilities		1,137,250,296			1,090,330,147

Shareholders' equity:
Common stock, $.01 par value per share, 10,000,000 shares authorized; 5,310,076 issued at June 30, 2012 and December 31, 2011		53,101			53,101
Additional-paid-in capital		45,525,152			45,582,861
Retained earnings		104,401,468			100,628,900
Treasury stock, at cost (742,091 shares at June 30, 2012; 741,003 shares at December 31, 2011)		(18,914,894	)		(18,894,044	)
Accumulated other comprehensive income (loss)		(856,026	)		(1,441,378	)

Total shareholders' equity		130,208,801			125,929,440

Total liabilities and shareholders' equity	$	1,267,459,097		$	1,216,259,587

See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(UNAUDITED)

	Six Months Ended				Three Months Ended
	June 30,		June 30,		June 30,			June 30,
Interest and dividend income:		2012		2011	2012			2011
Loans, including fees	$	22,704,549	$	19,783,190	$	11,033,636	$	11,207,847
Taxable securities		2,835,741		2,843,016		1,349,390		1,594,432
Tax exempt securities		676,247		684,511		335,626		369,088
Interest-bearing deposits		88,120		101,816		46,338		62,088
Total interest and dividend income		26,304,657		23,412,533		12,764,990		13,233,455

Interest expense:
Deposits		1,757,888		2,187,770		829,906		1,160,405
Borrowed funds		633,976		497,938		320,936		263,513
Securities sold under agreements to repurchase		532,300		729,553		249,528		358,454
Total interest expense		2,924,164		3,415,261		1,400,370		1,782,372
Net interest income		23,380,493		19,997,272		11,364,620		11,451,083
Provision for loan losses		528,897		250,000		51,593		125,000
Net interest income after provision for loan losses		22,851,596		19,747,272		11,313,027		11,326,083

Other operating income:
Wealth management group fee income		3,502,388		3,384,160		1,726,812		1,768,469
Service charges on deposit accounts		2,032,165		2,049,909		1,040,285		1,066,831
Net gain on securities transactions		299,919		679,209		2,750		485,811
Net gain on sales of loans held for sale		144,380		79,332		79,041		32,400
Casualty gains		780,435		-		21,578		-
Gains on sales of other real estate owned		20,426		88,961		20,426		88,961
Income from bank owned life insurance		43,269		43,611		21,744		22,024
Other		2,204,498		2,766,368		1,217,987		1,279,561
Total other operating income		9,027,480		9,091,550		4,130,623		4,744,057

Other operating expenses:
Salaries and wages		9,048,726		8,261,602		4,556,051		4,338,097
Pension and other employee benefits		2,756,477		2,124,770		1,466,537		1,081,663
Net occupancy expenses		2,580,009		2,432,515		1,285,131		1,258,473
Furniture and equipment expenses		1,095,848		1,062,530		577,482		565,083
Data processing expense		2,307,779		1,905,099		1,230,296		1,043,286
Amortization of intangible assets		548,190		465,192		264,050		288,689
Marketing and advertising expense		645,064		482,811		355,826		270,256
Losses on sales of other real estate owned		24,928		1,671		18,468		-
Other real estate owned expenses		131,899		48,491		88,420		21,268
FDIC insurance		410,043		442,385		183,412		189,989
Merger related expenses		8,545		2,223,419		4,000		1,187,347
Other		3,249,167		3,194,113		1,854,655		1,956,809
Total other operating expenses		22,806,675		22,644,598		11,884,328		12,200,960
Income before income tax expense		9,072,401		6,194,224		3,559,322		3,869,180
Income tax expense		3,013,828		1,909,105		1,115,282		1,249,076
Net income	$	6,058,573	$	4,285,119	$	2,444,040	$	2,620,104
Weighted average shares outstanding		4,639,204		4,127,969		4,636,395		4,631,504
Basic and diluted earnings per share	$	1.31	$	1.04	$	0.53	$	0.57

See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(UNAUDITED)

	Six Months Ended June 30							Three Months Ended June 30,
		2012				2011		2012			2011

Net income		$	6,058,573		$	4,285,119		$	2,444,040		$	2,620,104

Other comprehensive income
Unrealized holding gains on securities available for sale			673,527			5,191,291			159,166			4,443,919
Change in unrealized losses on securities available for sale for which a portion of an other-than-temporary impairment has been recognized in earnings, net of reclassification			-			-			-			-
Reclassification adjustment gains realized in net income			(299,919	)		(679,209	)		(2,750	)		(485,811	)
Net unrealized gains			373,608			4,512,082			156,416			3,958,108
Less: Tax effect			175,792			1,745,544			60,126			1,531,234
Net of tax amount			197,816			2,766,538			96,290			2,426,874

Change in funded status of defined benefit pension plan and other benefit plans			629,524			309,398			314,762			154,699
Less: Tax effect			241,988			119,694			120,994			59,847
Net of tax amount			387,536			189,704			193,768			94,852

Total other comprehensive income			585,352			2,956,242			290,058			2,521,726

Comprehensive income		$	6,643,925		$	7,241,361		$	2,734,098		$	5,141,830



See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY (UNAUDITED)

	Common Stock		Additional Paid-in Capital			Retained Earnings			Treasury Stock			Accumulated Other Comprehensive Income (Loss)			Total
Balances at December 31, 2010	$	43,001	$	22,022,122		$	94,407,620		$	(19,166,655	)	$	102,475		$	97,408,563
Net income		-		-			4,285,119			-			-			4,285,119
Other comprehensive income		-		-			-			-			2,956,242			2,956,242
Restricted stock awards		-		12,660			-			-			-			12,660
Restricted stock units for directors' deferred compensation plan		-		42,924			-			-			-			42,924
Cash dividends declared ($.50 per share)		-		-			(2,033,380	)		-			-			(2,033,380	)
Distribution of 10,378 shares of treasury stock for directors’ Compensation		-		(33,831	)		-			265,262			-			231,431
Distribution of 2,392 shares of treasury stock for employee Compensation		-		(6,140	)		-			61,140			-			55,000
Distribution of 286 shares of treasury stock for deferred directors’ Compensation		-		(7,364	)		-			7,310						(54	)
Distribution of 3,387 shares of treasury stock for employee restricted stock awards		-		(35,260	)		-			86,550			-			51,290
Purchase of 7,844 shares of treasury stock		-		-			-			(183,542	)		-			(183,542	)
Issuance of 1,009,942 shares related to FOFC Merger		10,100		23,723,538			-			-			-			23,733,638
Balances at June 30, 2011	$	53,101	$	45,718,649		$	96,659,359		$	(18,929,935	)	$	3,058,717		$	126,559,891

Balances at December 31, 2011	$	53,101	$	45,582,861		$	100,628,900		$	(18,894,044	)	$	(1,441,378	)	$	125,929,440
Net income		-		-			6,058,573			-			-			6,058,573
Other comprehensive income		-		-			-			-			585,352			585,352
Restricted stock awards		-		44,743			-			-			-			44,743
Restricted stock units for directors' deferred compensation plan		-		42,982			-			-			-			42,982
Cash dividends declared ($.50 per share)		-		-			(2,286,005	)		-			-			(2,286,005	)
Distribution of 10,238 shares of treasury stock for directors' Compensation		-		(28,121	)		-			261,069			-			232,948
Distribution of 3,453 shares of treasury stock for employee Compensation		-		(8,052	)		-			88,052			-			80,000
Distribution of 3,240 shares of treasury stock for deferred directors’ Compensation		-		(81,747	)		-			82,588						841
Distribution of 1,079 shares of treasury stock for employee restricted stock awards		-		(27,514	)		-			27,514			-			-
Purchase of 19,098 shares of treasury stock		-		-			-			(480,073	)		-			(480,073	)
Balances at June 30, 2012	$	53,101	$	45,525,152		$	104,401,468		$	(18,914,894	)	$	(856,026	)	$	130,208,801

See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

	Six Months Ended June 30
CASH FLOWS FROM OPERATING ACTIVITIES:	2012			2011
Net income	$	6,058,573		$	4,285,119
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of intangible assets		548,190			465,192
Provision for loan losses		528,897			250,000
Depreciation and amortization of fixed assets		1,497,490			1,450,227
Amortization of premiums on securities, net		894,292			557,177
Gains on sales of loans held for sale, net		(144,380	)		(79,332	)
Proceeds from sales of loans held for sale		5,360,780			3,480,239
Loans originated and held for sale		(5,303,317	)		(3,264,965	)
Net losses (gains) on sale of other real estate owned		4,502			(87,290	)
Net gains on trading assets		(17,369	)		(11,851	)
Net gains on securities transactions		(299,919	)		(679,209	)
Proceeds from sales of trading assets		92,584			-
Purchase of trading assets		(32,939	)		(249,568	)
Decrease in other assets		4,919,260			3,916,406
Decrease (increase) in prepaid FDIC assessment		372,601			(323,836	)
Decrease in accrued interest payable		(144,225	)		(160,511	)
Expense related to restricted stock units for directors' deferred compensation plan		42,982			42,924
Expense related to employee stock compensation		80,000			55,000
Expense related to employee stock awards		44,743			12,660
Decrease in other liabilities		(104,425	)		(2,255,146	)
Income from bank owned life insurance		(43,269	)		(43,611	)
Net cash provided by operating activities		14,355,051			7,359,625

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales and calls of securities available for sale		69,367,438			56,656,054
Proceeds from maturities and principal collected on securities available for sale		14,616,579			14,554,015
Proceeds from maturities and principal collected on securities held to maturity		3,518,840			2,579,275
Purchases of securities available for sale		(64,276,418	)		(80,994,140	)
Purchases of securities held to maturity		(1,541,250	)		(2,905,024	)
Purchase of Federal Home Loan Bank and Federal Reserve Bank stock		(26,250	)		(45,000	)
Redemption of Federal Home Loan Bank and Federal Reserve Bank stock		176,900			228,450
Purchases of premises and equipment		(1,452,526	)		(722,734	)
Cash paid Fort Orange Financial Corporation acquisition		-			(8,137,816	)
Cash received Fort Orange Financial Corporation acquisition		-			33,284,995
Proceeds from sales of other real estate owned		132,273			323,143
Net increase in loans		(58,445,477	)		(10,752,681	)
Net cash (used) provided by investing activities		(37,929,891	)		4,068,537

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, NOW accounts, savings accounts, and insured money market accounts		72,097,856			29,819,077
Net decrease in time deposits and individual retirement accounts		(16,911,987	)		(2,684,163	)
Net decrease in securities sold under agreements to repurchase		(5,356,414	)		(13,124,903	)
Repayments of Federal Home Loan Bank long term advances		(2,216,124	)		(157,983	)
Purchase of treasury stock		(480,073	)		(183,542	)
Cash dividends paid		(2,285,005	)		(1,772,606	)
Net cash provided by financing activities		44,848,253			11,895,880
Net increase in cash and cash equivalents		21,273,413			23,324,042
Cash and cash equivalents, beginning of period		52,901,853			60,619,777
Cash and cash equivalents, end of period	$	74,175,266		$	83,943,819

(continued)

Supplemental disclosure of cash flow information:
Cash paid during the year for:
Interest	$	3,068,390	$	3,272,153
Income Taxes	$	3,500	$	2,204,866
Supplemental disclosure of non-cash activity:
Transfer of loans to other real estate owned	$	223,071	$	32,621


See accompanying notes to unaudited consolidated financial statements.

CHEMUNG FINANCIAL CORPORATION AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

1. Basis of Presentation

Chemung Financial Corporation (the "Corporation"), through its wholly owned subsidiaries, Chemung

Canal Trust Company (the "Bank") and CFS Group, Inc., a financial services company, provides a wide

range of banking, financing, fiduciary and other financial services to its local market area. The

consolidated financial statements include the accounts of the Corporation and its wholly owned

subsidiaries. All material intercompany accounts and transactions are eliminated in consolidation.

The data in the consolidated balance sheet as of December 31, 2011 was derived from the audited

consolidated financial statements in the Corporation's 2011 Annual Report on Form 10-K, which was

filed with the Securities and Exchange Commission on March 28, 2012. That data, along with the other

interim financial information presented in the consolidated balance sheets, statements of income,

shareholders' equity and comprehensive income, and cash flows should be read in conjunction with the

audited consolidated financial statements, including the notes thereto, contained in the 2011 Annual

Report on Form 10-K. Amounts in prior periods' consolidated interim financial statements are

reclassified whenever necessary to conform to the current period's presentation.

The consolidated financial statements included herein reflect all adjustments which are, in the opinion of

management, of a normal recurring nature and necessary to present fairly the Corporation's financial

position as of June 30, 2012 and December 31, 2011, and results of operations for the three and six-

month periods ended June 30, 2012 and 2011, and changes in shareholders' equity and cash flows for the

six-month periods ended June 30, 2012 and 2011. Subsequent events were evaluated for any required

recognition or disclosure. The results for the periods presented are not necessarily indicative of results to

be expected for the entire fiscal year or any other interim period.

2. Earnings Per Common Share

Basic earnings per share is net income divided by the weighted average number of common shares

outstanding during the period. Issuable shares, including those related to directors’ restricted stock units

and directors’ stock compensation, are considered outstanding and are included in the computation of

basic earnings per share. All outstanding unvested share based payment awards that contain rights to

nonforfeitable dividends are considered participating securities for this calculation. Restricted stock

awards are grants of participating securities. The impact of the participating securities on earnings per

share is not material. Earnings per share information is adjusted to present comparative results for stock

splits and stock dividends that occur. Earnings per share were computed by dividing net income by

4,639,204 and 4,127,969 weighted average shares outstanding for the six-month periods ended June 30,

2012 and 2011, and 4,636,395 and 4,631,504 weighted average shares outstanding for the three-month

periods ended June 30, 2012 and 2011, respectively. There were no dilutive common stock equivalents

during the three and six-month periods ended June 30, 2012 or 2011.

3. Adoption of New Accounting Standards

In May, 2011, the FASB issued an amendment to achieve common fair value measurement and

disclosure requirements between U.S. and International accounting principles. Overall, the guidance is

consistent with existing U.S. accounting principles; however, there are some amendments that change a

particular principle or requirement for measuring fair value or for disclosing information about fair value

measurements. The amendments in this guidance are effective for interim and annual reporting periods

beginning after December 15, 2011. The effect of adopting this standard did not have a material effect

on the Corporation’s operating results or financial condition, but the additional disclosures are included

in Note 4.

In June 2011, the FASB amended existing guidance and eliminated the option to present the components

of other comprehensive income as part of the statement of changes in shareholders' equity. The

amendment requires that comprehensive income be presented in either a single continuous statement or

in two separate consecutive statements. The amendments in this guidance are effective as of the

beginning of a fiscal reporting year, and interim periods within that year, that begins after December 15,

2011. In connection with the adoption of this amendment, the Corporation changed the presentation of

the statement of comprehensive income for the Corporation to two consecutive statements instead of

presenting it as part of the consolidated statements of shareholders' equity.

4. Fair Value

Fair value is the exchange price that would be received for an asset or paid to transfer a liability in the

principal or most advantageous market for the asset or liability in an orderly transaction between market

participants on the measurement date. There are three levels of inputs that may be used to measure fair

value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the

entity has the ability to access as of the measurement date.

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices

for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that

are observable or can be corroborated by observable market data.

Level 3: Significant unobservable inputs that reflect a reporting entity's own assumptions

about the assumptions that market participants would use in pricing an asset or liability.

