Financial Institutions (FISI) 10-Q 2006 Q1 Quarterly report

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

þ	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
	FOR THE QUARTERLY PERIOD ENDEDMarch 31, 2006

Commission File Number0-26481

	Financial Institutions, Inc.
	(Exact Name of Registrant as specified in its charter)

NEW YORK	16-0816610
(State or other jurisdiction of	(I.R.S. Employer Identification Number)
incorporation or organization)
220 Liberty Street Warsaw, NY	14569
(Address of Principal Executive Offices)	(Zip Code)

Registrant’s Telephone Number Including Area Code:

(585) 786-1100

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding twelve months (or for such shorter period that the Registrant was required to file reports) and (2) has been subject to such requirements for at least the past 90 days. YESþ NOo

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check One):

Large Accelerated filero Accelerated filerþ Non-accelerated filero

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12-b2 of the Exchange Act). YESo NOþ

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

CLASS	OUTSTANDING AT MAY 1, 2006
Common Stock, $0.01 par value	11,320,000 shares

FINANCIAL INSTITUTIONS, INC.

FORM 10-Q

INDEX

PART I – FINANCIAL INFORMATION
Item 1.	Financial Statements (Unaudited)
	Consolidated Statements of Financial Condition as of March 31, 2006 and December 31, 2005	3
	Consolidated Statements of Income for the three months ended March 31, 2006 and 2005	4
	Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Income for the three months ended March 31, 2006	5
	Consolidated Statements of Cash Flows for the three months ended March 31, 2006 and 2005	6
	Notes to Unaudited Consolidated Financial Statements	7
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	14
Item 3.	Quantitative and Qualitative Disclosures about Market Risk	28
Item 4.	Controls and Procedures	28
PART II – OTHER INFORMATION
Item 1.	Legal Proceedings	29
Item 1A.	Risk Factors	29
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	29
Item 6.	Exhibits	30
SIGNATURES
EXHIBITS
EX-31.1 302 CEO Certification
EX-31.2 302 CFO Certification
EX-32.1 906 CEO Certification
EX-32.2 906 CFO Certification

2

Item 1. Financial Statements (Unaudited)

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION

(Unaudited)

	March 31,			December 31,
(Dollars in thousands, except per share amounts)	2006			2005
Assets
Cash, due from banks and interest-bearing deposits	$	44,480		$	47,258
Federal funds sold		28,270			44,682
Commercial paper due in less than 90 days		19,962			—
Securities available for sale, at fair value		772,193			790,855
Securities held to maturity (fair value of $42,963 and $42,898 at March 31, 2006 and December 31, 2005, respectively)		43,036			42,593
Loans held for sale		835			1,253
Loans, net		945,278			972,090
Premises and equipment, net		35,884			36,471
Goodwill		37,369			37,369
Other assets		53,524			49,821
Total assets	$	1,980,831		$	2,022,392
Liabilities And Shareholders’ Equity
Liabilities:
Deposits:
Demand	$	257,611		$	284,958
Savings, money market and interest-bearing checking		751,631			755,229
Certificates of deposit		668,916			677,074
Total deposits		1,678,158			1,717,261
Short-term borrowings		34,236			35,106
Long-term borrowings		63,375			63,391
Junior subordinated debentures issued to unconsolidated subsidiary trust (“Junior subordinated debentures”)		16,702			16,702
Accrued expenses and other liabilities		17,366			18,175
Total liabilities		1,809,837			1,850,635
Shareholders’ equity:
3% cumulative preferred stock, $100 par value, authorized 10,000 shares, issued and outstanding – 1,586 shares at March 31, 2006 and December 31, 2005		159			159
8.48% cumulative preferred stock, $100 par value, authorized 200,000 shares, issued and outstanding – 174,711 shares at March 31, 2006 and 174,747 shares at December 31, 2005		17,471			17,475
Common stock, $0.01 par value, authorized 50,000,000 shares, issued 11,334,874 shares at March 31, 2006 and December 31, 2005		113			113
Additional paid-in capital		23,459			23,278
Retained earnings		139,386			136,925
Accumulated other comprehensive loss		(9,374	)		(6,178	)
Treasury stock, at cost – 14,874 shares at March 31, 2006 and 1,000 shares at December 31, 2005		(220	)		(15	)
Total shareholders’ equity		170,994			171,757
Total liabilities and shareholders’ equity	$	1,980,831		$	2,022,392

See Accompanying Notes to Unaudited Consolidated Financial Statements.

3

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Unaudited)

	Three Months Ended
	March 31,
(Dollars in thousands, except per share amounts)	2006		2005
Interest and dividend income:
Loans	$	16,632	$	19,078
Securities		8,352		7,237
Other		291		105
Total interest and dividend income		25,275		26,420
Interest expense:
Deposits		8,221		6,559
Short-term borrowings		235		133
Long-term borrowings		908		927
Junior subordinated debentures issued to unconsolidated subsidiary trust		432		432
Total interest expense		9,796		8,051
Net interest income		15,479		18,369
Provision for loan losses		250		3,692
Net interest income after provision for loan losses		15,229		14,677
Noninterest income:
Service charges on deposits		2,672		2,595
Financial services group fees and commissions		625		739
Mortgage banking revenues		308		477
Net gain on sale of commercial-related loans		82		—
Other		1,269		1,096
Total noninterest income		4,956		4,907
Noninterest expense:
Salaries and employee benefits		8,758		8,795
Occupancy and equipment		2,362		2,213
Supplies and postage		559		557
Amortization of intangible assets		108		108
Computer and data processing expense		405		434
Professional fees		623		1,010
Other		2,460		3,301
Total noninterest expense		15,275		16,418
Income from continuing operations before income taxes		4,910		3,166
Income taxes from continuing operations		1,171		781
Income from continuing operations		3,739		2,385
Discontinued operation (note 7):
Loss from operation of discontinued subsidiary		—		(132	)
Income tax benefit		—		(36	)
Loss on discontinued operation		—		(96	)
Net income	$	3,739	$	2,289
Earnings per common share (note 3):
Basic:
Income from continuing operations	$	0.30	$	0.18
Net income	$	0.30	$	0.17
Diluted:
Income from continuing operations	$	0.30	$	0.18
Net income	$	0.30	$	0.17

See Accompanying Notes to Unaudited Consolidated Financial Statements.

4

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF CHANGES IN
SHAREHOLDERS’ EQUITY AND COMPREHENSIVE INCOME

(Unaudited)

													Accumulated
	3%		8.48%					Additional					Other						Total
(Dollars in thousands,	Preferred		Preferred			Common		Paid-in		Retained			Comprehensive			Treasury			Shareholders’
except per share amounts)	Stock		Stock			Stock		Capital		Earnings			Loss			Stock			Equity
Balance – December 31, 2005	$	159	$	17,475		$	113	$	23,278	$	136,925		$	(6,178	)	$	(15	)	$	171,757
Purchase 36 shares of preferred stock		—		(4	)		—		—		—			—			—			(4	)
Purchase 14,000 shares of common stock - director repurchase agreement		—		—			—		—		—			—			(207	)		(207	)
Issue 126 shares of common stock - exercised stock options		—		—			—		—		—			—			2			2
Amortization of unvested stock options		—		—			—		181		—			—			—			181
Comprehensive income:
Net income		—		—			—		—		3,739			—			—			3,739
Unrealized loss on securities available for sale (net of tax of $2,120)		—		—			—		—		—			(3,196	)		—			(3,196	)
Total comprehensive income																				543
Cash dividends declared:
3% Preferred — $0.75 per share		—		—			—		—		(1	)		—			—			(1	)
8.48% Preferred — $2.12 per share		—		—			—		—		(371	)		—			—			(371	)
Common — $0.08 per share		—		—			—		—		(906	)		—			—			(906	)
Balance – March 31, 2006	$	159	$	17,471		$	113	$	23,459	$	139,386		$	(9,374	)	$	(220	)	$	170,994

See Accompanying Notes to Unaudited Consolidated Financial Statements.

5

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)

	Three Months Ended
	March 31,
(Dollars in thousands)	2006			2005
Cash flows from operating activities:
Net income	$	3,739		$	2,289
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization		1,063			1,075
Net amortization of premiums and discounts on securities		222			355
Provision for loan losses		250			3,692
Amortization of unvested stock options		181			—
Deferred income tax expense (benefit)		404			(1,062	)
Tax benefit from stock-based compensation		—			(2	)
Proceeds from sale of loans held for sale		31,537			11,201
Originations of loans held for sale		(31,695	)		(10,086	)
Net gain on sale of loans held for sale		(226	)		(186	)
Net gain on sale of commercial-related loans held for sale		(82	)		—
Net (gain) loss on sale of premises and equipment		(11	)		14
Net gain on sale of other real estate and repossessed assets		(86	)		(29	)
Minority interest in net income of subsidiaries		—			8
(Increase) decrease in other assets		(1,637	)		2,205
Decrease in accrued expenses and other liabilities		(808	)		(1,499	)
Net cash provided by operating activities		2,851			7,975
Cash flows from investing activities:
Purchase of securities:
Available for sale		(13,210	)		(48,319	)
Held to maturity		(5,306	)		(2,229	)
Proceeds from maturity and call of securities:
Available for sale		26,337			35,373
Held to maturity		4,861			3,697
Net loan pay-downs		26,103			25,801
Proceeds from sale of commercial-related loans		970			—
Proceeds from sale of premises and equipment		36			35
Purchase of premises and equipment		(394	)		(1,956	)
Net cash provided by investing activities		39,397			12,402
Cash flows from financing activities:
Net (decrease) increase in deposits		(39,103	)		50,960
Net repayment of short-term borrowings		(870	)		(569	)
Repayment of long-term borrowings		(16	)		(3,036	)
Purchase of preferred and common shares		(211	)		(64	)
Issuance of common shares		2			10
Dividends paid		(1,278	)		(2,173	)
Net cash (used in) provided by financing activities		(41,476	)		45,128
Net increase in cash and cash equivalents		772			65,505
Cash and cash equivalents at the beginning of the period		91,940			46,085
Cash and cash equivalents at the end of the period	$	92,712		$	111,590
Supplemental information:
Cash paid during period for:
Interest	$	10,221		$	8,034
Income taxes		—			—
Noncash investing and financing activities:
Real estate acquired in settlement of loans	$	373		$	231

See Accompanying Notes to Unaudited Consolidated Financial Statements.

6

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

(1) Basis of Presentation

Financial Institutions, Inc. (“FII”), a bank holding company organized under the laws of New York State, and subsidiaries (the “Company”) provide deposit, lending and other financial services to individuals and businesses in Central and Western New York State. The Company is subject to regulation by certain federal and state agencies.

The Company for many years operated under a decentralized, “Super Community Bank” business model, with separate and largely autonomous subsidiary banks whose Boards and management had the authority to operate within guidelines set forth in broad corporate policies established at the holding company level. During 2005, FII’s Board of Directors decided to implement changes to the Company’s business model and governance structure. Effective December 3, 2005, the Company merged Wyoming County Bank (100% owned) (“WCB”), National Bank of Geneva (100% owned) (“NBG”) and Bath National Bank (100% owned) (“BNB”) into the New York State-chartered First Tier Bank & Trust (100% owned) (“FTB”), which was then renamed Five Star Bank (100% owned) (“FSB” or the “Bank”). The merger was accounted for at historical cost as a combination of entities under common control.

The Company formerly qualified as a financial holding company under the Gramm-Leach-Bliley Act, which allowed FII to expand business operations to include financial services businesses. The Company had two financial services subsidiaries: The Five Star Investment Services, Inc. (100% owned) (“FSIS”) (formerly known as The FI Group, Inc.) and the Burke Group, Inc. (formerly 100% owned) (“BGI”), collectively referred to as the “Financial Services Group” (“FSG”). FSIS is a brokerage subsidiary that commenced operations as a start-up company in March 2000. BGI was an employee benefits and compensation consulting firm acquired by the Company in October 2001. During 2005, the Company sold the stock of BGI and its results have been reported separately as a discontinued operation in the consolidated statements of income in these financial statements. Since the sale of BGI occurred during 2005, there are no assets or liabilities associated with the discontinued operation recorded at March 31, 2006 or December 31, 2005. BGI cash flows are shown in the consolidated statements of cash flows by activity (operating, investing and financing) consistent with the applicable source of cash flow.

During 2003, the Company terminated its financial holding company status and now operates as a bank holding company. The change in status did not affect the non-financial subsidiaries or activities being conducted by the Company, although future acquisitions or expansions of non-financial activities may require prior Federal Reserve Bank (“FRB”) approval and will be limited to those that are permissible for bank holding companies.

In February 2001, the Company formed FISI Statutory Trust I (100% owned) (“FISI” or the “Trust”) and capitalized the trust with a $502,000 investment in FISI’s common securities. The Trust was formed to facilitate the private placement of $16.2 million in capital securities (“trust preferred securities”). Effective December 31, 2003, the provisions of Financial Accounting Standards Board (“FASB”) Interpretation No. 46, “Consolidation of Variable Interest Entities,” resulted in the deconsolidation of the Trust. The deconsolidation resulted in the derecognition of the $16.2 million in trust preferred securities and the recognition of $16.7 million in junior subordinated debentures and a $502,000 investment in the trust recorded in other assets in the Company’s consolidated statements of financial position.

In management’s opinion, the interim consolidated financial statements reflect all adjustments necessary for a fair presentation. The results of operations for the interim periods are not necessarily indicative of the results of operation to be expected for the full year ended December 31, 2006. The interim consolidated financial statement should be read in conjunction with the Company’s 2005 Annual Report on Form 10-K. The consolidated financial information included herein combines the results of operations, the assets, liabilities and shareholders’ equity of the Company and its subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation. Amounts in the prior periods’ consolidated financial statements are reclassified when necessary to conform to the current period presentation.

The interim consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America and prevailing practices in the banking industry. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities, and the reported revenues and expenses for the period. Actual results could differ from those estimates. A material estimate that is particularly susceptible to near-term change is the allowance for loan losses.

For purposes of the consolidated statements of cash flows, short-term interest-bearing deposits, federal funds sold and commercial paper due in less than 90 days are considered cash equivalents.

7

(2) Stock Compensation Plans

The Company has a Management Stock Incentive Plan and a Director’s Stock Incentive Plan (the “Plans”). Under the Plans, the Company may grant stock options to purchase shares of common stock, shares of restricted stock or stock appreciation rights to its directors, directors of its subsidiaries, and key employees. To date, the Company has only granted stock options under the Plans. Grants under the plans may be made up to 10% of the number of shares of common stock issued, including treasury shares. The exercise price of each option equals the market price of the Company’s stock on the date of the grant. The maximum term of each option is ten years and the vesting period generally ranges between three and five years.

Prior to January 1, 2006, the Company applied Accounting Principles Board (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees”, and related interpretations in accounting for stock-based compensation. No stock-based compensation expense was recognized in the consolidated statements of income prior to 2006 for stock options, as the exercise price was equal to the market price of the common stock on the date of grant.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123R, “Share-Based Payment”, requiring the Company to recognize expense related to the fair value of the stock-based compensation awards. The Company elected the modified prospective transition method as permitted by SFAS No. 123R; accordingly, results from prior periods have not been restated. Under the transition method, stock-based compensation expense for the three months ended March 31, 2006 includes:

(a)	compensation expense for all stock-based compensation awards granted prior to, but not yet vested as of December 31, 2005, based on the grant date fair value estimated in accordance with the original provisions of SFAS No. 123, “Accounting for Stock-Based Compensation”, and
(b)	compensation expense for all stock-based compensation awards granted subsequent to December 31, 2005, based on the grant-date fair value estimated in accordance with the provisions of SFAS No. 123R.

Historically, SFAS No. 123 required pro forma disclosure of stock-based compensation expense and the Company has recognized pro forma compensation expense for stock option awards on a straight-line basis over the applicable vesting periods. This policy differs from the policy required to be applied to awards granted after the adoption of SFAS No. 123R, which requires that compensation expense be recognized for awards over the requisite service period of the award or to an employee’s eligible retirement date, if earlier. The Company will continue to recognize compensation expense over the vesting periods for awards granted prior to adoption of SFAS No. 123R, but for all awards after December 31, 2005, compensation expense will be recognized over the requisite service period of the award or over a period ending with an employee’s eligible retirement date, if earlier. Total stock-based compensation expense included in our consolidated statement of income for the three months ended March 31, 2006 was $181,000 ($109,000 net of tax or $0.01 per diluted share), of which $179,000 relates to awards granted prior to 2006 that continue to be expensed over the applicable vesting period.

Prior to adoption of SFAS No. 123R, the Company reported all tax benefits resulting from the exercise of stock options as operating cash flows in the consolidated statements of cash flows. In accordance with SFAS No. 123R, the presentation of the Company’s consolidated statement of cash flows has changed from prior periods to report excess tax benefits from the exercise of stock options as financing cash flows. For the three months ended March 31, 2006, there were no excess tax benefits reported as financing cash flows rather than operating cash flows, as the actual income tax benefit realized from stock option exercises totaled less than $1,000.

8

The table below illustrates the effect on net earnings and earnings per share as if the Company had applied the fair value recognition provision of SFAS No. 123 to stock-based compensation during the three months ended March 31, 2005.

	Three Months Ended
	March 31,
(Dollars in thousands, except per share amounts)	2005
Reported net income	$	2,289
Less: Total stock-based compensation expense determined under fair value based method for all awards, net of related tax effects (1)		91
Pro forma net income		2,198
Less: Preferred stock dividends		372
Pro forma net income available to common shareholders	$	1,826
Basic earnings per share:
Reported	$	0.17
Pro forma		0.16
Diluted earnings per share:
Reported	$	0.17
Pro forma		0.16

(1) For purposes of this pro forma disclosure, the value of the stock-based compensation is amortized to expense on a straight-line basis over the vesting periods.

The following table summarizes the stock option activity for the three months ended March 31, 2006:

						Weighted-
				Weighted-		Average
				Average		Remaining
				Exercise		Contractual		Aggregate
(Dollars in thousands,				Price		Term		Intrinsic
except per share amounts)	Options			Per Share		(in years)		Value
Outstanding at December 31, 2005		426,238		$	19.21
Granted		6,047			19.59
Exercised		(126	)		14.13
Forfeited		(482	)		21.64
Expired		(4,054	)		23.99
Outstanding at March 31, 2006		427,623		$	19.54		6.35	$	754,000
Vested and expected to vest at March 31, 2006		418,705		$	19.51		5.89	$	753,000
Exercisable at March 31, 2006		307,841		$	18.92		5.43	$	740,000

As of March 31, 2006, there was $762,000 of unrecognized compensation expense related to nonvested option awards that is expected to be recognized over a weighted average period of 1.53 years.

The aggregate intrinsic value of options (the amount by which the market price of the stock on the date of exercise exceeded the market price of the stock on the date of grant) exercised during the three months ended March 31, 2006 and 2005 was $1,000 and $6,000, respectively. In addition, the options that vested during the three months ended March 31, 2006 and 2005 had no intrinsic value. Net cash proceeds from the exercise of stock options were $2,000 and $8,000 for the three months ended March 31, 2006 and 2005, respectively. The actual income tax benefit realized from stock option exercises totaled less than $1,000 and $2,000, respectively, for those same periods.