The Corporation used the following methods and significant assumptions to estimate fair value:

Investment Securities: The fair values of securities available for sale are usually determined by

obtaining quoted prices on nationally recognized securities exchanges (Level 1 inputs), or matrix

pricing, which is a mathematical technique widely used to value debt securities without relying

exclusively on quoted prices for the specific securities but rather by relying on the securities'

relationship to other benchmark quoted securities (Level 2 inputs).

The Corporation's investment in collateralized debt obligations consisting of pooled trust preferred

securities which are issued by financial institutions were historically priced using Level 2 inputs. The

lack of observable inputs and market activity in this class of investments has been significant and

resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, have varied

widely. The once active market has become comparatively inactive. As a result, these investments are

now priced using Level 3 inputs.

The Corporation utilizes an external model for pricing these securities. This is the same model used in

determining other-than-temporary impairment (“OTTI”) as further described in Note 8. Information

such as historical and current performance of the underlying collateral, deferral/default rates, collateral

coverage ratios, break in yield calculations, cash flow projections, liquidity and credit premiums

required by a market participant, and financial trend analysis with respect to the individual issuing

financial institutions, are utilized in determining individual security valuations. Discount rates were

utilized along with the cash flow projections in order to calculate an appropriate fair value. These

discount rates were calculated based on industry index rates and adjusted for various credit and liquidity

factors. Due to current market conditions as well as the limited trading activity of these securities, the

market value of the securities is highly sensitive to assumption changes and market volatility.

Trading Assets: The fair values of trading assets are determined by quoted market prices (Level 1

inputs).

Impaired Loans: At the time a loan is considered impaired, it is valued at the lower of cost or fair value.

Impaired loans carried at fair value have been partially charged-off or receive specific allocations as part

of the allowance for loan loss accounting. For collateral dependent loans, fair value is commonly based

on real estate appraisals. These appraisals may utilize a single valuation approach or a combination of

approaches including comparable sales and the income approach. Adjustments are routinely made in the

appraisal process by independent appraisers to adjust for differences between the comparable sales and

income data available. Such adjustments are usually significant and typically result in a Level 3

classification of the inputs for determining fair value. Non-real estate collateral may be valued using an

appraisal, net book value per the borrower’s financial statements, or aging reports, adjusted or

discounted based on management’s historical knowledge, changes in market conditions from the time of

the valuation, and management’s expertise and knowledge of the client and client’s business, typically

resulting in a Level 3 fair value classification. Impaired loans are evaluated on a quarterly basis for

additional impairment and adjusted accordingly.

Other Real Estate Owned: Assets acquired through or instead of loan foreclosures are initially recorded

at fair value less costs to sell when acquired, establishing a new cost basis. These assets are

subsequently accounted for at lower of cost or fair value less estimated costs to sell. Fair value is

commonly based on recent real estate appraisals. These appraisals may utilize a single valuation

approach or a combination of approaches including comparable sales and the income approach.

Adjustments are routinely made in the appraisal process by independent appraisers to adjust for

differences between the comparable sales and income data available. Such adjustments are usually

significant and typically result in a Level 3 classification of the inputs for determining fair value.

Appraisals for both collateral-dependent impaired loans and other real estate owned (“OREO”) are

performed by certified general appraisers (for commercial properties) or certified residential appraisers

(for residential properties) whose qualifications and licenses have been reviewed and verified by the

Corporation. Once received, appraisals are reviewed for reasonableness of assumptions, approaches

utilized, Uniform Standards of Professional Appraisal Practice and other regulatory compliance, as well

as the overall resulting fair value in comparison with independent data sources such as recent market

data or industry-wide statistics. Appraisals are generally completed within the previous 12 month period

prior to a property being placed into OREO. On impaired loans, appraisal values are adjusted based on

the age of the appraisal, the position of the lien, the type of the property and its condition.

Assets and liabilities measured at fair value on a recurring basis are summarized below:

			Fair Value Measurement at June 30, 2012 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	147,351,879	$	37,929,000	$	109,422,879	$	-
Mortgage-backed securities, residential		40,608,180		-		40,608,180		-
Obligations of states and political subdivisions		43,427,345		-		43,427,345		-
Collateralized mortgage obligations		5,487,056		-		5,487,056		-
Corporate bonds and notes		13,711,247		-		13,711,247		-
SBA loan pools		1,863,449		-		1,863,449		-
Trust Preferred securities		2,426,785		-		2,083,750		343,035
Corporate stocks		6,065,505		5,375,502		690,003		-
Total available for sale securities	$	260,941,446	$	43,304,502	$	217,293,909	$	343,035

Trading assets	$	252,105	$	252,105	$	-	$	-

			Fair Value Measurement at December 31, 2011 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	152,079,770	$	35,950,000	$	116,129,770	$	-
Mortgage-backed securities, residential		50,766,604		-		50,766,604		-
Obligations of states and political subdivisions		46,512,971		-		46,512,971		-
Trust Preferred securities		2,310,066		-		2,015,156		294,910
Corporate bonds and notes		13,684,199		-		13,684,199		-
Collateralized mortgage obligations		7,536,753		-		7,536,753		-
SBA loan pools		1,949,606		-		1,949,606		-
Corporate stocks		6,029,841		5,339,839		690,002		-
Total available for sale securities	$	280,869,810	$	41,289,839	$	239,285,061	$	294,910

Trading assets	$	294,381	$	294,381	$	-	$	-

There were no transfers between Level 1 and Level 2 during the three or six-month periods ending June

30, 2012 or the year ending December, 31, 2011.

The significant unobservable inputs used in the fair value measurement of the Corporation’s

collateralized debt obligations are probabilities of specific-issuer defaults and deferrals and specific-

issuer recovery assumptions. Significant increases in specific-issuer default assumptions or decreases

in specific-issuer recovery assumptions would result in a significantly lower fair value measurement.

Conversely, decreases in specific-issuer default assumptions or increases in specific-issuer recovery

assumptions would result in a higher fair value measurement. The Corporation treats all interest

payment deferrals as defaults and assumes no recoveries on defaults.

The table below presents a reconciliation of all assets measured at fair value on a recurring basis

using significant unobservable inputs (Level 3) for the six-month periods ending June 30, 2012

and 2011:

	Fair Value Measurement for Six-Months Ended June 30, 2012 Using Significant Unobservable Inputs (Level 3)		Fair Value Measurement for Six-Months Ended June 30, 2011 Using Significant Unobservable Inputs (Level 3)
Trust Preferred Securities Available for Sale
Beginning balance	$	294,910	$	334,585
Total gains/losses (realized/unrealized):
Included in earnings:
Income on securities		-		-
Impairment charge on investment securities		-		-
Included in other comprehensive income		48,125		37,150
Transfers in and/or out of Level 3		-		-
Ending balance June 30	$	343,035	$	371,735

	Fair Value Measurement for Three-Months Ended June 30, 2012 Using Significant Unobservable Inputs (Level 3)			Fair Value Measurement for Three-Months Ended June 30, 2011 Using Significant Unobservable Inputs (Level 3)
Trust Preferred Securities Available for Sale
Beginning balance	$	346,210		$	349,035
Total gains/losses (realized/unrealized):
Included in earnings:
Income on securities		-			-
Impairment charge on investment securities		-			-
Included in other comprehensive income		(3,175	)		22,700
Transfers in and/or out of Level 3		-			-
Ending balance June 30	$	343,035		$	371,735

Assets and liabilities measured at fair value on a non-recurring basis are summarized below:

			Fair Value Measurement at June 30, 2012 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired Loans:
Commercial, financial and agricultural:
Commercial and industrial	$	1,123,030	$	-	$	-	$	1,123,030
Commercial mortgages:				-		-
Other		1,005,169		-		-		1,005,169
Residential mortgages		125,136		-		-		125,136
Total Impaired Loans	$	2,253,335	$	-	$	-	$	2,253,335

Other real estate owned:
Commercial, financial and agricultural:
Commercial and industrial	$	197,800	$	-	$	-	$	197,800
Commercial mortgages:
Other		316,060		-		-		316,060
Residential mortgages		419,810		-		-		419,810
Consumer loans:
Home equity lines & loans		36,600		-		-		36,600
Total Other real estate owned, net	$	970,270	$	-	$	-	$	970,270

			Fair Value Measurement at December 31, 2011 Using
Financial Assets:	Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Impaired Loans:
Commercial, financial and agricultural:
Commercial and industrial	$	831,601	$	-	$	-	$	831,601
Commercial mortgages:				-		-
Other		3,321,838		-		-		3,321,838
Total Impaired Loans	$	4,153,439	$	-	$	-	$	4,153,439

Other real estate owned:
Commercial, financial and agricultural:
Commercial and industrial	$	218,040	$	-	$	-	$	218,040
Commercial mortgages:
Other		366,760		-		-		366,760
Residential mortgages		276,355		-		-		276,355
Consumer loans:
Home equity lines & loans		36,600		-		-		36,600
Total Other real estate owned, net	$	897,755	$	-	$	-	$	897,755

Impaired loans, which are measured for impairment using the fair value of the collateral for collateral

dependent loans, had a carrying amount of $3,586,354 with a valuation allowance of $1,333,019 as of

June 30, 2012, resulting in no additional provision for loan losses for the three and six-month periods

ending June 30, 2012. Impaired loans had a carrying amount of $6,095,645, with a valuation allowance

of $1,942,206 as of December 31, 2011, resulting in a $958,333 provision for loan losses for the year

ending December 31, 2011.

OREO, which is measured by the lower of carrying or fair value less costs to sell, had a net carrying

amount of $970,270 at June 30, 2012. The net carrying amount reflects the outstanding balance of

$1,078,156 net of a valuation allowance of $107,886 at June 30, 2012, which resulted in a write down of

$20,240 for the three and six-month periods ending June 30, 2012. OREO had a net carrying amount of

$897,755 at December 31, 2011. The net carrying amount reflects the outstanding balance of

$1,009,162 net of a valuation allowance of $111,407 at December 31, 2011, which resulted in write

downs of $12,120 for the year ending December 31, 2011.

The carrying amounts and estimated fair values of other financial instruments, at June 30, 2012

and December 31, 2011, are as follows (dollars in thousands):

	Fair Value Measurements at June 30, 2012 Using
Financial assets:	Carrying Amount		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Estimated Fair Value (1)
Cash and due from financial institutions	$	33,673	$	33,673	$	-	-	$	33,673
Interest-bearing deposits in other financial institutions		40,502		37,615		2,887	-		40,502
Trading assets		252		252		-	-		252
Securities available for sale		260,941		43,304		217,294	343		260,941
Securities held to maturity		6,334		-		7,098	-		7,098
Federal Home Loan and Federal Reserve Bank stock		5,359		-		-	-		N/A
Net loans		845,555		-		-	865,579		865,579
Loans held for sale		482		-		482	-		482
Accrued interest receivable		3,810		172		1,268	2,370		3,810

Financial liabilities:
Deposits:
Demand, savings, and insured money market accounts		793,600		793,600		-	-		793,600
Time deposits		260,078		-		261,851	-		261,851
Securities sold under agreements to repurchase		31,750		-		34,299	-		34,299
Federal Home Loan Bank advances		41,128		-		43,747	-		43,747
Accrued interest payable		656		12		644	-		656
Dividends payable		1,142		1,142		-	-		1,142

	December 31, 2011
Financial assets:	Carrying Amount		Estimated Fair Value (1)
Cash and due from financial institutions	$	28,205	$	28,205
Interest-bearing deposits in other financial institutions		24,697		24,697
Trading assets		294		294
Securities available for sale		280,870		280,870
Securities held to maturity		8,312		9,176
Federal Home Loan and Federal Reserve Bank stock		5,509		N/A
Net loans		787,256		805,760
Loans held for sale		395		395
Accrued interest receivable		3,882		3,882

Financial liabilities:
Deposits:
Demand, savings, and insured money market accounts		721,503		721,503
Time deposits		276,990		279,441
Securities sold under agreements to repurchase		37,107		40,019
Federal Home Loan Bank advances		43,344		46,603
Accrued interest payable		800		800
Dividends payable		1,141		1,141

(1) Fair value estimates are made at a specific point in time, based on relevant market information and

information about the financial instrument. These estimates are subjective in nature and involve uncertainties

and matters of significant judgment and, therefore, cannot be determined with precision. Changes in

assumptions could significantly affect the estimates.

The methods and assumptions used to estimate fair value are described as follows:

Cash, Due From and Interest-Bearing Deposits in Other Financial Institutions

For those short-term instruments that generally mature in ninety days or less, the carrying value

approximates fair value of which non interest-bearing deposits are classified as Level 1 and interest-

bearing deposits with the Federal Home Loan Bank of New York (“FHLB”) and Federal Reserve Bank

of New York (“FRB”) are classified as Level 1, and time deposits are classified as Level 2.

FHLB and FRB Stock

It is not practicable to determine the fair value of FHLB and FRB stock due to restrictions placed on its

transferability.

Loans Receivable

For variable-rate loans that reprice frequently, fair values approximate carrying values. The fair values

for other loans are estimated through discounted cash flow analysis using interest rates currently being

offered for loans with similar terms and credit quality. Loans are classified as Level 3. The methods

utilized to estimate the fair value of loans do not necessarily represent an exit price. Loans held for sale

are classified as Level 2.

Deposits

The fair values disclosed for demand deposits, savings accounts and money market accounts are, by

definition, equal to the amounts payable on demand at the reporting date (i.e., their carrying values) and

classified as Level 1.

The fair value of certificates of deposits is estimated using a discounted cash flow approach that applies

interest rates currently being offered on certificates to a schedule of the weighted-average expected

monthly maturities and classified as Level 2.

Securities Sold Under Agreements to Repurchase (Repurchase Agreements)

These instruments bear both variable and fixed rates of interest. Therefore, the carrying value

approximates fair value for the variable rate instruments and the fair value of fixed rate instruments is

based on discounted cash flows to maturity. These are classified as Level 2.

Federal Home Loan Bank Advances

These instruments bear a stated rate of interest to maturity and, therefore, the fair value is based on

discounted cash flows to maturity and classified as Level 2.

Accrued Interest Receivable and Payable

For these short-term instruments, the carrying value approximates fair value resulting in a classification

of Level 1, Level 2 or Level 3 depending upon the classification of the asset/liability they are associated

with.

5. Goodwill and Intangible Assets

The changes in goodwill included in the core banking segment during the periods ending June 30, 2012

and 2011 were as follows:

	2012			2011
Beginning of year	$	21,983,617		$	9,872,375
Adjustment of Acquired goodwill		(159,174	)		-
June 30,	$	21,824,443		$	9,872,375

Acquired intangible assets were as follows at June 30, 2012 and December 31, 2011:

	At June 30, 2012				At December 31, 2011
	Balance Acquired		Accumulated Amortization		Balance Acquired		Accumulated Amortization
Core deposit intangibles	$	3,819,798	$	1,514,800	$	3,819,798	$	1,213,118
Other customer relationship intangibles		6,063,423		2,726,071		6,063,423		2,479,563
Total	$	9,883,221	$	4,240,871	$	9,883,221	$	3,692,681

Aggregate amortization expense was $548,190 and $465,192 for the six-month periods ended June 30,

2012 and 2011, respectively.