The fair value of each stock option was estimated on the date of the grant using the Black-Scholes option-pricing model. The weighted-average grant date fair value of stock options granted during the three months ended March 31, 2006 and 2005, was $8.00 and $6.52, respectively.

9

The weighted average Black-Scholes option valuation assumptions used for the stock option grants totaling 6,047 and 125,246 for the three months ended March 31, 2006 and 2005, respectively were as follows:

	Three Months Ended
	March 31,
	2006			2005
Risk-free interest rate		4.29	%(1)		4.17	%
Expected dividend yield		1.65	%		1.95	%
Expected stock price volatility		42.53	%(2)		26.47	%
Expected term of stock options (in years)	6.25 years		(3)	6.23 years

(1)	Based on the average of the five and seven year Treasury constant maturity (“TCM”) interest rates to be consistent with the expected term of the stock options.
(2)	Expected stock price volatility is based on actual experience using a historical period of 6.25 years to be consistent with the expected term of the stock options.
(3)	The Company estimated the expected term of the stock options using the simplified method prescribed by SEC Staff Accounting Bulletin (“SAB”) No. 107.

(3) Earnings Per Common Share

Basic earnings per share, after giving effect to preferred stock dividends, has been computed using weighted average common shares outstanding. Diluted earnings per share reflect the effects, if any, of incremental common shares issuable upon exercise stock options, if dilutive.

Earnings per common share have been computed based on the following:

	Three Months Ended
	March 31,
(Dollars and shares in thousands, except per share amounts)	2006		2005
Income from continuing operations	$	3,739	$	2,385
Less: Preferred stock dividends		372		372
Income from continuing operations available to common shareholders		3,367		2,013
Loss on discontinued operation, net of tax		—		(96	)
Net income available to common shareholders	$	3,367	$	1,917
Weighted average number of common shares outstanding used to calculate basic earnings per common share		11,328		11,250
Add: Effect of dilutive options		44		49
Weighted average number of common shares used to calculate diluted earnings per common share		11,372		11,299
Earnings per common share:
Basic:
Income from continuing operations	$	0.30	$	0.18
Loss on discontinued operation	$	—	$	(0.01	)
Net income	$	0.30	$	0.17
Diluted:
Income from continuing operations	$	0.30	$	0.18
Loss on discontinued operation	$	—	$	(0.01	)
Net income	$	0.30	$	0.17

There were approximately 284,000 and 218,000 weighted average stock options for the three months ended March 31, 2006 and 2005, respectively that were not considered in the calculation of diluted earnings per share since their effect would have been anti-dilutive.

10

(4) Retirement Plans and Postretirement Benefits

The Company participates in The New York State Bankers Retirement System, which is a defined benefit pension plan covering substantially all employees. The benefits are based on years of service and the employee’s highest average compensation during five consecutive years of employment. The Company’s funding policy is to contribute at least the minimum-funding requirement as determined actuarially to cover current service cost plus amortization of prior service costs.

Net periodic pension cost consists of the following components:

	Three Months Ended
	March 31,
(Dollars and shares in thousands)	2006			2005
Service cost	$	431		$	395
Interest cost on projected benefit obligation		335			321
Expected return on plan assets		(466	)		(408	)
Amortization of net transition asset		(7	)		(10	)
Amortization of unrecognized loss		56			55
Amortization of unrecognized prior service cost		4			4
Net periodic pension cost	$	353		$	357

The Company contributed approximately $1.6 million to the pension plan during February 2006. No additional contributions are expected in 2006.

Prior to December 31, 2001, BNB provided health and dental care benefits to retired employees who met specified age and service requirements through a postretirement health and dental care plan in which both BNB and the retiree shared the cost. The plan was amended in 2001 to curtail eligible benefit payments to only retired employees and active participants who were fully vested under the plan. Expense for the plan amounted to $3,000 for the three months ended March 31, 2006 and 2005.

(5) Commitments and Contingencies

In the normal course of business, the Company has outstanding commitments to extend credit not reflected in the Company’s consolidated financial statements. The commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company uses the same credit policy to make such commitments as it uses for on-balance-sheet items. Unused lines of credit and loan commitments totaling $241.1 million and $231.5 million were contractually available at March 31, 2006 and December 31, 2005, respectively. Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, the amount does not necessarily represent future cash commitments.

The Company guarantees the obligations or performance of customers by issuing stand-by letters of credit to third parties. The risk involved in issuing stand-by letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance sheet products. Typically, these instruments have terms of five years or less and expire unused; therefore, the amount does not necessarily represent future cash requirements. Stand-by letters of credit totaled $8.4 million and $9.5 million at March 31, 2006 and December 31, 2005, respectively. As of March 31, 2006, the fair value of the standby letters of credit was not material to the Company’s consolidated financial statements.

On March 28, 2006, FSB entered into a Trust Company Agreement and Plan of Merger with The Canandaigua National Bank and Trust Company (“Canandaigua”) pursuant to which Canandaigua will acquire FSB’s trust business. The sales price, net of estimated selling costs, of approximately $1.1 million is subject to adjustment based on the value of the trust assets at the time of transfer. The trust division has approximately $63.5 million in assets held in fiduciary or agency capacities. The transaction is subject to regulatory and court approval and is currently expected to close in September 2006.

11

(6) Supervision and Regulation

The supervision and regulation of financial and bank holding companies and their subsidiaries is intended primarily for the protection of depositors, the deposit insurance funds regulated by the FDIC and the banking system as a whole, and not for the protection of shareholders or creditors of bank holding companies. The various bank regulatory agencies have broad enforcement power over bank holding companies and banks, including the power to impose substantial fines, operational restrictions and other penalties for violations of laws and regulations.

The Company is also subject to varying regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material impact on the Company’s consolidated financial statements. For evaluating regulatory capital adequacy, companies are required to determine capital and assets under regulatory accounting practices. Quantitative measures established by regulation to ensure capital adequacy require the Company to maintain minimum amounts and ratios. The leverage ratio requirement is based on period-end capital to average adjusted total assets during the previous three months. Compliance with risk-based capital requirements is determined by dividing regulatory capital by the sum of a company’s weighted asset values. Risk weightings are established by the regulators for each asset category according to the perceived degree of risk. As of March 31, 2006 and December 31, 2005, the Company and FSB met all capital adequacy requirements to which they are subject.

At December 31, 2005, the most recent notification from the Federal Deposit Insurance Corporation (“FDIC”) categorized the Bank as well-capitalized under the regulatory framework for prompt corrective action. For purposes of determining the annual deposit insurance assessment rate for insured depository institutions, each insured institution is assigned an assessment risk classification. Each institution’s assigned risk classification is composed of a group and subgroup assignment based on capital group and supervisory subgroup. Prior to the Company’s restructuring in December 2005, the Company’s former bank subsidiaries NBG and BNB remained assigned to the well-capitalized capital group, but were placed in lower supervisory subgroups based on the formal agreements that were in place with the Office of the Comptroller of the Currency (“OCC”). Because of the downgrades, the Company’s FDIC insurance premiums increased in 2005. As a result of the merger of the Company’s subsidiary banks and the FDIC risk classification for FSB, the Company’s 2006 premiums are lower.

(7) Discontinued Operation

In 2005, the Company decided to dispose of its BGI subsidiary. The results of BGI have been reported separately as a discontinued operation in the consolidated statements of income in these financial statements. As of March 31, 2005, the Company recorded a loss on discontinued operations of $132,000 and an income tax benefit associated with discontinued operations of $36,000. Since the sale occurred during 2005, there are no assets or liabilities associated with the discontinued operation recorded at March 31, 2006 or December 31, 2005. Cash flows from BGI are shown in the consolidated statements of cash flows by activity (operating, investing and financing) consistent with the applicable source of the cash flow.

12

(8) Loans Held for Sale

During 2005, the Company transferred $169.0 million in commercial-related loans to held for sale at an estimated fair value less costs to sell of $132.3 million, therefore $36.7 million in commercial-related charge-offs were recorded as a result of classifying the loans as held for sale. In the second half of 2005, the Company realized a net gain of $9.4 million on the ultimate sale or settlement of these commercial-related loans held for sale. The remaining commercial-related loans held for sale were sold in the first quarter of 2006 and resulted in a net gain of $82,000.

A summary of loans held for sale is as follows:

	March 31,		December 31,
(Dollars in thousands)	2006		2005
Commercial and agricultural *	$	—	$	577
Residential real estate		835		676
Total loans held for sale	$	835	$	1,253

* All commercial and agricultural loans held for sale were in nonaccrual status.

The Company originates and sells certain residential real estate loans in the secondary market. The Company typically retains the right to service the mortgages upon sale. The Company makes the determination of whether or not to identify the mortgage as a loan held for sale at the time the application is received from the borrower. The Company also originates student loans and has a forward commitment to sell the student loans to a third-party at a fixed premium on the day of origination. The volume of student loans originated and sold increased beginning in the third quarter of 2005.

Proceeds from the sale of loans held for sale were $31.5 million and $11.2 million for the three months ended March 31, 2006 and 2005, respectively. These proceeds included proceeds from the sale of student loans totaling $25.2 million and $1.1 million for the three months ended March 31, 2006 and 2005, respectively. The net gain on sale of loans held for sale was $226,000 and $186,000 for the three months ended March 31, 2006 and 2005, respectively.