The remaining estimated aggregate amortization expense at June 30, 2012 is listed below:

Year	Estimated Expense
2012	$	498,530
2013		876,524
2014		777,801
2015		681,176
2016		607,713
2017 and thereafter		2,200,606
Total	$	5,642,350

6. Accumulated Other Comprehensive Income

Accumulated other comprehensive income or loss represents the net unrealized holding gains or losses

on securities available for sale and the funded status of the Corporation's defined benefit pension plan

and other benefit plans, as of the consolidated balance sheet dates, net of the related tax effect.

The following is a summary of the accumulated other comprehensive income balance, net of tax:

	Balance at December 31, 2011				Current Period Change		Balance at June 30, 2012
Unrealized gains on securities available for sale		$	7,987,055		$	197,816	$	8,184,871
Unrealized loss on pension plans and other benefit plans			(9,428,433	)		387,536		(9,040,897	)
Total		$	(1,441,378	)	$	585,352	$	(856,026	)

7. Commitments and Contingencies

The Corporation is a party to certain financial instruments with off-balance sheet risk such as

commitments under standby letters of credit, unused portions of lines of credit, overdraft protection

and commitments to fund new loans. In accordance with U.S. GAAP, these financial instruments are not

recorded in the financial statements. The Corporation's policy is to record such instruments when

funded. These transactions involve, to varying degrees, elements of credit, interest rate and liquidity

risk. Such transactions are generally used by the Corporation to manage clients' requests for funding

and other client needs.

On February 14 and April 14, 2011, the Bank received separate settlement demands from representatives

of beneficiaries of certain trusts for which the Bank has acted as trustee. The settlement demands relate

to alleged claims of, among other things, breach of the Bank’s fiduciary duties as trustee, including the

Bank’s alleged failure to adequately diversify the relevant trust portfolios. The beneficiaries seek

aggregate damages of up to approximately $27.0 million. On September 16, 2011, the beneficiaries

objected in the Surrogate’s Court of the State of New York, County of Chemung (the “Surrogate’s

Court”) to accountings with respect to the above-mentioned trusts provided by the Bank, based on

allegations similar to those offered in the settlement demands. The matter remains pending at the

Surrogate’s Court. Although these matters are inherently unpredictable, management will defend

against these claims vigorously. Management has concluded that it is reasonably possible, but not

probable, that the financial position, results of operations or cash flows of the Corporation could be

materially adversely affected in any particular period by the unfavorable resolution of these claims, not

withstanding any potential recovery under applicable insurance coverage. An amount of loss or range of

loss cannot be reasonably estimated at this time.

In the normal course of business, there are various outstanding claims and legal proceedings involving

the Corporation or its subsidiaries. Except for the above matter, we believe that we are not a party to

any pending legal, arbitration, or regulatory proceedings that could have a material adverse impact on

our financial results or liquidity.

8. Securities

Amortized cost and estimated fair value of securities available for sale are as follows:

	June 30, 2012
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	143,778,752	$	3,581,127	$	8,000	$	147,351,879
Mortgage-backed securities, residential		38,178,813		2,429,367		-		40,608,180
Collateralized Mortgage obligations		5,399,128		90,845		2,917		5,487,056
Obligations of states and political subdivisions		41,695,595		1,737,291		5,541		43,427,345
Corporate bonds and notes		13,435,143		304,121		28,017		13,711,247
SBA loan pools		1,828,325		35,124		-		1,863,449
Trust Preferred securities		2,542,121		197,274		312,610		2,426,785
Corporate stocks		787,807		5,284,374		6,676		6,065,505
Total	$	247,645,684	$	13,659,523	$	363,761	$	260,941,446

	December 31, 2011
	Amortized Cost		Unrealized Gains			Unrealized Losses		Estimated Fair Value
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	149,140,715	$	3,022,726	��	$	83,671	$	152,079,770
Mortgage-backed securities, residential		48,129,271		2,637,334			-		50,766,605
Collateralized mortgage obligations		7,412,470		135,603			11,321		7,536,753
Obligations of states and political subdivisions		44,561,789		1,954,265			3,083		46,512,971
Corporate bonds and notes		13,461,675		418,969			196,446		13,684,198
SBA loan pools		1,915,419		34,187			-		1,949,606
Trust preferred securities		2,538,286		132,516			360,735		2,310,066
Corporate stocks		788,030		5,246,655			4,844		6,029,841
Total	$	267,947,655	$	13,582,255		$	660,100	$	280,869,810

Amortized cost and estimated fair value of securities held to maturity are as follows:

	June 30, 2012
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value
Obligations of states and political subdivisions	$	6,334,331	$	763,815	$	-	$	7,098,146
Total	$	6,334,331	$	763,815	$	-	$	7,098,146

	December 31, 2011
	Amortized Cost		Unrealized Gains		Unrealized Losses		Estimated Fair Value

Obligations of states and political subdivisions	$	8,311,921	$	864,035	$	-	$	9,175,956
Total	$	8,311,921	$	864,035	$	-	$	9,175,956

The amortized cost and estimated fair value of debt securities are shown below by expected maturity.

Expected maturities may differ from contractual maturities if borrowers have the right to call or prepay

obligations with or without call or prepayment penalties. Securities not due at a single maturity date are

shown separately:

	June 30, 2012
	Available for Sale				Held to Maturity
	Amortized		Fair		Amortized		Fair
	Cost		Value		Cost		Value
Within One Year	$	60,679,329	$	61,410,522	$	1,613,513	$	1,647,827
After One, But Within Five Years		132,755,934		137,107,786		3,293,374		3,663,339
After Five, But Within Ten Years		7,360,703		8,055,913		1,427,444		1,786,980
After Ten Years		655,645		343,035		-		-
Mortgage-backed securities, residential		38,178,813		40,608,180		-		-
Collateralized mortgage obligations		5,399,128		5,487,056		-		-
SBA loan pools		1,828,325		1,863,449		-		-
Total	$	246,857,877	$	254,875,941	$	6,334,331	$	7,098,146

Proceeds from sales and calls of securities available for sale for the three and six months ended June 30,

2012 were $16,787,750 and $69,367,438, respectively. Realized gross gains on these sales and calls

were $2,750 and $299,919 during the three and six month periods ended June 30, 2012, respectively.

There were no sales or calls of securities available for sale that resulted in losses for the three or six-

months ended June 30, 2012.

Proceeds from sales and calls of securities available for sale for the three and six months ended June

30, 2011, were $6,485,156 and $56,656,054, respectively. Realized gross gains on these sales and calls

were $485,811 and $679,209 during the three and six month periods ended June 30, 2011, respectively.

There were no sales or calls of securities available for sale that resulted in losses for the three or six-

months ended June 30, 2011.

The following table summarizes the investment securities available for sale and held to maturity with

unrealized losses at June 30, 2012 and December 31, 2011 by aggregated major security type and length

of time in a continuous unrealized loss position:

	Less than 12 months				12 months or longer				Total
June 30, 2012	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	4,992,000	$	8,000	$	-	$	-	$	4,992,000	$	8,000
Collateralized mortgage obligations		553,923		2,917		-		-		553,923		2,917
Obligations of states and political subdivisions		948,419		5,541		-		-		948,419		5,541
Corporate bonds and notes		4,025,117		17,489		512,734		10,528		4,537,851		28,017
Trust preferred securities		-		-		343,035		312,610		343,035		312,610
Corporate stocks		45,285		4,707		1,670		1,969		46,955		6,676
Total temporarily impaired securities	$	10,564,744	$	38,654	$	857,439	$	325,107	$	11,422,183	$	363,761

	Less than 12 months				12 months or longer				Total
December 31, 2011	Fair Value		Unrealized Losses		Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Obligations of U.S. Government and U.S. Government sponsored enterprises	$	27,365,920	$	83,671	$	-	$	-	$	27,365,920	$	83,671
Collateralized mortgage obligations		2,546,461		11,321		-		-		2,546,461		11,321
Obligations of states and political subdivisions		947,203		3,083		-		-		947,203		3,083
Corporate bonds and notes		5,261,074		196,446		-		-		5,261,074		196,446
Trust preferred securities		-		-		294,910		360,735		294,910		360,735
Corporate stocks		1,669		1,969		47,117		2,875		48,786		4,844
Total temporarily impaired securities	$	36,122,327	$	296,490	$	342,027	$	363,610	$	36,464,354	$	660,100

Other-Than-Temporary Impairment (“OTTI”)

When OTTI occurs, for either debt securities or purchased beneficial interests, the amount of the OTTI

recognized in earnings depends on whether an entity intends to sell the security or more likely than not

will be required to sell the security before recovery of its amortized cost basis, less any current-period

credit loss. If an entity intends to sell or more likely than not will be required to sell the security before

recovery of its amortized cost basis, less any current-period credit loss, the OTTI shall be recognized in

earnings equal to the entire difference between the investment’s amortized cost basis and its fair value at

the balance sheet date. If an entity does not intend to sell the security and it is not more likely than not

that the entity will be required to sell the security before recovery of its amortized cost basis less any

current-period loss, the OTTI shall be separated into the amount representing the credit loss and the

amount related to all other factors. The amount of the total OTTI related to the credit loss is determined

based on the present value of cash flows expected to be collected and is recognized in earnings. The

amount of the total OTTI related to other factors is recognized in other comprehensive income, net of

applicable taxes. The previous amortized cost basis less the OTTI recognized in earnings becomes the

new amortized cost basis of the investment.

As of June 30, 2012, the majority of the Corporation's unrealized losses in the investment securities

portfolio related to two pooled trust preferred securities. The decline in fair value on these securities is

primarily attributable to the financial crisis and resulting credit deterioration and financial condition of

the underlying issuers, all of which are financial institutions. This deterioration may affect the future

receipt of both principal and interest payments on these securities. This fact combined with the current

illiquidity in the market makes it unlikely that the Corporation would be able to recover its investment in

these securities if the securities were sold at this time. One of these securities has been previously

written down through the income statement to an amount considered to be immaterial to the financial

statements. Therefore management is no longer analyzing this security for further impairment.

Our analysis of these investments includes a $629 thousand book value collateralized debt obligation

("CDO") which is a pooled trust preferred security. This security was rated high quality at inception, but

at June 30, 2012 Moody's rated this security as Caa3, which is defined as substantial risk of default. The

Corporation uses the OTTI evaluation model to compare the present value of expected cash flows to the

previous estimate to determine if there are adverse changes in cash flows during each quarter. The OTTI

model considers the structure and term of the CDO and the financial condition of the underlying issuers.

Specifically, the model details interest rates, principal balances of note classes and underlying issuers,

the timing and amount of interest and principal payments of the underlying issuers, and the allocation of

the payments to the note classes. The current estimate of expected cash flows is based on the most recent

trustee reports and any other relevant market information including announcements of interest payment

deferrals or defaults of underlying trust preferred securities.

Upon completion of the June 30, 2012 analysis, our model indicated no additional OTTI on this CDO.

This security remained classified as available for sale and represented $304 thousand of the unrealized

losses reported at June 30, 2012. Payments continue to be made as agreed on this security.

When conducting the June 30, 2012 analysis, the present value of expected future cash flows using a

discount rate equal to the yield in effect at the time of purchase was compared to the previous quarters'

analysis. The analysis indicated no further decline in value attributed to credit related factors stemming

from further deterioration in the underlying collateral payment streams. Additionally, to estimate fair

value the present value of the expected future cash flows was calculated using a current estimated

discount rate that a willing market participant might use to value the security based on current market

conditions and interest rates. This comparison indicated a slight decrease in value during the quarter,

based on factors other than credit, which resulted in a loss reported in other comprehensive income.

Changes in credit quality may or may not correlate to changes in the overall fair value of the impaired

securities as the change in credit quality is only one component in assessing the overall fair value of the

impaired securities. Therefore, the recognition of additional credit related OTTI could result in a gain

reported in other comprehensive income. Total other-than-temporary impairment recognized in

accumulated other comprehensive income was $190,833 and $214,680 for securities available for sale at

June 30, 2012 and June 30, 2011, respectively.

The table below presents a roll forward of the cumulative credit losses recognized in earnings for the

three and six-month periods ending June 30, 2012 and 2011:

	2012		2011
Beginning balance, January 1,	$	3,506,073	$	3,438,673
Amounts related to credit loss for which an other-than-temporary impairment was not previously recognized		-		-
Additions/Subtractions:
Amounts realized for securities sold during the period		-		-
Amounts related to securities for which the company intends to sell or that it will be more likely than not that the company will be required to sell prior to recovery of amortized cost basis		-		-
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security		-		-
Increases to the amount related to the credit loss for which other-than-temporary impairment was previously recognized		-		-
Ending balance, June 30,	$	3,506,073	$	3,438,673

Beginning balance, April 1,	$	3,506,073	$	3,438,673
Amounts related to credit loss for which an other-than-temporary impairment was not previously recognized		-		-
Additions/Subtractions:
Amounts realized for securities sold during the period		-		-
Amounts related to securities for which the company intends to sell or that it will be more likely than not that the company will be required to sell prior to recovery of amortized cost basis		-		-
Reductions for increase in cash flows expected to be collected that are recognized over the remaining life of the security		-		-
Increases to the amount related to the credit loss for which other-than-temporary impairment was previously recognized		-		-
Ending balance, June 30,	$	3,506,073	$	3,438,673

9. Loans and Allowance for Loan Losses

The composition of the loan portfolio is summarized as follows:

	June 30, 2012		December 31, 2011
Commercial, financial and agricultural	$	139,046,623	$	142,209,279
Commercial mortgages		297,158,610		264,589,013
Residential mortgages		194,511,823		193,599,853
Indirect consumer loans		124,061,078		97,165,447
Consumer loans		101,169,118		99,351,585
	$	855,947,252	$	796,915,177

Loans are charged against the allowance for loan losses when management believes that the

collectability of all or a portion of the principal is unlikely. The allowance is an amount that

management believes will be adequate to absorb probable incurred losses on existing loans.

Management's evaluation of the adequacy of the allowance for loan losses is performed on a periodic

basis and takes into consideration such factors as the credit risk grade assigned to the loan, historical

loan loss experience and review of specific problem loans (including evaluations of the underlying

collateral). Historical loss experience is adjusted by management based on their judgment as to the

current impact of qualitative factors including changes in the composition and volume of the loan

portfolio, overall portfolio quality, and current economic conditions that may affect the borrowers'

ability to pay. Management believes that the allowance for loan losses is adequate to absorb probable

incurred losses. While management uses available information to recognize losses on loans, future

additions to the allowance may be necessary based on changes in economic conditions. In addition,

various regulatory agencies, as an integral part of their examination process, periodically review the

Corporation's allowance for loan losses. Such agencies may require the Corporation to recognize

additions to the allowance based on their judgments about information available to them at the time of

their examination.

Management, after considering current information and events regarding a borrower's ability to repay its

obligations, classifies a loan as impaired when it is probable that the Corporation will be unable to

collect all amounts due according to the contractual terms of the loan agreement. If a loan is impaired, a

portion of the allowance is allocated so that the loan is reported, net, at the present value of estimated

future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected

solely from the collateral. Large groups of smaller balance homogeneous loans, such as consumer and

residential real estate loans are collectively evaluated for impairment, and accordingly, they are not

separately identified for impairment disclosures. Troubled debt restructurings are separately identified

for impairment disclosures and are measured at the present value of estimated future cash flows using

the loan’s effective rate at inception. If a troubled debt restructuring is considered to be a collateral

dependent loan, the loan is reported, net, at the fair value of the collateral. For troubled debt

restructurings that subsequently default, the Corporation determines the amount of reserve in accordance

with the accounting policy for the allowance for loan losses.

The general component of the allowance for loan losses covers non-impaired loans and is based on

historical loss experience adjusted for current factors. Loans not impaired but classified as substandard

and special mention use a historical loss factor on a rolling five year history of net losses. For all other

unclassified loans, the historical loss experience is determined by portfolio class and is based on the

actual loss history experienced by the Corporation over the most recent eight quarters. This actual loss

experience is supplemented with other economic factors based on the risks present for each portfolio

class. These economic factors include consideration of the following: levels of and trends in

delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume

and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in

lending policies, procedures, and practices; experience, ability, and depth of lending management and

other relevant staff; national and local economic trends and conditions; industry conditions; and effects

of changes in credit concentrations. The following portfolio segments have been identified: commercial,

financial and agricultural; commercial mortgages; residential mortgages; and consumer loans.

Risk Characteristics

Commercial, financial and agricultural loans primarily consist of loans to small to mid-sized businesses

in our market area in a diverse range of industries. These loans are of higher risk and typically are made

on the basis of the borrower’s ability to make repayment from the cash flow of the borrower’s business.

Further, the collateral securing the loans may depreciate over time, may be difficult to appraise and may

fluctuate in value. The credit risk related to commercial loans is largely influenced by general economic

conditions and the resulting impact on a borrower’s operations or on the value of underlying collateral,

if any.

Commercial mortgage loans generally have larger balances and involve a greater degree of risk than

residential mortgage loans, inferring higher potential losses on an individual customer basis. Loan

repayment is often dependent on the successful operation and management of the properties and/or the

businesses occupying the properties, as well as on the collateral securing the loan. Economic events or

conditions in the real estate market could have an adverse impact on the cash flows generated by

properties securing the Company’s commercial real estate loans and on the value of such properties.

Residential mortgage loans are generally made on the basis of the borrower’s ability to make repayment

from his or her employment and other income, but are secured by real property whose value tends to be

more easily ascertainable. Credit risk for these types of loans is generally influenced by general

economic conditions, the characteristics of individual borrowers and the nature of the loan collateral.

The consumer loan segment includes home equity lines of credit and home equity loans, which exhibit

many of the same risk characteristics as residential mortgages. Indirect and other consumer loans may

entail greater credit risk than residential mortgage and home equity loans, particularly in the case of

other consumer loans which are unsecured or, in the case of indirect consumer loans, secured by

depreciable assets, such as automobiles or boats. In such cases, any repossessed collateral for a defaulted

consumer loan may not provide an adequate source of repayment of the outstanding loan balance. In

addition, consumer loan collections are dependent on the borrower’s continuing financial stability, thus

are more likely to be affected by adverse personal circumstances such as job loss, illness or personal

bankruptcy. Furthermore, the application of various federal and state laws, including bankruptcy and

insolvency laws, may limit the amount which can be recovered on such loans.

The following tables present activity in the allowance for loan losses by portfolio segment for the three

and six-month periods ending June 30, 2012 and June 30, 2011 and by loans originated by the

Corporation (referred to as “Legacy” loans) and loans acquired in the merger with Fort Orange Financial

Corp. (“FOFC”) which was completed on April 8, 2011 (referred to as “Acquired” loans). The

Acquired loan allowance represents any valuation allowances established after acquisition for decreases

in cash flows expected to be collected on loans acquired with deteriorated credit quality:

Legacy Loans	Six Months Ended June 30, 2012
Allowance for loan losses	Commercial, Financial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Unallocated			Total
Beginning balance:	$	3,143,373		$	2,570,149		$	1,309,649		$	2,192,729		$	443,420		$	9,659,320
Charge Offs:		(5,792	)		(8,295	)		(72,613	)		(273,428	)		-			(360,128	)
Recoveries:		351,763			30,496			-			107,723			-			489,982
Net recoveries (charge offs)		345,971			22,201			(72,613	)		(165,705	)		-			129,854
Provision		(692,788	)		395,618			187,780			447,161			(29,772	)		307,999
Ending balance	$	2,796,556		$	2,987,968		$	1,424,816		$	2,474,185		$	413,648		$	10,097,173

Acquired loans	Six Months Ended June 30, 2012
Allowance for loan losses	Commercial, Financial and Agricultural		Commercial Mortgages			Residential Mortgages		Consumer Loans		Unallocated		Total
Beginning balance:	$	-	$	-		$	-	$	-	$	-	$	-
Reclassification of acquired loan Discount		73,228		50,331			-		-		-		123,559
Charge Offs:		-		(49,057	)		-		-		-		(49,057	)
Recoveries:		-		-			-		-		-		-
Net recoveries		73,228		1,274			-		-		-		74,502
Provision		134,427		86,470			-		-		-		220,897
Ending balance	$	207,655	$	87,744		$	-	$	-	$	-	$	295,399

Legacy Loans	Three Months Ended June 30, 2012
Allowance for loan losses	Commercial, Financial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Unallocated		Total
Beginning balance:	$	3,136,457		$	2,953,632		$	1,417,252		$	2,100,433		$	373,708	$	9,981,482
Charge Offs:		(5,792	)		(8,295	)		(58,273	)		(115,109	)		-		(187,469	)
Recoveries:		179,160			20,261			-			45,741			-		245,162
Net recoveries (charge offs)		173,368			11,966			(58,273	)		(69,368	)		-		57,693
Provision		(513,269	)		22,370			65,837			443,120			39,940		57,998
Ending balance	$	2,796,556		$	2,987,968		$	1,424,816		$	2,474,185		$	413,648	$	10,097,173

Acquired loans	Three Months Ended June 30, 2012
Allowance for loan losses	Commercial, Financial and Agricultural			Commercial Mortgages		Residential Mortgages		Consumer Loans		Unallocated		Total
Beginning balance:	$	224,936		$	76,872	$	-	$	-	$	-	$	301,808
Reclassification of acquired loan Discount		-			-		-		-		-		-
Charge Offs:		-			-		-		-		-		-
Recoveries:		-			-		-		-		-		-
Net charge offs		-			-		-		-		-		-
Provision		(17,281	)		10,872		-		-		-		(6,409	)
Ending balance	$	207,655		$	87,744	$	-	$	-	$	-	$	295,399

	Six Months Ended June 30, 2011
Allowance for loan losses	Commercial, Financial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Unallocated			Total
Beginning balance:	$	2,118,299		$	2,575,058		$	1,301,780		$	2,727,022		$	775,972		$	9,498,131
Charge Offs:		(3003	)		(3,764	)		-			(340,655	)		-			(347,422	)
Recoveries:		205,406			26,103			30,324			93,130			-			354,963
Net recoveries (charge offs)		202,403			22,339			30,324			(247,525	)		-			7,541
Provision		760,731			15,258			(85,224	)		(182,038	)		(258,727	)		250,000
Ending balance	$	3,081,433		$	2,612,655		$	1,246,880		$	2,297,459		$	517,245		$	9,755,672

	Three Months Ended June 30, 2011
Allowance for loan losses	Commercial, Financial and Agricultural			Commercial Mortgages			Residential Mortgages			Consumer Loans			Unallocated			Total
Beginning balance:	$	2,502,200		$	2,657,185		$	1,366,214		$	2,424,312		$	641,040		$	9,590,951
Charge Offs:		(3,003	)		-			-			(133,744	)		-			(136,747	)
Recoveries:		87,941			23,350			15,845			49,332			-			176,468
Net recoveries (charge offs)		84,938			23,350			15,845			(84,412	)		-			39,721
Provision		487,419			(61,004	)		(135,179	)		(42,441	)		(123,795	)		125,000
Ending balance	$	3,081,433		$	2,612,655		$	1,246,880		$	2,297,459		$	517,245		$	9,755,672

The following tables present the balance in the allowance for loan losses and the recorded investment in

loans by portfolio segment based on impairment method as of June 30, 2012 and December 31, 2011.

The recorded investment excludes Acquired loans except for those loans acquired with deteriorated

credit quality:

	June 30, 2012
Allowance for loan losses	Commercial, Financial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Unallocated		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,195,684	$	134,466	$	2,869	$	-	$	-	$	1,333,019
Collectively evaluated for impairment		1,600,872		2,853,502		1,421,947		2,474,185		413,648		8,764,154
Acquired with deteriorated credit quality		207,655		87,744		-		-		-		247,963
Total ending allowance balance	$	3,004,211	$	3,075,712	$	1,424,816	$	2,474,185	$	413,648	$	10,392,572

	December 31, 2011
Allowance for loan losses	Commercial, Financial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Unallocated		Total
Ending allowance balance attributable to loans:
Individually evaluated for impairment	$	1,528,651	$	413,555	$	-	$	-	$	-	$	1,942,206
Collectively evaluated for impairment		1,614,722		2,156,594		1,309,649		2,192,729		443,420		7,717,114
Total ending allowance balance	$	3,143,373	$	2,570,149	$	1,309,649	$	2,192,729	$	443,420	$	9,659,320

	June 30, 2012
Loans:	Commercial, Financial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	2,499,767	$	2,065,838	$	140,043	$	-	$	4,705,648
Loans collectively evaluated for impairment		114,594,272		215,053,094		178,839,976		220,242,896		728,730,238
Acquired with deteriorated credit quality		1,197,884		11,433,363		235,555		-		12,866,802
Total ending loans balance	$	118,921,923	$	228,552,295	$	179,215,574	$	220,242,896	$	746,302,688

	December 31, 2011
Loans:	Commercial, Financial and Agricultural		Commercial Mortgages		Residential Mortgages		Consumer Loans		Total
Loans individually evaluated for impairment	$	5,275,043	$	4,603,563	$	179,337	$	-	$	10,057,943
Loans collectively evaluated for impairment		111,532,413		169,658,759		175,405,950		190,904,630		647,501,752
Total ending loans balance	$	116,807,456	$	174,262,322	$	175,585,287	$	190,904,630	$	657,559,695

The following tables present loans individually evaluated for impairment recognized by class of loans as of June 30, 2012 and December 31, 2011, the average

recorded investment and interest income recognized by class of loans as of the three and six-month periods ending June 30, 2012 and 2011:

	June 30, 2012						December 31, 2011
	Unpaid Principal Balance		Allowance for Loan Losses Allocated		Recorded Investment		Unpaid Principal Balance			Allowance for Loan Losses Allocated		Recorded Investment
With no related allowance recorded:
Commercial, financial and agricultural:
Commercial & industrial	$	180,672	$	-	$	180,785	$	2,914,401	$	-	$	2,914,776
Commercial mortgages:
Construction		10,454		-		10,454		10,454		-		10,454
Other		928,897		-		915,838		862,815		-		860,648
Residential mortgages		12,038		-		12,038		178,925		-		179,337
With an allowance recorded:
Commercial, financial and agricultural:
Commercial & industrial		2,318,714		1,195,684		2,318,982		2,360,252		1,528,651		2,360,267
Commercial mortgages:
Construction		-		-		-		8,295		8,295		8,295
Other		1,139,635		134,466		1,139,546		3,727,097		405,260		3,724,166
Residential mortgages		128,005		2,869		128,005		-		-		-
Total	$	4,718.415	$	1,333,019	$	4,705,648	$	10,062,239	$	1,942,206	$	10,057,943

		Six-Months Ended June 30, 2012			Six-Months Ended June 30, 2011				Three Months Ended June 30, 2012				Three Months Ended June 30, 2011
		Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized	Average Recorded Investment		Interest Income Recognized		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial, financial and agricultural:
Commercial & industrial	$	1,067,170	$	-	$	3,141,620	$	18,759	$	143,367	$	-	$	3,116,317	$	10,933
Commercial mortgages:
Construction		10,454		-		31,128		-		10,454		-		30,559		-
Other		827,553		-		3,451,644		-		811,005		-		3,402,624		-
Residential mortgages		111,368		-		349,501		5,640		77,384		-		320,055		3,266
Consumer loans:
Home equity lines & loans		19,856		2,289		-		-		29,784		1,123		-		-
With an allowance recorded:
Commercial, financial and agricultural:
Commercial & industrial		2,347,963		-		1,306,572		144,242		2,341,810		-		1,948,091		144,242
Commercial mortgages:
Construction		5,530		-		30,318		-		4,148		-		20,008		-
Other		2,109,919		-		703,733		-		1,302,796		-		646,603		-
Residential mortgages		42,668		-		-		-		-		-		-		-
Total	$	6,542,481	$	2,289	$	9,014,516	$	168,641	$	4,720,748	$	1,123	$	9,484,257	$	157,841

The following table presents the recorded investment in non accrual and loans past due over 90 days still

on accrual by class of loans as of the periods ending June 30, 2012 and December 31, 2011. This table

includes Acquired loans except for those loans with evidence of credit deterioration at the time of the

FOFC merger:

	June 30, 2012				December 31, 2011
	Non-Accrual		Loans Past Due Over 90 Days Still Accruing		Non-Accrual		Loans Past Due Over 90 Days Still Accruing
Commercial, financial and agricultural:
Commercial & industrial	$	2,903,371	$	-	$	5,611,805	$	-
Commercial mortgages:
Construction		419,434		6,269,714		18,749		7,295,104
Other		2,248,954		-		4,778,384		-
Residential mortgages		2,492,865		-		2,611,096		-
Consumer loans
Credit cards		-		6,710		-		9,053
Home equity lines & loans		467,544		-		455,418		-
Indirect consumer loans		22,457		-		22,287		-
Other direct consumer loans		177,886		-		113,349		-
Total	$	8,732,511	$	6,276,424	$	13,611,088	$	7,304,157

The following tables present the aging of the recorded investment in loans past due (including non-accrual loans) by class of loans as of June 30,

2012 and December 31, 2011 and by Legacy loans and Acquired loans:

	June 30, 2012
Legacy Loans:	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due			Loans Acquired with deteriorated credit quality	Loans Not Past Due			Total
Commercial, financial and agricultural:
Commercial & industrial	$	27,835	$	-	$	229,807	$	257,642	$	-	$	116,317,883	$	116,575,525
Agricultural		-		-		-		-		-		518,514		518,514
Commercial mortgages:
Construction		340,910		-		10,454		351,364		-		22,835,834		23,187,198
Other		46,100		-		506,261		552,361		-		193,379,374		193,931,735
Residential mortgages		1,614,383		336,911		770,010		2,721,304		-		176,258,714		178,980,018
Consumer loans:
Credit cards		5,187		5,171		6,710		17,068		-		1,762,968		1,780,036
Home equity lines & loans		121,678		54,119		179,233		355,030		-		76,597,137		76,952,167
Indirect consumer loans		724,477		123,534		135,626		983,637		-		123,425,437		124,409,074
Other direct consumer loans		44,009		7,367		12,977		64,353		-		17,037,265		17,101,618
Total	$	2,924,579	$	527,102	$	1,851,078	$	5,302,759	$	-	$	728,133,127	$	733,435,886

	June 30, 2012
Acquired Loans:	30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due			Loans Acquired with deteriorated credit quality	Loans Not Past Due			Total
Commercial, financial and agricultural:
Commercial & industrial	$	168,854	$	124,049	$	313,216	$	606,119	$	1,197,884	$	22,396,047	$	24,200,050
Commercial mortgages:
Construction		-		-		6,678,694		6,678,694		1,190,848		2,475,508		10,345,050
Other		544,679		953,295		193,570		1,691,544		10,242,515		56,718,062		68,652,121
Residential mortgages		857,208		57,966		204,636		1,119,810		235,555		14,685,097		16,040,462
Consumer loans:
Home equity lines & loans		-		-		-		-		-		5,528,355		5,528,355
Other direct consumer loans		-		-		362		362		-		91,599		91,961
Total	$	1,570,741	$	1,135,310	$	7,390,478	$	10,096,529	$	12,866,802	$	101,894,668	$	124,857,999