13

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

FORWARD LOOKING STATEMENTS

This report contains certain forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), that involve substantial risks and uncertainties. When used in this report, or in the documents incorporated by reference herein, the words “anticipate”, “believe”, “estimate”, “expect”, “intend”, “may”, “project”, “plan”, “seek” and similar expressions identify such forward-looking statements. Actual results, performance or achievements could differ materially from those contemplated, expressed or implied by the forward-looking statements contained herein. There are a number of important factors that could affect the Company’s forward-looking statements which include the quality of collateral associated with nonperforming loans, the ability of customers to continue to make payments on criticized or substandard loans, the impact of rising interest rates on customer cash flows, the speed or cost of resolving bad loans, the ability to hire and train personnel, the economic conditions in the area in which the Company operates, customer preferences, the competition and other factors discussed in the Company’s filings with the Securities and Exchange Commission. Many of these factors are beyond the Company’s control.

GENERAL

The principal objective of this discussion is to provide an overview of the financial condition and results of operations of the Company for the periods covered in this quarterly report. This discussion and tabular presentations should be read in conjunction with the accompanying consolidated financial statements and accompanying notes.

The Company’s revenue is primarily dependent on net interest income, which is the difference between the income earned on loans and securities and the cost of funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by the provision for loan losses, service charges on deposits, financial services group fees and commissions, mortgage banking activities, gain or loss on the sale of securities, gain or loss on sale of loans, other miscellaneous income and noninterest expense. Noninterest expense primarily consists of salaries and employee benefits, occupancy and equipment, supplies and postage, amortization of intangible assets, computer and data processing, professional fees, other miscellaneous expense and income taxes. The results of operations are also significantly affected by general economic and competitive conditions, particularly changes in interest rates, government policies and the actions of regulatory authorities.

OVERVIEW

Diluted earnings per share for the first quarter of 2006 were $0.30, up $0.13 per share, or 76%, compared with $0.17 for the same period last year. Net income for the first quarter was $3.7 million compared with $2.3 million in the first quarter of 2005. A significantly lower provision for loan loss, which reflected the much improved credit quality of the loan portfolio, combined with reduced noninterest expense, drove the earnings increase. These positive effects were somewhat offset by decreased revenue on a lower earning asset base.

The Company’s provision for loan losses for the three months ended March 31, 2006 and 2005 totaled $250,000 and $3.7 million, respectively. The Company’s net charge-offs for the three months ended March 31, 2006 and 2005 totaled $190,000 and $2.9 million, respectively. The Company improved its loan quality by selling a substantial portion of its commercial-related problem loans during the second half of 2005. At March 31, 2006, nonperforming assets totaled $19.5 million comparable to $19.7 million at December 31, 2005.

The Company for many years operated under a decentralized, “Super Community Bank” business model, with separate and largely autonomous subsidiary banks whose Boards and management had the authority to operate within guidelines set forth in broad corporate policies established at the holding company level. During 2005, the Board of Directors decided to implement changes to the Company’s business model and governance structure. Effective December 3, 2005, the Company merged its commercial subsidiary banks into the New York State-chartered First Tier Bank & Trust (“FTB”), which was then renamed Five Star Bank (“FSB”). The Company also sold its Burke Group, Inc. (“BGI”) subsidiary during 2005 in order to focus on its core community banking business. The results of BGI have been reported separately as a discontinued operation in the consolidated statements of income and the loss on discontinued operation totaled $96,000 for the three months ended March 31, 2005.

As part of the Company’s strategy to focus on growing its core banking franchise, it has agreed to sell its trust operations. The trust division has approximately $63.5 million in assets held in fiduciary or agency capacities. The transaction is subject to regulatory and court approval and is currently expected to close in September 2006.

14

CRITICAL ACCOUNTING POLICIES

The Company’s consolidated financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and are consistent with predominant practices in the financial services industry. Application of critical accounting policies, those policies that Management believes are the most important to the Company’s financial position and results, requires Management to make estimates, assumptions, and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes and are based on information available as of the date of the financial statements. Future changes in information may affect these estimates, assumptions and judgments, which, in turn, may affect amounts reported in the financial statements.

The Company has numerous accounting policies, of which the most significant are presented in Note 1 of the Notes to Consolidated Financial Statements included in the Company’s Annual Report on Form 10-K as of December 31, 2005, dated March 15, 2006, as filed with the Securities and Exchange Commission. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how significant assets, liabilities, revenues and expenses are reported in the financial statements and how those reported amounts are determined. Based on the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, Management has determined that the accounting policies with respect to the allowance for loan losses, goodwill and stock-based compensation require particularly subjective or complex judgments important to the Company’s consolidated financial statements, results of operations or liquidity, and are therefore considered to be critical accounting policies as discussed below.

Allowance for Loan Losses: The allowance for loan losses represents management’s estimate of probable credit losses inherent in the loan portfolio. Determining the amount of the allowance for loan losses is considered a critical accounting estimate because it requires significant judgment and the use of subjective measurements including management’s assessment of the internal risk classifications of loans, changes in the nature of the loan portfolio, industry concentrations and the impact of current local, regional and national economic factors on the quality of the loan portfolio. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

A loan is considered impaired when, based on current information and events, it is probable that a creditor will be unable to collect all amounts of principal and interest under the original terms of the agreement or any loan that is restructured in a troubled debt restructuring. Accordingly, the Company evaluates impaired commercial and agricultural loans individually based on the present value of future cash flows discounted at the loan’s effective interest rate, or at the loan’s observable market price or the net realizable value of the collateral if the loan is collateral dependent. The majority of the Company’s loans are secured.

Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days (120 days for consumer loans), unless such loans are well-collateralized and in the process of collection. Loans that are on a current payment status or past due less than 90 days may also be classified as nonaccrual if repayment in full of principal and/or interest is in doubt.

For additional discussion related to the Company’s accounting policies for the allowance for loan losses, see the section titled “Analysis of the Allowance for Loan Losses.”

Goodwill: Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other Intangible Assets” prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets are subject to at least an annual impairment review, and more frequently if certain impairment indicators are in evidence. Changes in the estimates and assumptions used to evaluate impairment may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity. During 2005, the Company evaluated goodwill for impairment using a discounted cash flow analysis and determined no impairment existed.

15

Stock-Based Compensation: The Company grants stock options to its management and directors as part of their compensation. The amount of stock option compensation expense incurred and to be incurred in future periods is dependent upon a number of factors, such as the number of options granted, the timing of incentive stock option exercises and actual forfeiture rates. The Company estimates the fair value of all stock option awards as of the date of grant by applying the Black-Scholes option-pricing model. The application of this valuation model involves assumptions, some of which are judgmental and highly sensitive, in the determination of stock option compensation expense. These assumptions include the expected stock price volatility, expected dividend yield and the expected term of the stock options. The fair value of each option is amortized into compensation expense on a straight-line basis over the requisite service period or to an employee’s eligible retirement date, if earlier. This is because the options typically vest over three to five years or upon retirement, thus, options are expensed immediately upon grant for retirement eligible employees, which results in relatively higher expense in the period of grant (see note 2 also).

NEW ACCOUNTING PRONOUNCEMENT

In March 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 156, “Accounting for Servicing of Financial Assets”, an amendment of SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, which requires that all separately recognized servicing assets and servicing liabilities be initially measured at fair value, if practicable and permits the entities to elect either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of SFAS No. 140 for subsequent measurement. SFAS No. 156 is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. Earlier adoption is permitted as of the beginning of an entity’s fiscal year, provided the entity has not yet issued financial statements, including interim financial statements for any period of that fiscal year. The Company plans to adopt this statement on January 1, 2007 and does not expect adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.

16

SELECTED FINANCIAL DATA

The following tables present certain information and ratios that management of the Company considers important in evaluating performance:

(Dollars in thousands, except per share amounts)	At or For the Three Months Ended March 31,
	2006			2005			$ Change			% Change
Per common share data:
Basic:
Income from continuing operations	$	0.30		$	0.18		$	0.12			67	%
Net income	$	0.30		$	0.17		$	0.13			76	%
Diluted:
Income from continuing operations	$	0.30		$	0.18		$	0.12			67	%
Net income	$	0.30		$	0.17		$	0.13			76	%
Cash dividends declared	$	0.08		$	0.16		$	(0.08	)		(50	)%
Book value	$	13.55		$	14.29		$	(0.74	)		(5	)%
Common shares outstanding:
Weighted average shares – basic		11,328,404			11,249,474
Weighted average shares – diluted		11,372,253			11,298,967
Period end		11,320,000			11,249,676
Performance ratios, annualized:
Return on average assets		0.77	%		0.43	%
Return on average common equity		8.82	%		4.67	%
Common dividend payout ratio		26.67	%		94.12	%
Net interest margin (tax-equivalent)		3.64	%		3.90	%
Efficiency ratio (2)		69.99	%		66.12	%
Asset quality data:
Past due over 90 days and accruing	$	35		$	12
Nonaccrual loans		18,561			62,580
Total nonperforming loans		18,596			62,592
Other real estate owned (ORE)		879			981
Total nonperforming loans and other real estate owned		19,475			63,573
Nonaccrual commercial-related loans held for sale		—			—
Total nonperforming assets	$	19,475		$	63,573
Net loan charge-offs	$	190		$	2,870
Asset quality ratios:
Nonperforming loans to total loans (1)		1.93	%		5.11	%
Nonperforming loans and ORE to total loans and ORE (1)		2.02	%		6.40	%
Nonperforming assets to total assets		0.98	%		3.14	%
Allowance for loan losses to total loans (1)		2.10	%		3.27	%
Allowance for loan losses to nonperforming loans (1)		109	%		64	%
Net loan charge-offs to average loans (annualized)		0.08	%		0.93	%
Capital ratios:
Average common equity to average total assets		7.83	%		7.75	%
Leverage ratio		8.11	%		7.30	%
Tier 1 risk-based capital ratio		14.07	%		11.40	%
Risk-based capital ratio		15.32	%		12.67	%
(1) Ratios exclude nonaccruing commercial-related loans held for sale from nonperforming loans and exclude loans held for sale from total loans.
(2) The efficiency ratio represents noninterest expense less other real estate expense and amortization of intangibles (all from continuing operations) divided by net interest income (tax equivalent) plus other noninterest income less gain on sale of securities and net gain on sale of commercial-related loans held for sale (all from continuing operations) calculated using the following detail:
Noninterest expense	$	15,275		$	16,418
Less: Other real estate expense		71			176
Amortization of intangibles		108			108
Net expense (numerator)	$	15,096		$	16,134
Net interest income	$	15,479		$	18,369
Plus: Tax equivalent adjustment		1,217			1,125
Net interest income (tax equivalent)		16,696			19,494
Plus: Noninterest income		4,956			4,907
Less: Net gain on sale of commercial-related loans		82			—
Net revenue (denominator)	$	21,570		$	24,401

17

NET INCOME ANALYSIS

Average Balance Sheets

The following table presents the average annualized yields and rates on interest-earning assets and interest-bearing liabilities on a fully tax equivalent basis for the periods indicated. All average balances are average daily balances.