	December 31, 2011
Legacy Loans:		30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due			Loans Acquired with deteriorated credit quality	Loans Not Past Due			Total
Commercial, financial and agricultural:
Commercial & industrial		$	4,571	$	10,940	$	2,920,906	$	2,936,417	$	-	$	113,612,941	$	116,549,358
Agricultural			-		-		-		-		-		258,098		258,098
Commercial mortgages:
Construction			-		-		-		-		-		7,383,731		7,383,731
Other			82,986		-		2,977,010		3,059,996		-		163,818,595		166,878,591
Residential mortgages			1,418,234		293,337		1,221,056		2,932,627		-		172,652,660		175,585,287
Consumer loans:
Credit cards			3,660		8,031		9,053		20,744		-		1,934,471		1,955,215
Home equity lines & loans			368,556		27,717		212,573		608,846		-		76,280,502		76,889,348
Indirect consumer loans			597,180		75,817		85,763		758,760		-		96,781,480		97,540,240
Other direct consumer loans			21,876		10,243		9,644		41,763		-		14,478,064		14,519,827
Total		$	2,497,063	$	426,085	$	7,436,005	$	10,359,153	$	-	$	647,200,542	$	657,559,695

	December 31, 2011
Acquired Loans:		30-59 Days Past Due		60-89 Days Past Due		Greater than 90 Days Past Due		Total Past Due			Loans Acquired with deteriorated credit quality	Loans Not Past Due			Total
Commercial, financial and agricultural:
Commercial & industrial		$	275,121	$	82,677	$	195,687	$	553,485	$	1,499,141	$	25,335,874	$	27,388,500
Commercial mortgages:
Construction			-		418,518		7,295,104		7,713,622		2,022,149		2,715,270		12,451,041
Other			-		-		193,570		193,570		11,063,483		65,836,938		77,093,991
Residential mortgages			405,087		62,017		84,083		551,187		226,937		17,753,898		18,532,022
Consumer loans:
Home equity lines & loans			-		-		-		-		-		6,168,831		6,168,831
Other direct consumer loans			171		-		-		171		-		147,439		147,610
Total		$	680,379	$	563,212	$	7,768,444	$	9,012,035	$	14,811,710	$	117,958,250	$	141,781,995

Troubled Debt Restructurings:

The Corporation has $3 thousand of allocated specific reserves to customers whose loan terms have

been modified in troubled debt restructurings which are included in non-accrual loans as of June 30,

2012. The Corporation had $218 thousand allocated specific reserves to customers whose loan terms

have been modified in troubled debt restructurings which are included in non-accrual loans as of

December 31, 2011. The Corporation has not committed to lend any additional amounts as of June 30,

2012 or December 31, 2011 to customers with outstanding loans that are classified as trouble debt

restructurings.

During the six months ended June 30, 2012, one loan in the amount of $59 thousand was modified as a

troubled debt restructuring by the Corporation. This loan was paid off during the second quarter of

2012. The modification of the terms of this loan included an extension of the maturity date. During the

three months ended June 30, 2012, no loans were modified as troubled debt restructurings by the

Corporation. Additionally, there were no payment defaults on any loans previously modified as troubled

debt restructurings within twelve months following the modification. A loan is considered to be in

payment default once it is 90 days contractually past due under the modified terms.

Credit Quality Indicators:

The Corporation establishes a risk rating at origination for all commercial loans. The main factors

considered in assigning risk ratings include, but not limited to: historic and future debt service coverage,

collateral position, operating performance, liquidity, leverage, payment history, management ability, and

the customer’s industry. Commercial relationship managers monitor all loans in their respective

portfolios for any changes in the borrower’s ability to service their debt and affirm the risk ratings for

the loans at least annually.

For the retail loans, which include lines of credit, installment, mortgage, and home equity loans, once a

loan is properly approved and closed, the Corporation evaluates credit quality based upon loan

repayment.

The Corporation uses the risk rating system to identify criticized and classified loans. Commercial

relationships within the criticized and classified risk ratings are analyzed quarterly. The Corporation

uses the following definitions for criticized and classified loans (which are consistent with regulatory

guidelines):

Special Mention – Loans classified as special mention have a potential weakness that deserves

management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration

of the repayment prospects for the loan or the institution’s credit position as some future date.

Substandard – Loans classified as substandard are inadequately protected by the current net worth and

paying capability of the obligor or of the collateral pledged, if any. Loans so classified have a well-

defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by

the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

Doubtful – Loans classified as doubtful have all the weaknesses inherent in those classified as

substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on

the basis of currently existing facts, conditions, and values, highly questionable and improbable.

Loans not meeting the criteria above that are analyzed individually as part of the above described

process are considered to be not rated loans. Based on the analysis’s performed as of June 30, 2012 and

December 31, 2011, the risk category of the recorded investment of loans by class of loans is as follows:

	June 30, 2012
Legacy Loans:	Not Rated		Pass		Special Mention		Substandard		Doubtful
Commercial, financial and agricultural:
Commercial & industrial	$	-	$	99,732,167	$	12,130,092	$	2,768,639	$	1,944,627
Agricultural		-		518,514		-		-		-
Commercial mortgages:
Construction		-		22,220,989		201,730		764,479		-
Other		-		179,478,529		9,211,037		4,844,286		397,883
Residential mortgages		176,749,755		-		-		2,230,263		-
Consumer loans:
Credit cards		1,780,036		-		-		-		-
Home equity lines & loans		76,399,344		-		-		552,823		-
Indirect consumer loans		124,231,188		-		-		177,886		-
Other direct consumer loans		17,079,524		-		-		22,095		-
Total	$	396,239,847	$	301,950,199	$	21,542,859	$	11,360,471	$	2,342,510

	June 30, 2012
Acquired Loans:		Not Rated		Pass		Loans Acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful
Commercial, financial and agricultural:
Commercial & industrial		$	-		22,078,338	$	1,197,884	$	548,402	$	287,646	$	87,780
Commercial mortgages:			-
Construction			-		997,892		1,190,848		6,557,221		1,599,089		-
Other			-		55,072,078		10,242,515		474,202		2,669,756		193,570
Residential mortgages			15,542,306		-		235,555		-		262,601		-
Consumer loans
Home equity lines & loans			5,528,355		-		-		-		-		-
Other direct consumer loans			91,961		-		-		-		-		-
Total		$	21,162,622		78,148,308	$	12,866,802	$	7,579,825	$	4,819,092	$	281,350

	December 31, 2011
Legacy Loans:	Not Rated		Pass		Special Mention		Substandard		Doubtful
Commercial, financial and agricultural:
Commercial & industrial	$	-	$	93,923,356	$	14,957,683	$	4,139,413	$	3,528,906
Agricultural		-		258,098		-		-		-
Commercial mortgages:
Construction		-		6,391,614		208,360		783,757		-
Other		-		152,435,884		6,503,087		7,423,514		516,106
Residential mortgages		173,120,292		-		-		2,464,995		-
Consumer loans:
Credit cards		1,955,215		-		-		-		-
Home equity lines & loans		76,432,196		-		-		457,152		-
Indirect consumer loans		97,426,891		-		-		113,349		-
Other direct consumer loans		14,497,795		-		-		22,032		-
Total	$	363,432,389	$	253,008,952	$	21,669,130	$	15,404,212	$	4,045,012

	December 31, 2011
Acquired Loans:		Not Rated		Pass		Loans Acquired with deteriorated credit quality		Special Mention		Substandard		Doubtful
Commercial, financial and agricultural:
Commercial & industrial		$	-	$	25,164,742	$	1,499,141	$	602,006	$	24,635	$	97,976
Commercial mortgages:
Construction			-		1,790,731		2,022,149		7,447,661		1,190,500		-
Other			-		62,684,708		11,063,483		475,036		2,677,194		193,570
Residential mortgages			18,158,984		-		226,937		-		146,101		-
Consumer loans
Home equity lines & loans			6,168,831		-		-		-		-		-
Other direct consumer loans			147,610		-		-		-		-		-
Total		$	24,475,425	$	89,640,181	$	14,811,710	$	8,524,703	$	4,038,430	$	291,546

The Corporation considers the performance of the loan portfolio and its impact on the allowance for loan

losses. For residential and consumer loan classes, the Corporation also evaluates credit quality based on

the aging status of the loan, which was previously presented, and by payment activity. The following

table presents the recorded investment in residential and consumer loans based on payment activity as of

June 30, 2012 and December 31, 2011:

	June 30, 2012
			Consumer Loans
Legacy Loans:	Residential Mortgages		Credit Card		Home Equity Lines & Loans		Indirect Consumer Loans		Other Direct Consumer Loans
Performing	$	176,749,755	$	1,773,326	$	76,484,390	$	124,231,188	$	17,079,523
Non-Performing		2,230,263		6,710		467,777		177,886		22,095
		178,980,018		1,780,036		76,952,167		124,409,074		17,101,618

Acquired Loans:
Performing	$	15,777,861	$	-	$	5,528,355	$	-	$	91,599
Non-Performing		262,601		-		-		-		362
Total	$	16,040,462	$	-	$	5,528,355	$	-	$	91,961

	December 31, 2011
			Consumer Loans
Legacy Loans:	Residential Mortgages		Credit Card		Home Equity Lines & Loans		Indirect Consumer Loans		Other Direct Consumer Loans
Performing	$	173,120,292	$	1,946,162	$	76,432,196	$	97,426,891	$	14,497,878
Non-Performing		2,464,995		9,053		457,152		113,349		21,949
Total	$	175,585,287	$	1,955,215	$	76,889,348	$	97,540,240	$	14,519,827

Acquired Loans:
Performing	$	18,385,921	$	-	$	6,168,831	$	-	$	147,610
Non-Performing		146,101		-		-		-		-
Total	$	18,532,022	$	-	$	6,168,831	$	-	$	147,610

Acquired loans include loans acquired with deteriorated credit quality. The Corporation adjusted its

estimates of future expected losses, cash flows, and renewal assumptions during the current year. The

tables below summarize the changes in total contractually required principal and interest cash payments,

management’s estimate of expected total cash payments and carrying value of the loans from January 1,

2012 to June 30, 2012 and from March 31, 2012 to June 30, 2012 (in thousands of dollars):

Six Months Ended June 30, 2012	Balance at December 31, 2011			Income Accretion		All Other Adjustments			Balance at June 30, 2012
Contractually required principal and interest	$	21,261		$	-	$	(1,426	)	$	19,835
Contractual cash flows not expected to be collected (nonaccretable discount)		(4,662	)		-		684			(3,978	)
Cash flows expected to be collected		16,599			-		(742	)		15,857
Interest component of expected cash flows (accretable yield)		(1,844	)		1,171		(2,299	)		(2,972	)
Fair value of loans acquired with deteriorating credit quality	$	14,755		$	1,171	$	(3,041	)	$	12,885

Three Months Ended June 30, 2012	Balance at March 31, 2012			Income Accretion		All Other Adjustments			Balance at June 30, 2012
Contractually required principal and interest	$	17,780		$	-	$	2,055		$	19,835
Contractual cash flows not expected to be collected (nonaccretable discount)		(4,222	)		-		244			(3,978	)
Cash flows expected to be collected		13,558			-		2,299			15,857
Interest component of expected cash flows (accretable yield)		(1,417	)		255		(1,810	)		(2,972	)
Fair value of loans acquired with deteriorating credit quality	$	12,141		$	255	$	489		$	12,885

10. Components of Quarterly and Year-to-Date Net Periodic Benefit Costs

	Six Months Ended						Three Months Ended
	June 30,			June 30,			June 30,				June 30,
		2012			2011		2012				2011
Qualified Pension
Service cost, benefits earned during the period	$	646,702		$	518,268		$	323,351		$	259,134
Interest cost on projected benefit obligation		812,220			785,912			406,110			392,956
Expected return on plan assets		(1,326,986	)		(1,171,346	)		(663,493	)		(585,673	)
Amortization of unrecognized transition obligation		-			-			-			-
Amortization of unrecognized prior service cost		6,928			14,940			3,464			7,470
Amortization of unrecognized net loss		661,136			338,226			330,568			169,113
Net periodic pension expense	$	800,000		$	486,000		$	400,000		$	243,000

Supplemental Pension
Service cost, benefits earned during the period	$	17,384		$	15,312		$	8,692		$	7,656
Interest cost on projected benefit obligation		25,546			26,887			12,773			13,443
Expected return on plan assets		-			-			-			-
Amortization of unrecognized prior service cost		-			-			-			-
Amortization of unrecognized net loss		9,960			4,732			4,980			2,366
Net periodic supplemental pension expense	$	52,890		$	46,931		$	26,445		$	23,465

Postretirement, Medical and Life
Service cost, benefits earned during the period	$	17,500		$	16,500		$	8,750		$	8,250
Interest cost on projected benefit obligation		36,000			37,500			18,000			18,750
Expected return on plan assets		-			-			-			-
Amortization of unrecognized prior service cost		(48,500	)		(48,500	)		(24,250	)		(24,250	)
Amortization of unrecognized net gain		-			-			-			-
Net periodic postretirement, medical and life expense	$	5,000		$	5,500		$	2,500		$	2,750

11. Segment Reporting

The Corporation manages its operations through two primary business segments: core banking and wealth management group services. The core banking segment

provides revenues by attracting deposits from the general public and using such funds to originate consumer, commercial, commercial real estate, and residential

mortgage loans, primarily in the Corporation's local markets and to invest in securities. The wealth management group services segment provides revenues by

providing trust and investment advisory services to clients.

Summarized financial information concerning the Corporation’s reportable segments and the reconciliation to the Corporation’s consolidated results is shown in the

following table. Income taxes are allocated based on the separate taxable income of each entity and indirect overhead expenses are allocated based on reasonable

and equitable allocations applicable to the reportable segment. Holding company amounts are the primary differences between segment amounts and consolidated

totals, and are reflected in the Holding Company and Other column below, along with amounts to eliminate transactions between segments (dollars in thousands):

		Three Months Ended June 30, 2012								Six Months Ended June 30, 2012
		Core Banking		Wealth Management Group Services			Holding Company And Other		Consolidated Totals	Core Banking		Wealth Management Group Services			Holding Company And Other			Consolidated Totals
Net interest income	$	11,363	$	-		$	2	$	11,365	$	23,376	$	-		$	5		$	23,381
Provision for loan losses		52		-			-		52		529		-			-			529
Net interest income after provision for loan losses		11,311		-			2		11,313		22,847		-			5			22,852
Other operating income		2,139		1,727			264		4,130		5,216		3,502			309			9,027
Other operating expenses		9,903		1,762			219		11,884		18,834		3,571			402			22,807
Income or (loss) before income tax expense		3,547		(35	)		47		3,559		9,229		(69	)		(88	)		9,072
Income tax expense (benefit)		1,127		(14	)		2		1,115		3,110		(26	)		(70	)		3,014
Segment net income (loss)	$	2,420	$	(21	)	$	45	$	2,444	$	6,119	$	(43	)	$	(18	)	$	6,058

Segment assets										$	1,259,532	$	5,356		$	2,571		$	1,267,459

		Three Months Ended June 30, 2011								Six Months Ended June 30, 2011
		Core Banking		Wealth Management Group Services			Holding Company And Other		Consolidated Totals	Core Banking		Wealth Management Group Services			Holding Company And Other		Consolidated Totals
Net interest income	$	11,448	$	-		$	3	$	11,451	$	19,992	$	-		$	5	$	19,997
Provision for loan losses		125		-			-		125		250		-			-		250
Net interest income after provision for loan losses		11,323		-			3		11,326		19,742		-			5		19,747
Other operating income		2,732		1,768			244		4,744		4,819		3,384			888		9,091
Other operating expenses		10,215		1,791			195		12,201		18,620		3,607			417		22,644
Income or (loss) before income tax expense		3,840		(23	)		52		3,869		5,941		(223	)		476		6,194
Income tax expense (benefit)		1,255		(9	)		3		1,249		1,846		(86	)		149		1,909
Segment net income (loss)	$	2,585	$	(14	)	$	49	$	2,620	$	4,095	$	(137	)	$	327	$	4,285

Segment assets										$	1,228,705	$	6,020		$	2,311	$	1,237,036

12. Stock Based Compensation

Board of Director’s Stock Compensation

Members of the Board of Directors receive common shares of the Corporation equal in value to the

amount of fees individually earned during the previous year for service as a director. The common

shares are distributed to the Corporation's individual board members from treasury shares of the

Corporation on or about January 15 following the calendar year of service.

Additionally, the President and CEO of the Corporation, who does not receive cash compensation as a

member of the Board of Directors, is awarded common shares equal in value to the average of those

awarded to board members not employed by the Corporation who have served for twelve (12) months

during the prior year.

During January 2012, 10,238 shares were re-issued from treasury to fund the stock component of

directors' compensation. An expense of $107 thousand related to this compensation was recognized

during the period ending June 30, 2012. This expense is accrued as shares are earned.

Restricted Stock Plan

Pursuant to the Corporation’s Restricted Stock Plan (the “Plan”) the Corporation may make

discretionary grants of restricted stock to officers other than the Corporation's Chief Executive Officer.

Compensation expense is recognized over the vesting period of the awards based on the fair value of the

stock at issue date. The maximum number of shares as to which stock awards may be granted under the

Plan is 10,000 per year, with these shares vesting over a 5 year period.

A summary of restricted stock activity from December 31, 2011 to June 30, 2012 is presented below:

	Shares		Weighted–Average Grant Date Fair Value
Nonvested at December 31, 2011	12,458		$	22.33
Granted	1,079			23.18
Vested	(624	)		22.47
Forfeited or Cancelled	-			-
Nonvested at June 30, 2012	12,913		$	22.40

As of June 30, 2012, there was $254,191 of total unrecognized compensation cost related to nonvested

shares granted under the Plan. The cost is expected to be recognized over a weighted-average period of

4.12 years.

Item 2: Management's Discussion and Analysis of Financial Condition and Results of Operations

The review that follows focuses on the significant factors affecting the financial condition and results of

operations of the Corporation during the three and six-month periods ended June 30, 2012, with

comparisons to the comparable periods in 2011, as applicable. The following discussion and the

unaudited consolidated interim financial statements and related notes included in this report should be

read in conjunction with our 2011 Annual Report on Form 10-K, which was filed with the Securities and

Exchange Commission on March 28, 2012. The results for the periods presented are not necessarily

indicative of results to be expected for the entire fiscal year or any other interim period.

Forward-looking Statements

This discussion contains forward-looking statements within the meaning of Section 27A of the Securities

Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Corporation intends its forward-

looking statements to be covered by the safe harbor provisions for forward-looking statements in these

sections. Statements regarding, among other things, the Corporation's expected financial position and

operating results, the Corporation's business strategy, the Corporation's financial plans, forecasted

demographic and economic trends relating to the Corporation's industry and similar matters are forward-

looking statements. These statements can sometimes be identified by the Corporation's use of forward-

looking words such as "may," "will," "anticipate," "estimate," "expect," or "intend." The Corporation

cannot promise that its expectations in such forward-looking statements will turn out to be correct. The

Corporation's actual results could be materially different from expectations because of various factors,

including changes in economic conditions or interest rates, credit risk, difficulties in managing our growth,

competition, changes in law or the regulatory environment, including as a result of regulations or rules

promulgated pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, and changes in

general business and economic trends. Information concerning risks facing the Corporation can be found in

our periodic filings with the Securities and Exchange Commission, including in our 2011 Annual Report on

Form 10-K. These filings are available publicly on the SEC's website at http://www.sec.gov, on the

Corporation's website at http://www.chemungcanal.com or upon request from the Corporate Secretary at

(607) 737-3746. Except as otherwise required by law, the Corporation undertakes no obligation to publicly

update or revise its forward-looking statements, whether as a result of new information, future events or

otherwise.

Critical Accounting Policies, Estimates and Risks and Uncertainties

Critical accounting policies include the areas where the Corporation has made what it considers to be

particularly difficult, subjective or complex judgments concerning estimates, and where these estimates

can significantly affect the Corporation's financial results under different assumptions and conditions.

The Corporation prepares its financial statements in conformity with accounting principles generally

accepted in the United States of America. As a result, the Corporation is required to make certain

estimates, judgments and assumptions that it believes are reasonable based upon the information

available at that time. These estimates, judgments and assumptions affect the reported amounts of

assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses

during the periods presented. Actual results could be different from these estimates.

Allowance for Loan Losses

Management considers the accounting policy relating to the allowance for loan losses to be a critical

accounting policy given the uncertainty in evaluating the level of the allowance required to cover

probable incurred credit losses inherent in the loan portfolio, and the material effect that such judgments

can have on the Corporation's results of operations. While management's current evaluation of the

allowance for loan losses indicates that the allowance is adequate, under adversely different conditions

or assumptions the allowance would need to be increased. For example, if historical loan loss

experience significantly worsened or if current economic conditions significantly deteriorated,

additional provisions for loan losses would be required to increase the allowance. In addition, the

assumptions and estimates used in the internal reviews of the Corporation's non-performing loans

and potential problem loans, and the associated evaluation of the related collateral coverage for these loans,

has a significant impact on the overall analysis of the adequacy of the allowance for loan losses. Real

estate values in the Corporation’s market area did not increase dramatically in the prior several years,

and, as a result, any declines in real estate values have been modest. While management has concluded

that the current evaluation of collateral values is reasonable under the circumstances, if collateral

evaluations were significantly lowered, the Corporation's allowance for loan losses policy would also

require additional provisions for loan losses.

Other-Than-Temporary Impairment

Management also considers the accounting policy relating to other-than-temporary impairment ("OTTI")

of investment securities to be a critical accounting policy. The determination of whether a decline in

market value is other-than-temporary is necessarily a matter of subjective judgment. The timing and

amount of any realized losses reported in the Corporation's financial statements could vary if

management's conclusions were to change as to whether an other-than-temporary impairment exists. The

Corporation assesses whether it intends to sell, or it is more likely than not that it will be required to sell

a security in an unrealized loss position before recovery of its amortized cost basis. If either of these

criteria is met, the entire difference between amortized cost and fair value is recognized through a

charge to earnings. For those securities that do not meet the aforementioned criteria, such as those that

management has determined to be other-than-temporarily impaired, the amount of impairment charged to

earnings is limited to the amount related to credit losses, while impairment related to other factors is

recognized in other comprehensive income. For the three-month and six-month periods ended June 30,

2012, the Corporation recognized no OTTI charges.

Goodwill and Other Intangible Assets

Management also considers the accounting policy relating to the valuation of goodwill and other

intangible assets to be a critical accounting policy. The initial carrying value of goodwill and other

intangible assets is determined using estimated fair values developed from various sources and other

generally accepted valuation techniques. Estimates are based upon financial, economic, market and

other conditions as they existed as of the date of a particular acquisition. These estimates of fair value

are the results of judgments made by the Corporation based upon estimates that are inherently uncertain

and changes in the assumptions upon which the estimates were based may have a significant impact on

the resulting estimates. In addition to the initial determination of the carrying value, on an ongoing basis

management must assess whether there is any impairment of goodwill and other intangible assets that

would require an adjustment in carrying value and recognition of a loss in the consolidated statement of

income.

Financial Condition

Consolidated assets at June 30, 2012 totaled $1.267 billion, an increase of $51.2 million or 4.2% since

December 31, 2011. The increase was principally due to a $59.0 million increase in loans, net of

deferred fees and costs and unearned income, and a $21.3 million increase in cash and cash equivalents,

offset primarily by a $21.9 million decrease in the Corporation’s securities portfolio and a $5.7 million

decrease in other assets.

As noted above, total loans, net of deferred fees and costs and unearned income, increased $59.0 million

or 7.4% from December 31, 2011 to June 30, 2012 driven primarily by increases in commercial loans

(including commercial mortgages) and total consumer loans totaling $29.4 million and $28.7 million,

respectively, as well as a $912 thousand increase in residential mortgages. The increase in commercial

loans was due in large part to a $28.0 million increase in commercial loans at the Corporation’s offices

located in FOFC’s former market area (the “Capital Region offices”), which were acquired in April of

last year. The increase in total consumer loans was due principally to a $26.9 million increase in

indirect consumer loans and a $2.1 million increase in direct consumer installment loans, offset

primarily by a $564 thousand decrease in home equity balances. The increase in indirect consumer

loans reflects reduced pricing on high quality indirect auto loans during the second quarter in an effort to

put excess liquidity to better use, while the increase in direct consumer loans resulted from a loan

promotion that began early in the second quarter of this year. During the first half of this year,

approximately $5.2 million of newly originated residential mortgages were sold in the secondary market

to Freddie Mac, with an additional $254 thousand originated and sold to the State of New York

Mortgage Agency.

The composition of the loan portfolio is summarized as follows:

	June 30, 2012		December 31, 2011
Commercial, financial and agricultural	$	139,046,623	$	142,209,279
Commercial mortgages		297,158,610		264,589,013
Residential mortgages		194,511,823		193,599,853
Indirect Consumer loans		124,061,078		97,165,447
Consumer loans		101,169,118		99,351,585

Total loans, net of deferred origination fees and cost, and unearned income	$	855,947,252	$	796,915,177

Securities

The available for sale segment of the securities portfolio totaled $260.9 million at June 30, 2012, a

decrease of approximately $19.9 million or 7.1% from December 31, 2011. At amortized cost, the

available for sale portfolio decreased $20.3 million, with unrealized appreciation related to the available

for sale portfolio increasing $374 thousand. The decrease was principally due to paydowns on

mortgage-backed securities and collateralized mortgage obligations totaling approximately $12.0 million

and a $7.3 million decrease in federal agency bonds, as during the first half of 2012, purchases of federal

agency bonds totaling $35.0 million were exceeded by called bonds. In addition to the above, available

for sale municipal bonds decreased $2.9 million. These decreases were offset in part by a $1.9 million

increase in U.S. Treasury bonds, as the purchase of a $27.5 million bond was partially offset by the sale

of a U.S. Treasury bond in the first quarter of 2012. The held to maturity portion of the portfolio,

consisting of local municipal obligations, decreased approximately $2.0 million from $8.3 million at

December 31, 2011 to $6.3 million at June 30, 2012.

Cash and Cash Equivalents

As noted above, cash and cash equivalents increased $21.3 million since December 31, 2011. This

increase was principally due to a $15.8 million increase in interest-bearing deposits at other financial

institutions due in large part to the significant increase in deposits as discussed below, along with the

decrease in the securities portfolio, exceeding the growth in the loan portfolio. Additionally, cash and

due from financial institutions increased $5.5 million due to a $7.5 million increase in the volume of

items in process of clearing through the Federal Reserve Bank, offset by a $2.0 million decrease in

branch cash levels. With total cash and due from banks totaling $74.2 million at June 30, 2012, the

Corporation continues to maintain a strong liquidity position and continues to evaluate alternative

investment of these funds with caution given the historically low interest rate environment and the

inherent interest rate risk associated with longer term securities portfolio investments.

Other Assets

A $5.7 million decrease in other assets was due principally to a $2.4 million decrease in the over

payment of 2011 estimated income taxes and a $1.6 million decrease in net deferred tax assets.

Deposits

Since December 31, 2011, total deposits have increased $55.2 million or 5.5% to $1.054 billion, with

public fund balances increasing $23.3 million and all other deposits increasing $31.9 million. The

increase in public fund deposits was due principally to increases in insured money market account

(“IMMA”) and NOW account balances totaling $9.8 million and $9.1 million, respectively, as well as a

$3.0 million increase in demand deposits and a $1.9 million increase in savings balances. The increase

in all other period-end deposits reflects a $45.1 million increase in IMMA balances, as well as increases

in demand deposits and NOW accounts totaling $35.6 million and $4.7 million, respectively. These

increases were partially offset by a $37.2 million decrease in savings balances and a $16.4 million

decrease in total time deposits. Both the decrease in savings balances and the increase in IMMA

accounts were impacted by an initiative to convert funds from the former Capital Bank tiered savings

accounts into the Capital Bank Privilege IMMA account.

Other Borrowings

Both a $5.4 million decrease in securities sold under agreements to repurchase and a $2.2 million decrease

in Federal Home Loan Bank of New York (“FHLB”) term advances reflect the maturity of obligations

during the first half of this year.

Shareholders’ Equity

A $4.3 million increase in shareholders’ equity was primarily due to a $3.8 million increase in retained

earnings as well as a $585 thousand increase in accumulated other comprehensive income.

Asset Quality

Non-Performing Loans

The recorded investment in non-performing loans at June 30, 2012 totaled $15.009 million compared to

$20.915 million at year-end 2011, a decrease of $5.906 million. Not included in the non-performing

loan totals are loans acquired in the April 2011 acquisition of Fort Orange Financial Corp. (“FOFC”)

and its wholly owned subsidiary, Capital Bank & Trust Company, which the Corporation has identified

as purchased credit impaired (“PCI”) loans totaling $12.867 million at June 30, 2012, which are

accounted for under separate accounting guidance, Accounting Standards Codification (“ASC”)

Subtopic 310-30, “Receivables - Loans and Debt Securities Acquired with Deteriorated Credit Quality”

as disclosed in Note 9 of the financial statements. The decrease in non-performing loans was due to

decreases in non-accrual loans and loans 90 days or more past due totaling $4.878 million and $1.028

million, respectively. The $4.878 million decrease in non-accrual loans was principally due to a $4.837

million decrease in non-accrual commercial loans, as non-accrual commercial loans to one borrower

were reduced $5.231 million, including $5.132 million from the receipt of funds under United States

Department of Agriculture (“USDA”) guarantees. Other non-accrual commercial loans increased $394

thousand from December 31, 2011 to June 30, 2012. Additionally, during the first six months of 2012,

non-accrual residential mortgages decreased $118 thousand, while non-accrual home equity and

consumer loans increased $12 thousand and $65 thousand, respectively. It is generally the Corporation's

policy that a loan 90 days past due be placed in non-accrual status unless factors exist that would

eliminate the need to place a loan in this status. A loan may also be designated as non-accrual at any

time if payment of principal or interest in full is not expected due to deterioration in the financial

condition of the borrower. Loans remain in non-accrual status until the loans have been brought current

and remain current for a period of six months. In the case of non-accrual loans where a portion of the

loan has been charged off, the remaining balance is kept in non-accrual status until the entire principal

balance has been recovered.