	For the Three Months Ended March 31,
	2006								2005
	Average			Interest		Annualized			Average			Interest		Annualized
	Outstanding			Earned/		Yield/			Outstanding			Earned/		Yield/
(Dollars in thousands)	Balance			Paid		Rate			Balance			Paid		Rate
Interest-earning assets:
Federal funds sold and interest-bearing deposits	$	16,400		$	185		4.59	%	$	16,732		$	105		2.54	%
Commercial paper due in less than 90 days		9,276			106		4.63	%		—			—		—	%
Investment securities (1):
Taxable		578,268			6,092		4.21	%		513,009			5,147		4.01	%
Non-taxable		262,537			3,477		5.30	%		244,830			3,215		5.25	%
Total investment securities		840,805			9,569		4.55	%		757,839			8,362		4.41	%
Loans (2):
Commercial and agricultural		446,150			8,104		7.37	%		729,476			11,139		6.19	%
Residential real estate		273,226			4,242		6.24	%		259,537			4,159		6.44	%
Consumer and home equity		256,847			4,286		6.77	%		250,311			3,780		6.13	%
Total loans		976,223			16,632		6.89	%		1,239,324			19,078		6.23	%
Total interest-earning assets		1,842,704		$	26,492		5.79	%		2,013,895		$	27,545		5.52	%
Allowance for loans losses		(20,528	)							(39,674	)
Other non-interest-earning assets		155,657								174,727
Total assets	$	1,977,833							$	2,148,948
Interest-bearing liabilities:
Savings and money market	$	349,492		$	927		1.08	%	$	403,876		$	776		0.78	%
Interest-bearing checking		397,066			1,560		1.59	%		393,233			927		0.96	%
Certificates of deposit		667,273			5,734		3.48	%		750,503			4,856		2.62	%
Short-term borrowings		35,011			235		2.73	%		32,051			133		1.69	%
Long-term borrowings		63,381			908		5.81	%		79,455			927		4.73	%
Junior subordinated debentures issued to unconsolidated subsidiary trust		16,702			432		10.35	%		16,702			432		10.35	%
Total interest-bearing liabilities		1,528,925			9,796		2.60	%		1,675,820			8,051		1.95	%
Non-interest-bearing demand deposits		259,050								271,322
Other non-interest-bearing liabilities		17,335								17,557
Total liabilities		1,805,310								1,964,699
Shareholders’ equity (3)		172,523								184,249
Total liabilities and shareholders’ equity	$	1,977,833							$	2,148,948
Net interest income – tax equivalent					16,696								19,494
Less: tax equivalent adjustment					1,217								1,125
Net interest income				$	15,479							$	18,369
Net interest rate spread							3.19	%							3.57	%
Net earning assets	$	313,779							$	338,075
Net interest income as a percentage of average interest-earning assets							3.64	%							3.90	%
Ratio of average interest-earning assets to average interest-bearing liabilities							120.52	%							120.17	%

(1)	Amounts shown are amortized cost for both held to maturity securities and available for sale securities. In order to make pre-tax income and resultant yields on tax-exempt securities comparable to those on taxable securities and loans, a tax-equivalent adjustment to interest earned from tax-exempt securities has been computed using a federal rate of 35%.
(2)	Net of loan deferred fees and costs, discounts and premiums. Loans held for sale and nonaccrual loans are included in the average loan amounts.
(3)	Includes unrealized gains (losses) on securities available for sale.

18

Net Interest Income

Net interest income in the first quarter of 2006 was $15.5 million, down $2.9 million in comparison with the same period last year, primarily the result of a 26 basis point drop in net interest margin and a $171.2 million reduction in average earning assets. Net interest margin was 3.64% for the three months ended March 31, 2006 compared with 3.90% for the same period last year. The decrease was a result of the 65 basis point increase in the cost of interest-bearing liabilities to 2.60% for the quarter ended March 31, 2006 compared to the same period a year ago. The Company’s total cost of funds was 2.15% for the first quarter of 2006, an increase of 53 basis points from the same quarter last year. The increase in cost of funds exceeded the 27 basis point increase in yield on interest-earning assets to 5.79% for the quarter ended March 31, 2006 compared to the same period a year ago. The increase in cost of funds was associated with the rising interest rate environment. The effect of the rising interest rate environment on interest-earning assets was partially offset by a shift in the mix of interest-earnings assets from higher yielding loans to lower yielding investment securities. For the first quarter of 2006, average investment securities, federal funds sold and commercial paper increased $91.9 million, while average loans decreased $263.1 million compared to the first quarter of 2005.

Rate/Volume Analysis

The following table presents the extent to which changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities have affected the Company’s interest income and interest expense during the periods indicated. Information is provided in each category with respect to: (i) changes attributable to changes in volume (changes in volume multiplied by current year rate); (ii) changes attributable to changes in rate (changes in rate multiplied by prior volume); and (iii) the net change. The changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and the changes due to rate.

	Three Months ended March 31,
	2006 vs. 2005
	Increase/(Decrease)						Total
	Due To						Increase/
(Dollars in thousands)	Volume			Rate			(Decrease)
Interest-earning assets:
Federal funds sold and interest-bearing deposits	$	(4	)	$	84		$	80
Commercial paper due in less than 90 days		106			—			106
Investment securities (1):
Taxable		688			257			945
Non-taxable		231			31			262
Total investment securities		919			288			1,207
Loans (2):
Commercial and agricultural		(5,163	)		2,128			(3,035	)
Residential real estate		211			(128	)		83
Consumer and home equity		109			397			506
Total loans		(4,843	)		2,397			(2,446	)
Total interest-earning assets		(3,822	)		2,769			(1,053	)
Interest-bearing liabilities:
Savings and money market		(142	)		293			151
Interest-bearing checking		15			618			633
Certificates of deposit		(715	)		1,593			878
Short-term borrowings		20			82			102
Long-term borrowings		(242	)		223			(19	)
Total interest-bearing liabilities		(1,064	)		2,809			1,745
Net interest income	$	(2,758	)	$	(40	)	$	(2,798	)

(1)	Amounts shown are amortized cost for both held to maturity securities and available for sale securities. In order to make pre-tax income and resultant yields on tax-exempt securities comparable to those on taxable securities and loans, a tax-equivalent adjustment to interest earned from tax-exempt securities has been computed using a federal rate of 35%.
(2)	Net of loan deferred fees and costs, discounts and premiums. Loans held for sale and nonaccrual loans are included in the average loan amounts.

19

Provision for Loan Losses

The provision for loan losses represents management’s estimate of the expense necessary to maintain the allowance for loan losses at a level representative of probable credit losses inherent in the portfolio. The provision for loan losses for the first quarter of 2006 totaled $250,000, a decrease of $3.4 million compared to the $3.7 million provision for loan losses for the first quarter of 2005. Net loan charge-offs in the first quarter of 2006 were $190,000 compared to $2.9 million for the prior year’s first quarter. Net loan charge-offs to average loans (annualized) for the first quarter 2006 was 0.08% compared with 0.93% in the same quarter last year. The 2006 decreases in both the provision for loan losses and net charge-offs reflect the much improved credit quality of the loan portfolio, a direct result of selling a substantial portion of commercial-related problem loans during 2005.

Noninterest Income

Noninterest income for the first quarter of 2006 increased $49,000 to $5.0 million from $4.9 million in the first quarter of 2005. The most significant component of noninterest income is service charges on deposits, which increased $77,000 to $2.7 million for the quarter ended March 31, 2006 compared to a year ago, despite an 8% decline in total average deposits for first quarter of 2006 compared to first quarter of 2005. The increase in service charges on deposits was accompanied by an increase in other noninterest income, which were offset by decreases in mortgage banking activities and financial services group fees and commissions.

Noninterest Expense

Noninterest expense decreased $1.1 million for the first quarter of 2006 to $15.3 million from $16.4 million for the first quarter of 2005. This decrease is due in part to a $387,000 decrease in professional fees for the first quarter 2006 in comparison to a year ago, a result of resolution of regulatory and asset quality issues in 2005. The decrease also relates to an $841,000 decline in other noninterest expenses for the first quarter 2006 in comparison to a year ago. The decline in other noninterest expenses can be attributed to lower Federal Deposit Insurance Corporation (“FDIC”) insurance costs, cost savings associated with the reduction in problem loans and operational efficiencies gained from the fourth quarter 2005 restructuring. In addition, the first quarter of 2005 included $476,000 in personnel separation costs. Salaries and benefits declined $37,000 to $8.8 million in the first quarter of 2006 compared with the same quarter last year. In addition, salaries and benefits for the first quarter of 2006 includes $181,000 of stock compensation expense associated with the adoption of Statement of Financial Accounting Standards (“SFAS”) No. 123R. The decreases in noninterest expense, combined with a decline in revenue, resulted in an increase in the efficiency ratio to 69.99% for the first quarter of 2006 compared with 66.12% for the first quarter of 2005. The efficiency ratio represents noninterest expense less other real estate expense and amortization of intangibles (all from continuing operations) divided by net interest income (tax equivalent) plus other noninterest income less gain on sale of securities and net gain on sale of commercial-related loans held for sale (all from continuing operations).