The recorded investment in accruing loans 90 days or more past due totaled $6.276 million at June 30,

2012 compared to $7.304 million at year-end 2011, a decrease of $1.028 million. This decrease was

principally due to a $1.025 million decrease in construction loans not considered by management to be

PCI loans acquired in the FOFC acquisition totaling $6.270 million at June 30, 2012, which for a variety

of reasons are 90 days or more past their stated maturity dates, however the borrowers continue to make

required interest payments. Additionally, these loans carry third party credit enhancements, and based

upon the strength of those credit enhancements, the Corporation has not identified these loans as PCI

loans and expects to incur no losses on these loans.

At June 30, 2012, other real estate owned (“OREO”) totaled $970 thousand compared to $898 thousand

at December 31, 2011, an increase of $72 thousand. During the first half of 2012, three properties

totaling $223 thousand were placed in OREO and three properties totaling $131 thousand were sold.

Additionally, the Corporation recognized a write-down on one property totaling $20 thousand following

the receipt of an updated appraisal.

Impaired Loans

Impaired loans, excluding residential real estate loans determined to be troubled debt restructurings, at

June 30, 2012 totaled $4.566 million compared to $9.879 million at December 31, 2011. Not included

in the impaired loan totals are loans acquired in the FOFC acquisition which the Corporation has

identified as PCI loans as these loans are accounted for under ASC Subtopic 310-30 as noted under the

above discussion of non-performing loans. The decrease of $5.313 million resulted principally from the

above-discussed decrease in non-accrual commercial loans. Included in the impaired loan total at June

30, 2012 are loans totaling $3.459 million for which impairment allowances of $1.330 million have been

specifically allocated to the allowance for loan losses. As of December 31, 2011, the impaired loan total

included $6.093 million of loans for which specific impairment allowances of $1.942 thousand were

allocated to the allowance for loan losses. The decrease in the amount of impaired loans for which

specific allowances were allocated to the allowance for loan losses was due in large part to the above

mentioned receipt of funds under USDA guarantees. The reduction in specific impairment allowances

allocated to the allowance for loan losses was also related to the above mentioned receipt of funds as

well as improvement in the collateral position on an impaired loan. The majority of the Corporation's

impaired loans are secured and measured for impairment based on collateral evaluations. It is the

Corporation's policy to obtain updated appraisals on loans secured by real estate at the time a loan is

determined to be impaired. Prior to the receipt of the updated appraisal, an impairment measurement is

performed based upon the most recent appraisal on file to determine the amount of any specific

allocation or charge-off. Upon receipt and review of the updated appraisal, an additional measurement

is performed to determine if any adjustments are necessary to reflect the proper provisioning or charge-

off. Impaired loans are reviewed on a quarterly basis to determine if any changes in credit quality or

market conditions would require any additional allocation or recognition of additional charge-offs. If

market conditions warrant, future appraisals are obtained. Real estate values in the Corporation's market

area had not increased dramatically in the prior several years, and, as a result, declines in real estate

values have been modest.

Appraisals are performed by independent third parties and reflect the properties market value "as is". In

determining the amount of any specific allocation or charge-off, the Corporation will make adjustments

to reflect the estimated costs to sell the property. In situations where partial charge-offs have been

recognized, any balance remaining continues to be reflected as non-performing until the loan has been

paid in full. Non-real estate collateral may be valued using an appraisal, net book value per the

borrower’s financial statements, or aging reports, adjusted or discounted based on management’s

historical knowledge, changes in market conditions from the time of the valuation, and management’s

expertise and knowledge of the client and client’s business.

The following table summarizes the Corporation's recorded investment in non-performing assets:

(dollars in thousands)	June 30, 2012		December 31, 2011
Non-accrual loans	$	8,733	$	13,611
Troubled debt restructurings		-		-
Accruing loans past due 90 days or more		6,276		7,304
Total non-performing loans	$	15,009	$	20,915
Other real estate owned		970		898
Total non-performing assets	$	15,979	$	21,813

In addition to non-performing loans, as of June 30, 2012, the Corporation has identified commercial

relationships totaling $7.8 million as potential problem loans, as compared to $8.2 million at December

31, 2011. Potential problem loans are loans that are currently performing, but known information about

possible credit problems of the related borrowers causes management to have serious doubts as to the

ability of such borrowers to comply with the present loan repayment terms, which may result in the

disclosure of such loans as non-performing at some time in the future. Potential problem loans are

typically loans that are performing but are classified in the Corporation's loan rating system as

"substandard." Management cannot predict the extent to which economic conditions may worsen or

other factors which may impact borrowers and the potential problem loans. Accordingly, there can be

no assurance that other loans will not become 90 days or more past due, be placed on non-accrual status,

be restructured, or require increased allowance coverage and provisions for loan losses.

Management's evaluation of the adequacy of the allowance for loan losses is performed on a periodic

basis and takes into consideration such factors as historical loan loss experience, review of specific

problem loans (including evaluation of the underlying collateral), changes in the composition and

volume of the loan portfolio, recent charge-off experience, overall portfolio quality, current economic

conditions that may affect the borrowers' ability to pay and, as of the first quarter of 2012, global and

national fiscal uncertainties, including their potential effects on our borrowers.

During the second quarter of this year, the provision for loan loss expense totaled $52 thousand as

compared to $125 thousand during the comparable period in 2011, a decrease of $73 thousand. This

decrease was principally due to the improvement in the volume of non-performing and impaired loans,

resulting in a reduction in allocations to the allowance for loan losses related to these loans, which was

offset in part by loan portfolio growth and allowances for this growth after consideration of the factors

described above. The year-to-date provision for loan loss expense totaled $529 thousand compared to

$250 thousand for the comparable period in the prior year, an increase of $279 thousand. This increase

was principally due to $221 thousand of impairment charges recognized on certain PCI loans. The

balance of the increase was related to loan portfolio growth, which was offset in part by improved credit

quality as noted above and a reduction in specific allocations on non-performing loans.

During the second quarter of this year, the Corporation recorded net recoveries of $58 thousand

compared to net recoveries of $40 thousand during the second quarter of last year. This improvement

was principally due to a $77 thousand increase in net commercial loan recoveries and a $15 thousand

decrease in net consumer loan charge-offs, partially offset by a $74 thousand increase in net residential

mortgage charge-offs. During the first six months of 2012, net recoveries totaled $81 thousand

compared to net recoveries of $8 thousand during the first half of last year. This $73 thousand

improvement in net recoveries was due to a $95 thousand increase in net commercial loan recoveries

and an $81 thousand decrease in net consumer loan charge-offs, offset in part by a $103 thousand

increase in residential mortgage charge-offs. At June 30, 2012, the Corporation's allowance for loan

losses on legacy loans totaled $10.097 million, resulting in a coverage ratio of allowance to non-

performing loans of 67.3%. Included in the non-performing loan totals are loans totaling $350 thousand

for which previous partial charge-offs have been recognized. Excluding these loans, the coverage ratio

of allowance to non-performing loans was 68.9%. This ratio, as well as the ratio of allowance to total

loans, was impacted by the April 2011 FOFC acquisition, as current accounting rules do not allow the

acquiror to transfer the acquiree’s allowance for loan losses to the acquiror’s balance sheet. Rather, the

acquiree’s overall loan quality is a component in determining the fair value of loans acquired, which are

carried on the balance sheet at fair value. Excluding Acquired loans reported above as non-performing

loans totaling $7.518 million, the allowance to non-performing loan ratio was 141.4%. Excluding loans

acquired in the FOFC acquisition, the allowance for loan losses on Legacy loans to total Legacy loans

was 1.38% and represents an amount that management believes is adequate to absorb probable incurred

loan losses on the Corporation’s Legacy loan portfolio.

The allocated portions of the allowance reflect management's estimates of specific known risk elements

in the respective portfolios. Management's methodology followed in evaluating the allowance for loan

losses includes a detailed analysis of historical loss factors for pools of similarly graded loans, as well as

specific collateral reviews of relationships graded special mention, substandard or doubtful with

outstanding balances of $1.0 million or greater. Among the factors considered in allocating portions of

the allowance by loan type are the current levels of past due, non-accrual and impaired loans, as well as

historical loss experience and the evaluation of collateral. In addition, management has formally

documented factors considered in determining the appropriate level of general reserves, including

current economic conditions, forecasted trends in the credit quality cycle, loan growth, entry into new

markets, and industry and peer group trends. These amounts have been included in the allocated portion

of the loan categories to which they relate.

At June 30, 2012, in addition to the qualitative factors allocated within the allowance, the Corporation

maintained $414 thousand of the allowance as unallocated. While some improvements have been seen

in the local economy and some loans have improved, the recovery is still fragile and management

believes it is prudent to see a longer period of sustained improvement before completely reflecting this

in the allowance. Additionally, management monitors coverage ratios of nonperforming loans and total

loans compared to peers on a regular basis. This analysis also suggests that it would not be prudent to

eliminate the unallocated portion of the allowance at this time.

Activity in the allowance for loan losses was as follows:

	Six Months Ended June 30, 2012
(dollars in thousands)		Legacy Loans			Acquired Loans
Balance at beginning of period	$	9,659		$	-
Reclassification of acquired loan discount		-			124
Charge-offs:
Commercial, financial and agricultural		(6	)		-
Commercial mortgages		(8	)		(49	)
Residential mortgages		(73	)		-
Consumer loans		(273	)		-
Total		(360	)		(49	)
Recoveries:
Commercial, financial and agricultural		352			-
Commercial mortgages		30			-
Residential mortgages		-			-
Consumer loans		108			-
Total		490			-
Net recoveries (charge-offs)		130			(49	)
Provision charged to operations		308			221
Balance at end of period	$	10,097		$	296

	Six Months Ended June 30, 2011
(dollars in thousands)
Balance at beginning of period	$	9,498
Charge-offs:
Commercial, financial and agricultural		(3	)
Commercial mortgages		(4	)
Residential mortgages		-
Consumer loans		(340	)
Total		(347	)
Recoveries:
Commercial, financial and agricultural		205
Commercial mortgages		26
Residential mortgages		30
Consumer loans		94
Total		355
Net recoveries (charge-offs)		8
Provision charged to operations		250
Balance at end of period	$	9,756

Results of Operations

Second Quarter of 2012 vs. Second Quarter of 2011

Net income for the second quarter of 2012 totaled $2.444 million, a decrease of $176 thousand or 6.7%

as compared to second quarter 2011 net income of $2.620 million. Earnings per share were down 7.0%

from $0.57 to $0.53 per share on 4,891 additional average shares outstanding. The decrease in earnings

was due principally to decreases in net interest income and non-interest income, offset in part by lower

operating expenses and a decrease in the provision for loan loss expense.

Net interest income for the second quarter of 2012 compared to the second quarter of 2011 decreased

$86 thousand or 0.8%, with the net interest margin decreasing 11 basis points to 3.97%. The decrease in

net interest income and margin was due to a 25 basis point decrease in the yield on average earning

assets, offset in part by a 17 basis point decrease in the cost of average interest bearing liabilities and an

increase in average earning assets. Average earning assets increased $23.9 million or 2.1% as a $57.8

million increase in average loans was partially offset by decreases in average interest bearing deposits at

other financial institutions and average investment securities totaling $22.6 million and $11.3 million,

respectively. While average earning assets increased 2.1%, total interest and dividend income decreased

$468 thousand or 3.5% as the yield on average earning assets decreased 25 basis points to 4.46%.

Total average funding liabilities, including non-interest bearing demand deposits, as compared to the second

quarter of last year, increased $17.6 million or 1.6% to $1.114 billion as a $30.0 million increase in average

deposits was partially offset by a $12.4 million decrease in average borrowings. Average non-interest

bearing deposits increased $32.9 million, while total average interest bearing deposits were down $2.9

million. The decrease in average interest bearing deposits was due to a $53.8 million decrease in average

time deposits and a $20.1 million decrease in average savings accounts. These decreases were offset in part

by a $62.2 million increase in average IMMA accounts and an $8.8 million increase in average NOW

accounts. The decrease in average borrowings was primarily due to decreases in average securities sold

under agreements to repurchase and average FHLB term borrowings totaling $11.8 million and $553

thousand, respectively. While average interest bearing liabilities decreased $15.3 million or 1.8%, interest

expense decreased $382 thousand or 21.4%, as the cost of average interest bearing liabilities decreased 17

basis points to 0.67%.

The provision for loan loss expense in the second quarter of this year totaled $52 thousand compared to

$125 thousand in the second quarter of 2011, a decrease of $73 thousand. As discussed under the “Asset

Quality” section of this report, the decrease in the provision for loan losses reflects in large part the

improvement in credit quality and a reduction in specific allocations on impaired loans, somewhat offset

by loan growth and the associated allocations on performing loans. Management’s evaluation of the

adequacy of the allowance for loan losses takes into consideration several factors including an analysis

of historical loss factors, the evaluation of collateral, recent charge-off experience, overall credit quality,

current economic conditions, global and national fiscal uncertainties and loan growth.

Non-interest income was down $613 thousand or 12.9% compared to the second quarter of last year due

principally to a $483 thousand decrease in gains recognized on the sale of securities, a $69 thousand

decrease in gains on the sale of OREO, a $42 thousand decrease in Wealth Management Group fee

income and decreases in check card interchange fee income and service charges totaling $36 thousand

and $27 thousand, respectively. Additionally, during the second quarter of 2011 we received

approximately $41 thousand in private mortgage insurance refunds on properties which prior to 2011

had been sold out of OREO. The above decreases were offset in part primarily by increases in gains on

the sale of mortgages and revenue at CFS Group, Inc. totaling $47 thousand and $40 thousand, respectively.

Operating expenses were down $317 thousand or 2.6% compared to the second quarter of 2011 due to a

$1.183 million decrease in merger related expenses associated with the FOFC acquisition. Excluding

these costs, all other operating expenses increased $867 thousand, or 7.9%. This increase was due in

large part to increases in salaries and employee benefits totaling $218 thousand and $385 thousand,

respectively. Other significant increases included a $187 thousand increase in data processing costs, an

$86 thousand increase in marketing and advertising expenses and a $44 thousand increase in education

expense. The increase in salaries reflects merit increases over the past year and higher incentive

compensation, while the increase in employee benefits was due principally to increases in pension costs,

health insurance and payroll taxes. The increase in data processing reflects higher check card processing

costs due in large part to costs incurred in converting to a new processor, as well as increases in software

maintenance and license fees and Wealth Management Group processing costs. Higher marketing and

advertising expenses reflect an increase in advertising in the Capital Region. The above increases were

offset in part by decreases in professional services and stationery and supplies totaling $40 thousand and

$31 thousand, respectively.

A $134 thousand decrease in income tax expense reflects a $310 thousand decrease in pre-tax income,

and a decrease in the effective tax rate from 32.3% to 31.3% due principally to an increase in the relative

percentage of tax exempt income to pre-tax income.

Year-to-Date 2012 vs. Year-to-Date 2011

Net income for the six-month period ended June 30, 2012 totaled $6.059 million, an increase of $1.773

million or 41.4% compared to the corresponding period in 2011. Earnings per share increased 26.0%

from $1.04 to $1.31 per share on 511,235 additional average shares outstanding, with the increase in

average shares outstanding due principally to the Corporation’s acquisition of FOFC in April 2011. The

increase in earnings was due in part to a $2.215 million decrease in direct merger related transaction

costs associated with the above acquisition, as well as the recognition of $780 thousand in casualty gains

from flood insurance reimbursements in excess of the carrying amount of fixed assets lost in the

September 2011 flooding of our Owego and Tioga offices. We also attribute the increase in net income

to the FOFC acquisition, particularly due to the increase in net interest income.

Net interest income increased $3.383 million or 16.9% compared to the first six months of 2011 with the

net interest margin increasing 16 basis points to 4.13%. These increases reflect a higher level of average

earning assets due in large part to the above acquisition and a 20 basis decrease in the cost of average

interest bearing liabilities, offset by a 1 basis point decrease in the yield on average earning assets.

Average earning assets increased $123.7 million or 12.2%, as increases in average loans and investment

securities totaling $119.1 million and $24.6 million, respectively were partially offset by a $20.0 million

decrease in average interest bearing deposits at other financial institutions. The increases in average

loans and investment securities include increases at the Capital Region offices totaling $120.6 million

and $14.8 million, respectively, reflecting the benefit of having these assets for a full six months as

compared to approximately three months in 2011. Due to the growth in average earning assets, total

interest and dividend income increased $2.892 million or 12.4% despite a 1 basis point decrease in yield

to 4.64%.

Total average funding liabilities, including non-interest bearing demand deposits increased $119.8 million

or 12.1% to $1.106 billion as compared to the first six months of 2011 with average deposits and

borrowings increasing $118.0 million and $1.8 million, respectively. These increases include increases in

average deposits and borrowings at the Capital Region offices of $78.6 million and $11.1 million,

respectively. In total, average non-interest bearing deposits increased $45.0 million, with Capital Region

non-interest bearing deposits comprising $15.4 million of that increase. Average interest bearing deposits

increased $73.0 million, including a $63.2 million increase in average interest bearing deposits at the

Capital Region offices. The increase in average interest bearing deposits was reflected principally in a

$52.1 million increase in average IMMA balances, a $22.1 million increase in average savings balances and

an $18.1 million increase in average NOW accounts. These increases were partially offset by a $19.3

million decrease in average time deposits. While average interest-bearing liabilities increased $74.8 million

or 9.8%, interest expense decreased $491 thousand or 14.4%, as the average cost of interest-bearing

liabilities decreased 20 basis points to 0.70%.

A $279 thousand increase in the year-to-date provision for loan losses includes $221 thousand of

impairment charges recognized on certain PCI loans acquired in the FOFC acquisition. The balance of

the increase was principally due to loan portfolio growth, offset by improved credit quality and a

reduction in specific allocation on impaired loans.

Non-interest income was $64 thousand or 0.7% lower than last year due primarily to a $555 thousand

decrease in revenue from our equity investment in Cephas Capital Partners, L.P. (“Cephas”), as well as a

$379 thousand decrease in realized gains on the sale of securities and a $69 thousand decrease in gains

on the sale of OREO. The decrease in revenue from our equity investment in Cephas was due in large

part to a gain recognized during the first quarter of last year on the exercise of stock warrants held in one

of their investments. The above decreases were offset primarily by the above mentioned $780 thousand

gain on flood insurance reimbursements, as well as increases in Wealth Management Group fee income

and gains on the sale of mortgages of $118 thousand and $65 thousand, respectively.

Year-to-date operating expenses were $162 thousand or 0.7% higher than last year. However, excluding

direct merger related costs, all other operating expenses increased $2.377 million or 11.6%. As was the

case with second quarter results, this increase was significantly impacted by a $787 thousand increase in

salaries, a $632 thousand increase in employee benefit costs and a $403 thousand increase in data

processing expense. The increase in salaries reflects additional compensation related to the Capital

Region offices, as well as merit increases over the past year and higher incentive compensation, while

the increase in employee benefits was principally due to higher pension costs, health insurance and

payroll taxes. The increase in data processing reflects higher data communication line costs, as well as

increases in hardware and software maintenance fees, check card processing costs, including costs

associated with the conversion to a new processor and higher Wealth Management Group processing

charges. Other significant factors include a $162 thousand increase in marketing and advertising, a $147

thousand increase in net occupancy costs, a $132 thousand increase in loan and OREO expenses and an

$83 thousand increase in amortization of intangible assets. These increases were all due in large part to

higher costs related to the FOFC acquisition.

A $1.105 million increase in income tax expense was principally due to the $2.878 million increase in

pre-tax income, as well as an increase in the effective tax rate from 30.8% to 33.2% due principally to a

decrease in the relative percentage of tax exempt income to pre-tax income.

Average Consolidated Balance Sheet and Interest Analysis

For the purpose of the table below, non-accruing loans are included in the daily average loan amounts outstanding. Daily balances were used for average balance computations. Investment securities are stated at amortized cost. No tax equivalent adjustments have been made in calculating yields on obligations of states and political subdivisions. (dollars in thousands)

	Six Months Ended June 30, 2012								Six Months Ended June 30, 2011								Three Months Ended June 30, 2012								Three Months Ended June 30, 2011
Assets	Average Balance			Interest		Yield/ Rate			Average Balance			Interest		Yield/ Rate			Average Balance			Interest		Yield/ Rate			Average Balance			Interest		Yield/ Rate
Earning assets:
Loans	$	809,894		$	22,705		5.64	%	$	690,759		$	19,783		5.78	%	$	823,754		$	11,034		5.39	%	$	765,918		$	11,208		5.87	%
Taxable securities		226,044			2,836		2.52	%		201,575			2,842		2.84	%		219,414			1,349		2.47	%		226,177			1,594		2.83	%
Tax-exempt securities		51,306			676		2.65	%		51,203			685		2.70	%		50,450			336		2.68	%		55,034			369		2.69	%
Federal funds sold		-			-		N/A			-			-		N/A			-			-		N/A			-			-		N/A
Interest-bearing deposits		51,816			88		0.34	%		71,810			102		0.29	%		56,455			46		0.33	%		79,085			62		0.31	%
Total earning assets		1,139,060			26,305		4.64	%		1,015,347			23,412		4.65	%		1,150,073			12,765		4.46	%		1,126,214			13,233		4.71	%

Non-earning assets:
Cash and due from banks		23,533								21,667								23,163								22,564
Premises and equipment, net		24,851								24,240								24,976								24,447
Other assets		52,998								42,812								51,100								51,959
Allowance for loan losses		(10,124	)							(9,648	)							(10,394	)							(9,702	)
AFS valuation allowance		13,639								10,655								13,543								11,675
Total	$	1,243,957							$	1,105,073							$	1,252,461							$	1,227,157

Liabilities and Shareholders' Equity
Interest-bearing liabilities:
Interest-bearing demand deposits	$	85,630		$	45		0.11	%	$	67,454		$	37		0.11	%	$	90,269		$	24		0.11	%	$	81,437		$	26		0.13	%
Savings and insured money market deposits		405,903			447		0.22	%		331,690			416		0.25	%		410,518			211		0.21	%		368,448			240		0.26	%
Time deposits		265,959			1,266		0.96	%		285,286			1,735		1.23	%		262,630			595		0.91	%		316,417	��		894		1.13	%
Federal Home Loan Bank advances and securities sold under agreements to Repurchase		78,446			1,167		2.99	%		76,661			1,227		3.23	%		76,050			570		3.02	%		88,485			622		2.82	%
Total interest-bearing liabilities		835,938			2,925		0.70	%		761,091			3,415		0.90	%		839,467			1,400		0.67	%		854,787			1,782		0.84	%

Non-interest-bearing liabilities:
Demand deposits		270,314								225,338								274,159								241,266
Other liabilities		8,481								7,376								8,581								7,794
Total liabilities		1,114,733								993,805								1,122,207								1,103,847
Shareholders' equity		129,224								111,268								130,254								123,310
Total	$	1,243,957							$	1,105,073							$	1,252,461							$	1,227,157
Net interest income				$	23,380							$	19,997							$	11,365							$	11,451
Net interest rate spread							3.94	%							3.75	%							3.79	%							3.87	%
Net interest margin							4.13	%							3.97	%							3.97	%							4.08	%

The following table demonstrates the impact on net interest income of the changes in the volume of

earning assets and interest-bearing liabilities and changes in rates earned and paid by the Corporation.

For purposes of constructing this table, average investment securities are at average amortized cost and

earning asset averages include non-performing loans. Therefore, the impact of changing levels of non-

performing loans is reflected in the change due to rate, but does not affect changes due to volume. No

tax equivalent adjustments were made.

	Six Months Ended June 30, 2012 Compared to Six Months Ended June 30, 2011									Three Months Ended June 30, 2012 Compared to Three Months Ended June 30, 2011
	Increase (Decrease) Due to (1)									Increase (Decrease) Due to (1)
	Volume			Rate			Net			Volume			Rate			Net
Interest and dividends earned on:
Loans	$	3,399		$	(477	)	$	2,922		$	796		$	(970	)	$	(174	)
Taxable securities		331			(337	)		(6	)		(47	)		(198	)		(245	)
Tax-exempt securities		2			(11	)		(9	)		(32	)		(1	)		(33	)
Interest-bearing deposits		(32	)		18			(14	)		(19	)		3			(16	)

Total earning assets	$	2,922		$	(29	)	$	2,893		$	265			(733	)		(468	)

Interest paid on:
Demand deposits	$	10		$	(2	)	$	8		$	3		$	(5	)	$	(2	)
Savings and insured money market deposits		87			(56	)		31			24			(53	)		(29	)
Time deposits		(111	)		(358	)		(469	)		(139	)		(160	)		(299	)
Federal Home Loan Bank advances and securities sold under agreements to repurchase		29			(89	)		(60	)		(92)			40			(52	)

Total interest-bearing liabilities	$	318		$	(808	)	$	(490	)	$	(31	)	$	(351	)	$	(382	)

Net interest income	$	2,604		$	779		$	3,383		$	296		$	(382	)	$	(86	)
(1) The change in interest due to both rate and volume has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

Liquidity and Capital Resources

Liquidity management involves the ability to meet the cash flow requirements of deposit customers,

borrowers, and the operating, investing, and financing activities of the Corporation. The Corporation

uses a variety of resources to meet its liquidity needs. These include short term investments, cash flow

from lending and investing activities, core deposit growth and non-core funding sources, such as time

deposits of $100,000 or more, securities sold under agreements to repurchase and other borrowings.

The Corporation is a member of the FHLB, which allows it to access borrowings which enhance

management's ability to satisfy future liquidity needs. Based on available collateral and current

advances outstanding, the Corporation was eligible to borrow up to a total of $81.4 million and $76.8

million at June 30, 2012 and June 30, 2011, respectively.

During the first six months of 2012, cash and cash equivalents increased $21.3 million as compared to

an increase of $23.3 million during the first six months of last year. In addition to cash provided by

operating activities, major sources of cash during the first six months of 2012 included proceeds from

sales, maturities, calls and principal reductions on securities totaling $87.5 million and a $55.2 million

increase in deposits. Proceeds from the above were used primarily to fund purchases of securities

totaling $65.8 million, a $58.4 million increase in loans, a decrease in securities sold under agreements

to repurchase totaling $5.4 million, the payment of cash dividends in the amount of $2.3 million, a $2.2

million reduction in FHLB long term advances and purchases of fixed assets totaling $1.5 million.

In addition to cash provided by operating activities, major sources of cash during the first six months of

2011 included proceeds from sales, maturities, calls and principal reductions on securities totaling $73.8

million, a $27.1 million increase in deposits and $25.1 million in net cash received in the FOFC

acquisition. These proceeds were used primarily to fund purchases of securities totaling $83.9 million, a

net decrease in securities sold under agreements to repurchase totaling $13.1 million, a $10.8 million net

increase in loans, the payment of cash dividends in the amount of $1.8 million and purchases of fixed

assets totaling $723 thousand.

As of June 30, 2012, the Bank’s leverage ratio was 8.21%. The Tier I and Total Risk Adjusted Capital

ratios were 11.22% and 12.65%, respectively. All of the above ratios are in excess of the requirements

for being considered "well capitalized" by the FDIC, the Federal Reserve and the New York State

Department of Financial Services.

During the first six months of 2012 the Corporation declared cash dividends totaling $0.50 per share,

unchanged from the dividends declared during the first six months of 2011.

When shares of the Corporation become available in the market, the Corporation may purchase them after

careful consideration of its capital position. On November 16, 2011, the Corporation’s Board of Directors

approved a one year extension of the stock repurchase program that had been initially approved on

November 18, 2009 and extended for one year on November 17, 2010. The extension authorizes the

purchase of up to 90,000 shares of the Corporation’s outstanding common stock, including those shares

purchased during the first two years of the plan. Purchases may be made from time to time on the open

market or in privately negotiated transactions at the discretion of management. Through June 30, 2012, a

total of 62,342 shares had been purchased under this program. During the first half of 2012, the

Corporation purchased 19,098 shares at a cost of $480 thousand or an average of $25.14 per share. During

the first six months of 2012, 18,010 shares were re-issued from treasury to fund the stock component of

directors’ 2011 compensation, distributions under the Corporation’s directors’ deferred compensation plan,

an unrestricted stock grant to an executive officer and a restricted stock grant to an executive officer.

Interest Rate Risk

As intermediaries between borrowers and savers, commercial banks incur both interest rate risk and

liquidity risk. The Corporation's Asset/Liability Committee (ALCO) has the strategic responsibility for

setting the policy guidelines on acceptable exposure to these areas. These guidelines contain specific

measures and limits regarding these risks, which are monitored on a regular basis. The ALCO is made

up of the president & chief executive officer, the chief financial officer, the asset liability management

officer, and other officers representing key functions.

The ALCO is also responsible for supervising the preparation and annual revisions of the financial

segments of the annual budget, which is built upon the committee's economic and interest-rate

assumptions. It is the responsibility of the ALCO to modify prudently the Corporation's asset/liability

policies.

Interest rate risk is the risk that net interest income will fluctuate as a result of a change in interest rates.

It is the assumption of interest rate risk, along with credit risk, that drives the net interest margin of a

financial institution. For that reason, the ALCO has established tolerance limits based upon a 200-basis

point change in interest rates. At June 30, 2012, it is estimated that an immediate 200-basis point

decrease in interest rates would negatively impact the next 12 months net interest income by 9.73% and

an immediate 200-basis point increase would negatively impact the next 12 months net interest income

by 4.47%. Both are within the Corporation's policy guideline of 15% established by ALCO. Given the

overall low level of current interest rates and the unlikely event of a 200-basis point decline from this

point, management additionally modeled an immediate 100-basis point decline and an immediate 300-

basis point increase in interest rates. When applied, it is estimated these scenarios would result in

negative impacts to net interest income of 4.69% and 6.96%, respectively. Management is comfortable

with the level of exposures at these levels.

A related component of interest rate risk is the expectation that the market value of our capital account

will fluctuate with changes in interest rates. This component is a direct corollary to the earnings-impact

component: an institution exposed to earnings erosion is also exposed to shrinkage in market value. At

June 30, 2012, it is estimated that an immediate 200-basis point decrease in interest rates would

negatively impact the market value of our capital account by 9.18% and an immediate 200-basis point

increase in interest rates would positively impact the market value by 0.21%. Both are within the

established tolerance limit of 15%. Management also modeled the impact to the market value of our

capital with an immediate 100-basis point decline and an immediate 300-basis point increase in interest

rates, based on the current interest rate environment. When applied, it is estimated these scenarios

would result in negative impacts to the market value of our capital of 7.78% and 2.07%, respectively.

Management is also comfortable with the level of exposures at these levels.

Management does recognize the need for certain hedging strategies during periods of anticipated higher

fluctuations in interest rates and the Board-approved Funds Management Policy provides for limited use

of certain derivatives in asset liability management. These strategies were not employed during the first

six months of 2012.

Adoption of New Accounting Standards