Income Taxes from Continuing Operations

The provision for income taxes from continuing operations provides for Federal and New York State income taxes, which amounted to $1.2 million and $781,000 for the first quarter of 2006 and 2005, respectively. The effective tax rate decreased to 23.8% for the first quarter of 2006, compared to 24.7% for the first quarter of 2005.

Discontinued Operation

The Company sold its BGI subsidiary during 2005 in order to focus on its core community banking business. The results of BGI have been reported separately as a discontinued operation in the consolidated statements of income and the loss on discontinued operation totaled $96,000 for the three months ended March 31, 2005.

20

ANALYSIS OF FINANCIAL CONDITION

Lending Activities

Loans Held for Sale

Loans held for sale (not included in the table below) totaled $835,000 at March 31, 2006, all of which were residential real estate loans. Loans held for sale (not included in the table below) totaled $1.3 million as of December 31, 2005, comprised of nonaccruing commercial-related loans (including mortgages and agricultural loans) of $577,000 and residential real estate loans of $676,000.

Loan Portfolio Composition

Set forth below is selected information regarding the composition of the Company’s loan portfolio at the dates indicated.

	March 31,					December 31,
(Dollars in thousands)	2006					2005
Commercial	$	112,784		11.7	%	$	116,444		11.7	%
Commercial real estate		256,387		26.5			264,727		26.7
Agricultural		69,167		7.2			75,018		7.5
Residential real estate		271,344		28.1			274,487		27.7
Consumer and home equity		255,887		26.5			261,645		26.4
Total loans		965,569		100.0			992,321		100.0
Allowance for loan losses		(20,291	)				(20,231	)
Total loans, net	$	945,278				$	972,090

Total gross loans decreased $26.7 million to $965.6 million at March 31, 2006 from $992.3 million at December 31, 2005. Commercial loans and commercial real estate loans decreased $12.0 million to $369.2 million or 38.2% of the portfolio at March 31, 2006 from $381.2 million or 38.4% of the portfolio at December 31, 2005. Agricultural loans decreased $5.8 million, to $69.2 million at March 31, 2006 from $75.0 million at December 31, 2005. The decline in commercial-related loans can be primarily attributed to loan pay-offs coupled with decreased loan production. Commercial-related loan originations have slowed as the Company has implemented more stringent underwriting requirements.

Residential real estate loans decreased $3.2 million to $271.3 million at March 31, 2006 in comparison to December 31, 2005. The consumer and home equity line portfolio decreased $5.7 million to $255.9 million at March 31, 2006 in comparison to December 31, 2005. The decrease in residential and consumer loans again reflects loan pay-offs coupled with decreased loan production and overall seasonal slowdowns.

21

Nonaccruing Loans and Nonperforming Assets

Information regarding nonaccruing loans and other nonperforming assets is as follows:

	March 31,			December 31,
(Dollars in thousands)	2006			2005
Nonaccruing loans (1)
Commercial	$	5,895		$	4,389
Commercial real estate		6,798			6,985
Agricultural		2,467			2,786
Residential real estate		3,045			3,096
Consumer and home equity		356			505
Total nonaccruing loans		18,561			17,761
Accruing loans 90 days or more delinquent		35			276
Total nonperforming loans		18,596			18,037
Other real estate owned (ORE)		879			1,099
Total nonperforming loans and other real estate owned		19,475			19,136
Nonaccruing commercial-related loans held for sale		—			577
Total nonperforming assets	$	19,475		$	19,713
Total nonperforming loans to total loans (2)		1.93	%		1.82	%
Total nonperforming loans and ORE to total loans and ORE (2)		2.02	%		1.93	%
Total nonperforming assets to total assets		0.98	%		0.97	%

(1)	Although loans are generally placed on nonaccrual status when they become 90 days or more past due, they may be placed on nonaccrual status earlier if they have been identified by the Company as presenting uncertainty with respect to the collectibility of interest or principal. Loans past due 90 days or more remain on accruing status if they are both well secured and in the process of collection.
(2)	Ratios exclude nonaccruing commercial-related loans held for sale from nonperforming loans and exclude loans held for sale from total loans.

The Company experienced a $238,000 decline in total nonperforming assets to $19.5 million at March 31, 2006 compared to December 31, 2005. Accruing loans 90 days or more delinquent, ORE and nonaccruing commercial-related loans held for sale declined by $241,000, $220,000 and $577,000, respectively, during the first quarter of 2006. Offsetting those declines was an $800,000 increase in total nonaccrual loans to $18.6 million at March 31, 2006 compared to December 31, 2005.

The following table details nonaccrual loan activity for the periods indicated.

	Three Months Ended
	March 31,			December 31,
(Dollars in thousands)	2006			2005
Nonaccruing loans, beginning of period	$	17,761		$	16,140
Additions		5,334			6,727
Payments		(2,018	)		(1,724	)
Charge-offs		(972	)		(2,712	)
Returned to accruing status		(1,226	)		(506	)
Transferred to other real estate		(318	)		(164	)
Nonaccruing loans, end of period	$	18,561		$	17,761

Potential problem loans are loans that are currently performing, but information known about possible credit problems of the borrowers causes management to have concern as to the ability of such borrowers to comply with the present loan payment terms and may result in disclosure of such loans as nonperforming at some time in the future. These loans remain in a performing status due to a variety of factors, including payment history, the value of collateral supporting the credits, and personal or government guarantees. Management considers loans classified as substandard, which continue to accrue interest, to be potential problem loans. The Company identified $20.1 million and $23.2 million in loans that continued to accrue interest which were classified as substandard as of March 31, 2006 and December 31, 2005, respectively.

22

Analysis of the Allowance for Loan Losses

The allowance for loan losses represents the estimated amount of probable credit losses inherent in the Company’s loan portfolio. The Company performs periodic, systematic reviews of the Bank’s loan portfolio to estimate probable losses in the respective loan portfolios. In addition, the Company regularly evaluates prevailing economic and business conditions, industry concentrations, changes in the size and characteristics of the portfolio and other pertinent factors. The process used by the Company to determine the overall adequacy of the allowance for loan losses is based on this analysis. Based on this analysis the Company believes the allowance for loan losses is adequate at March 31, 2006.

Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon management’s evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing various factors. The adequacy of the allowance for loan losses is subject to ongoing management review.

While management evaluates currently available information in establishing the allowance for loan losses, future adjustments to the allowance may be necessary if conditions differ substantially from the assumptions used in making the evaluations. In addition, various regulatory agencies, as an integral part of their examination process, periodically review a financial institution’s allowance for loan losses. Such agencies may require the financial institution to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

The following table sets forth the activity in the allowance for loan losses for the periods indicated.

	Three Months Ended
	March 31,
(Dollars in thousands)	2006			2005
Balance at beginning of period	$	20,231		$	39,186
Charge-offs:
Commercial		327			1,642
Commercial real estate		274			988
Agricultural		222			204
Residential real estate		42			16
Consumer and home equity		438			261
Total charge-offs		1,303			3,111
Recoveries:
Commercial		716			101
Commercial real estate		68			18
Agricultural		35			20
Residential real estate		1			8
Consumer and home equity		293			94
Total recoveries		1,113			241
Net charge-offs		190			2,870
Provision for loan losses		250			3,692
Balance at end of period	$	20,291		$	40,008
Ratio of net loan charge-offs to average loans (annualized)		0.08	%		0.93	%
Ratio of allowance for loan losses to total loans (1)		2.10	%		3.27	%
Ratio of allowance for loan losses to nonperforming loans (1)		109	%		64	%

(1) Ratios exclude nonaccruing commercial-related loans held for sale from nonperforming loans and exclude loans held for sale from total loans.

Net loan charge-offs were $190,000 for the first quarter of 2006 or 0.08% (annualized) of average loans compared to $2.9 million or 0.93% (annualized) of average loans in the same period last year. The ratio of the allowance for loan losses to nonperforming loans was 109% at March 31, 2006 compared to 112% at December 31, 2005 and 64% at March 31, 2005. The ratio of the allowance for loan losses to total loans was 2.10% at March 31, 2006 compared to 2.04% at December 31, 2005 and 3.27% a year ago.

23

Investing Activities

The Company’s total investment security portfolio totaled $815.2 million as of March 31, 2006 compared to $833.4 million as of December 31, 2005. Further detail regarding the Company’s investment portfolio follows.

U.S. Government-Sponsored Enterprise (“GSE”) Securities

At March 31, 2006, the available for sale GSE securities portfolio totaled $243.2 million. The portfolio consisted of approximately $142.5 million, or 59%, of callable securities at March 31, 2006. At March 31, 2006 this category of securities also includes $98.2 million of structured notes, the majority of which are step callable agency debt issues. The step callable bonds step-up in rate at specified intervals and are periodically callable by the issuer. At March 31, 2006, the structured notes had a current average coupon of 4.06% that adjust on average to 6.47% within five years. At December 31, 2005, the available for sale GSE securities portfolio totaled $251.9 million.

State and Municipal Obligations

At March 31, 2006, the portfolio of state and municipal obligations totaled $260.8 million, of which $217.8 million was classified as available for sale. At that date, $43.0 million was classified as held to maturity, with a fair value of $42.9 million. At December 31, 2005, the portfolio of state and municipal obligations totaled $262.9 million, of which $220.3 million was classified as available for sale. At that date, $42.6 million was classified as held to maturity, with a fair value of $42.9 million.

Mortgage-Backed Pass-through Securities (“MBS”), Collateralized Mortgage Obligations (“CMO”) and Other Asset-Backed Securities (“ABS”)

MBS, CMO and ABS securities, all of which were classified as available for sale, totaled $310.1 million and $317.6 million at March 31, 2006 and December 31, 2005, respectively. The portfolio was comprised of $221.5 million of MBS, $83.2 million of CMO and $5.4 million of other ABS securities at March 31, 2006. The MBSs were predominantly issued by U.S. government agencies or GSEs (GNMA, FNMA or FHLMC). Approximately 65% of the MBSs were in fixed rate securities that were most frequently formed with mortgages having an original balloon payment of five or seven years. The adjustable rate agency mortgage-backed securities portfolio is principally indexed to the one-year Treasury bill. The CMO portfolio consists primarily of fixed rate government issues and privately issued AAA rated securities. The ABS securities are primarily Student Loan Marketing Association (“SLMA”) floaters, which are variable rate securities backed by student loans. At December 31, 2005, the portfolio consisted of $234.3 million of MBS, $77.4 million of CMO and $5.9 million of other ABS securities.

Corporate Bonds

The Company did not hold any corporate bonds at March 31, 2006 nor December 31, 2005. The Company’s investment policy limits investments in corporate bonds to no more than 10% of total investments and to bonds rated as Baa or better by Moody’s Investors Service, Inc. or BBB or better by Standard & Poor’s Ratings Services at the time of purchase.

Equity Securities

Available for sale equity securities totaled $1.1 million and $1.0 million at March 31, 2006 and December 31, 2005, respectively.

24

Funding Activities

Deposits

The Bank offers a broad array of deposit products including checking accounts, interest-bearing transaction accounts, savings and money market accounts and certificates of deposit. At March 31, 2006, total deposits were $1.678 billion in comparison to $1.717 billion at December 31, 2005. A majority of the decline in deposits relates to nonpublic deposits whose decrease is attributed to seasonality, the timing of rate campaigns and loss of deposits associated with the effects of the 2005 loan sale.

The Company considers all deposits core except certificates of deposit over $100,000. Core deposits amounted to $1.465 billion or 87.3% of total deposits at March 31, 2006 compared to $1.517 billion or 88.4% of total deposits at December 31, 2005. The core deposit base consists almost exclusively of in-market accounts. Core deposits are supplemented with certificates of deposit over $100,000, which amounted to $213.3 million and $199.8 million as of March 31, 2006 and December 31, 2005, respectively. The Company also utilizes brokered certificates of deposit as a funding source. Brokered certificates of deposit included in certificates of deposit over $100,000 totaled $26.5 million and $31.5 million at March 31, 2006 and December 31, 2005, respectively. The decline in brokered certificates of deposit resulted as the Company actively managed to lower the level of these higher cost funds due to increased liquidity levels.

Non-Deposit Sources of Funds

The Company’s most significant source of non-deposit funds is FHLB borrowings. FHLB advances outstanding amounted to $50.4 million and $53.4 million as of March 31, 2006 and December 31, 2005, respectively. These FHLB borrowings include both short and long-term advances maturing on various dates through 2014. The Company had approximately $37.4 million and $35.5 million of immediate credit available under lines of credit with the FHLB at March 31, 2006 and December 31, 2005, respectively. The FHLB lines of credit are collateralized by FHLB stock and real estate mortgage loans. The Company also had $93.1 million and $75.0 million of credit available under unsecured lines of credit with various banks at March 31, 2006 and December 31, 2005, respectively. There were no advances outstanding on these lines of credit at March 31, 2006 and December 31, 2005. The Company also utilizes securities sold under agreements to repurchase as a source of funds. These short-term repurchase agreements amounted to $22.2 million and $20.1 million as of March 31, 2006 and December 31, 2005, respectively.

The Company also has a credit agreement with M&T Bank and has pledged the stock of FSB as collateral for the credit facility. The credit agreement includes a $25.0 million term loan facility. The interest rate and maturity of the term loan facility were modified during 2005. The amended and restated term loan requires monthly payments of interest only at a variable interest rate of London Interbank Offered Rate (“LIBOR”) plus 2.00% through the third quarter of 2006, with the opportunity for a future interest rate step-down to LIBOR plus 1.75% beginning in the fourth quarter of 2006 with financial covenant compliance for the quarter ended September 30, 2006. Principal installments of $6.25 million are due annually beginning in December of 2007. The $5.0 million revolving loan was also modified to accrue interest at a rate of LIBOR plus 1.75% and is scheduled to mature April of 2007. There were no advances outstanding on the revolving loan at March 31, 2006.

During 2001, FISI Statutory Trust I (the “Trust”) was established and issued 30 year guaranteed preferred beneficial interests in junior subordinated debentures of the Company (“capital securities”) in the aggregate amount of $16.2 million at a fixed rate of 10.2%. As of March 31, 2006, all of the capital securities qualified as Tier I capital under regulatory definitions. Effective December 31, 2003, the provisions of FASB Interpretation No. 46 (Revised), “Consolidation of Variable Interest Entities,” resulted in the deconsolidation of the Company’s wholly-owned Trust. The deconsolidation resulted in the derecognition of the $16.2 million in trust preferred securities and the recognition of $16.7 million in junior subordinated debentures and a $502,000 investment in the subsidiary trust recorded in other assets in the Company’s consolidated statements of financial condition.

Equity Activities

Total shareholders’ equity amounted to $171.0 million at March 31, 2006, a decrease of $763,000 from $171.8 million at December 31, 2005. The decrease in shareholders’ equity during the three months ended March 31, 2006 results from the $1.3 million in dividends declared and $3.2 million in unrealized loss on securities offset by the $3.7 million of net income.

25

LIQUIDITY AND CAPITAL RESOURCES

Liquidity

The objective of maintaining adequate liquidity is to assure the ability of the Company and its subsidiaries to meet their financial obligations. These obligations include the withdrawal of deposits on demand or at their contractual maturity, the repayment of borrowings as they mature, the ability to fund new and existing loan commitments and the ability to take advantage of new business opportunities. The Company and its subsidiaries achieve liquidity by maintaining a strong base of core customer funds, maturing short-term assets, the ability to sell securities, lines of credit, and access to capital markets.

Liquidity at the Bank level is managed through the monitoring of anticipated changes in loans, the investment portfolio, core deposits and wholesale funds. The strength of the Bank’s liquidity position is a result of its base of core customer deposits. These core deposits are supplemented by wholesale funding sources that include credit lines with the other banking institutions, the FHLB and the Federal Reserve Bank.

The primary source of liquidity for the parent company is dividends from the Bank, lines of credit (including the M&T loan), and access to capital markets. Dividends from the Bank are limited by various regulatory requirements related to capital adequacy and earnings trends. The Company’s Bank relies on cash flows from operations, core deposits, borrowings, short-term liquid assets, and, in the case of non-banking subsidiaries, funds from the parent company. See “Management Discussion and Analysis of Financial Condition and Results of Operation”, which is incorporated herein by reference.

The Company’s cash and cash equivalents were $92.7 million at March 31, 2006, an increase of $772,000 from $91.9 million at December 31, 2005. The Company began investing in commercial paper due in less than 90 days during the first quarter of 2006 and has classified the short-term investment as a cash equivalent. The Company’s net cash provided by operating activities totaled $2.9 million and the principal source of operating activity cash flow was the Company’s net income adjusted for noncash income and expense items. The Company’s net cash provided by investing activities totaled $39.4 million. Net cash provided from investment activities primarily included net proceeds of $12.7 million in securities and $26.1 million of loan payments in excess of loan originations. The Company utilized cash in financing activities by funding a $39.1 million decrease in deposits, reducing debt by $886,000, the net acquisition of preferred and common shares of $211,000 and paying $1.3 million in dividends to shareholders. The Company’s cash and cash equivalents were $111.6 million at March 31, 2005, an increase of $46.1 million from $65.5 million at December 31, 2004.

Capital Resources

The Federal Reserve Board has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies. The guidelines require a minimum total risk-based capital ratio of 8.0%. Leverage ratio is also utilized in assessing capital adequacy with a minimum requirement that can range from 4.0% to 5.0%.

The Company’s Tier 1 leverage ratio was 8.11% at March 31, 2006 an increase of 51 basis points from 7.60% at December 31, 2005. Total Tier 1 capital of $157.8 million at March 31, 2006 was comparable to $155.3 million at December 31, 2005. Adjusted quarterly average assets of $1.946 billion for the first quarter of 2006 were down in comparison to $2.043 billion in the fourth quarter of 2005.

The Company’s Tier 1 risk-based capital ratio was 14.07% at March 31, 2006, up from 13.75% at December 31, 2005. The Company’s total risk-weighted capital ratio was 15.32% at March 31, 2006 compared to 15.01% at December 31, 2005. Total risk-based capital at March 31, 2006 was $172.0 million a decrease of $2.5 million from December 31, 2005. Net risk-weighted assets at March 31, 2006 were $1.122 billion, down $7.2 million compared to $1.129 billion at December 31, 2005.

26

The following is a summary of the risk-based capital ratios for the Company and FSB:

	March 31,			December 31,
	2006			2005
Tier 1 leverage ratio
Company		8.11	%		7.60	%
FSB		8.84	%		8.20	%
Tier 1 risk-based capital ratio
Company		14.07	%		13.75	%
FSB		15.38	%		14.87	%
Total risk-based capital ratio
Company		15.32	%		15.01	%
FSB		16.63	%		16.13	%

27

Item 3. Quantitative and Qualitative Disclosures about Market Risk

The principal objective of the Company’s interest rate risk management is to evaluate the interest rate risk inherent in certain assets and liabilities, determine the appropriate level of risk to the Company given its business strategy, operating environment, capital and liquidity requirements and performance objectives, and manage the risk consistent with the guidelines approved by the Company’s Board of Directors. The Company’s senior management is responsible for reviewing with the Board its activities and strategies, the effect of those strategies on the net interest margin, the fair value of the portfolio and the effect that changes in interest rates will have on the portfolio and exposure limits. Senior Management developed an Asset-Liability Policy that meets strategic objectives and regularly reviews the activities of the Bank.

The primary tool the Company uses to manage interest rate risk is a “rate shock” simulation to measure the rate sensitivity of the balance sheet. Rate shock simulation is a modeling technique used to estimate the impact of changes in rates on net interest income and economic value of equity. The Company measures net interest income at risk by estimating the changes in net interest income resulting from instantaneous and sustained parallel shifts in interest rates of different magnitudes over a period of 12 months. This simulation is based on management’s assumption as to the effect of interest rate changes on assets and liabilities and assumes a parallel shift of the yield curve. It also includes certain assumptions about the future pricing of loans and deposits in response to changes in interest rates. Further, it assumes that delinquency rates would not change because of changes in interest rates, although there can be no assurance that this will be the case. While this simulation is a useful measure as to net interest income at risk due to a change in interest rates, it is not a forecast of the future results and is based on many assumptions that, if changed, could cause a different outcome.

In addition to the changes in interest rate scenarios listed above, the Company typically runs other scenarios to measure interest rate risk, which vary as deemed appropriate as the economic and interest rate environments change.

Management also uses a static gap analysis to identify and manage the Company’s interest rate risk profile. Interest sensitivity gap (“gap”) analysis measures the difference between the assets and liabilities repricing or maturing within specific time periods.

The Company has experienced no significant changes in market risk due to changes in interest rates since the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, dated March 15, 2006, as filed with the Securities and Exchange Commission.

Item 4. Controls and Procedures

(a)	Disclosure Controls and Procedures
	As of March 31, 2006 the Company, under the supervision of its Chief Executive Officer and Chief Financial Officer conducted an evaluation of the effectiveness of disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended). Based on their evaluation of the effectiveness of disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in ensuring that all material information required to be filed in the Company’s periodic SEC reports is made known to them in a timely fashion.
(b)	Changes in Internal Control Over Financial Reporting
	There have been no changes in the Company’s internal control over financial reporting that occurred during the first three months of 2006 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

28

PART II — OTHER INFORMATION

Item 1. Legal Proceedings

From time to time the Company and its subsidiaries are parties to or otherwise involved in legal proceedings arising in the normal course of business. Management does not believe that there is any pending or threatened proceeding against the Company or its subsidiaries, which, if determined adversely, would have a material effect on the Company’s business, results of operations or financial condition. In late January 2005, the Company received a letter and other information from a law firm stating that it was representing a shareholder and was writing to demand that the Board take action to remedy alleged “breaches of fiduciary duty” by certain directors and officers of the Company. The Chairman of the Board responded in early February, informing the law firm that the Board had determined to appoint a Special Committee to consider these allegations. The Special Committee was comprised of independent and disinterested directors and was formed to investigate the allegations and determine the appropriate course of action for the Board to take. On September 29, 2005, the Special Committee reported its findings and conclusions to the Board. The Special Committee concluded, after a thorough investigation conducted in conjunction with independent legal counsel, that the certain directors and officers of the Company did not breach their fiduciary duties as alleged and that it would not be in the best interests of the Company to pursue any claims against them.

Item 1A. Risk Factors

The Company has experienced no significant changes in its risk factors since the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, dated March 15, 2006, as filed with the Securities and Exchange Commission.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

The table below sets forth the information with respect to purchases made by the Company (as defined in Rule 10b-18(a)(3) under the Securities Exchange Act of 1934), of our common stock during the three months ended March 31, 2006:

					Total Number of Shares		Maximum Number of
	Total Number		Average Price		Purchased as Part of		Shares that May Yet Be
	of Shares		Paid per		Publicly Announced		Purchased Under the
Period	Purchased		Share		Plans or Programs		Plans or Programs
01/01/06 – 01/31/06		* 3,000	$	14.81		—		—
02/01/06 – 02/28/06		* 4,000		14.81		—		—
03/01/06 – 03/31/06		* 7,000		14.81		—		—
Total		14,000	$	14.81		—		—

* Shares were purchased in a private transaction pursuant to an agreement that priced the shares at the Company’s book value at December 31, 2004.

29

Item 6. Exhibits

Exhibit No.	Description	Location
3.1	Amended and Restated Certificate of Incorporation	Filed as Exhibit 3.1 to FII’s Registration Statement on Form S-1 dated June 25, 1999
		(File No. 333-76865, the “S-1 Registration Statement”)
3.3	Amended and Restated Bylaws dated February 18, 2004	Filed as Exhibit 3.3 to the Form 10-K for the year ended December 31, 2003, dated March 12, 2004
10.1	1999 Management Stock Incentive Plan	Filed as Exhibit 10.1 to the S-1 Registration Statement
10.2	1999 Directors Stock Incentive Plan	Filed as Exhibit 10.2 to the S-1 Registration Statement
10.3	Agreement with investment banker dated March 14, 2005	Filed as Exhibit 10.3 to the Form 10-K for the year ended December 31, 2004, dated March 16, 2005
10.4	Stock Ownership Requirements (effective January 1, 2005)	Filed as Exhibit 10.4 to the Form 10-K for the year ended December 31, 2004, dated March 16, 2005
10.5	Senior Management Incentive Compensation Plan (effective January 1, 2005)	Filed as Exhibit 10.5 to the Form 10-K for the year ended December 31, 2004, dated March 16, 2005
10.6	Separation Agreement and Release for Randolph C. Brown dated March 15, 2005	Filed as Exhibit 10.6 to the Form 10-K for the year ended December 31, 2004, dated March 16, 2005
10.7	Employment Agreement for Randolph C. Brown dated June 2001	Filed as Exhibit 10.7 to the Form 10-K for the year ended December 31, 2004, dated March 16, 2005
10.8	Separation Agreement and Release for Jon J. Cooper dated March 25, 2005	Filed as Exhibit 10.1 to the Form 8-K, dated March 31, 2005
10.9	Executive Agreement with Peter G. Humphrey	Filed as Exhibit 10.1 to the Form 8-K, dated June 30, 2005
10.10	Executive Agreement with James T. Rudgers	Filed as Exhibit 10.2 to the Form 8-K, dated June 30, 2005
10.11	Executive Agreement with Ronald A. Miller	Filed as Exhibit 10.3 to the Form 8-K, dated June 30, 2005
10.12	Executive Agreement with Thomas D. Grover	Filed as Exhibit 10.4 to the Form 8-K, dated June 30, 2005
10.13	Executive Agreement with Martin K. Birmingham	Filed as Exhibit 10.4 to the Form 8-K, dated June 30, 2005
10.14	Agreement with Peter G. Humphrey	Filed as Exhibit 10.6 to the Form 8-K, dated June 30, 2005
10.15	Executive Agreement with John J. Witkowski	Filed as Exhibit 10.7 to the Form 8-K, dated September 14, 2005
10.16	Agreement with investment banker dated May 16, 2005	Filed as Exhibit 10.15 to the Form 10-Q for the quarterly period ended June 30, 2005, dated August 9, 2005
10.17	Term and Revolving Credit Loan Agreements between FII and M&T Bank, dated December 15, 2003	Filed as Exhibit 1.1 to the Form 10-K for the year ended December 31, 2003, dated March 12, 2004
10.18	Second Amendment to Term Loan Credit Agreement between FII and M&T Bank, dated September 30, 2005	Filed as Exhibit 10.17 to the Form 10-Q for the quarterly period ended September 30, 2005, dated November 4, 2005
10.19	Fourth Amendment to Revolving Credit Agreement between FII and M&T Bank, dated September 30, 2005	Filed as Exhibit 10.18 to the Form 10-Q for the quarterly period ended September 30, 2005, dated November 4, 2005
10.20	Executive Agreement with George D. Hagi	Filed as Exhibit 10.7 to the Form 8-K, dated February 2, 2006
10.21	Trust Company Agreement and Plan of Merger between The Canandaigua National Bank and Trust Company and Five Star Bank	Filed as Exhibit 10.1 to the Form 8-K, dated April 3, 2006
10.22	Amended Stock Ownership Requirements, dated December 14, 2005	Filed as Exhibit 10.19 to the Form 10-K for the year ended December 31, 2005, dated March 15, 2006
10.23	2006 Annual Incentive Plan, dated March 13, 2006	Filed as Exhibit 10.20 to the Form 10-K for the year ended December 31, 2005, dated March 15, 2006
10.24	Executive Enhanced Incentive Plan, dated January 25, 2006	Filed as Exhibit 10.21 to the Form 10-K for the year ended December 31, 2005, dated March 15, 2006

30

Exhibit No.	Description	Location
11.1	Statement of Computation of Per Share Earnings	Data required by SFAS No. 128, Earnings per Share, is provided in note 3 to the unaudited consolidated financial statements in this report.
31.1	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 -CEO	Filed Herewith
31.2	Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 -CFO	Filed Herewith
32.1	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -CEO	Filed Herewith
32.2	Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 -CFO	Filed Herewith

31

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.

	FINANCIAL INSTITUTIONS, INC.
Date		Signatures
May 5, 2006	By:	/s/ Peter G. Humphrey
		Peter G. Humphrey
		President and Chief Executive Officer
		(Principal Executive Officer)
May 5, 2006	By:	/s/ Ronald A. Miller
		Ronald A. Miller
		Executive Vice President
		and Chief Financial Officer
		(Principal Accounting Officer)

32