UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

FOR THE QUARTERLY PERIOD ENDED March 31, 2007

(Exact Name of Registrant as specified in its charter)

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

Registrant’s Telephone Number Including Area Code:

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 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. YES þ      NO o

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 filer o      Accelerated filer þ      Non-accelerated filer o

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

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

CLASS		OUTSTANDING AT MAY 1, 2007
Common Stock, $0.01 par value		11,204,266 shares

 

 

FINANCIAL INSTITUTIONS, INC.

FORM 10-Q

INDEX

PART I – FINANCIAL INFORMATION
Item 1.		Financial Statements (Unaudited)
		Consolidated Statements of Financial Condition (Unaudited) as of March 31, 2007 and December 31, 2006			3
		Consolidated Statements of Income (Unaudited) for the Three Months Ended March 31, 2007 and 2006			4
		Consolidated Statement of Changes in Shareholders’ Equity and Comprehensive Income (Unaudited) for the Three Months Ended March 31, 2007			5
		Consolidated Statements of Cash Flows (Unaudited) for the Three Months Ended March 31, 2007 and 2006			6
		Notes to Unaudited Consolidated Financial Statements			7
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			12
Item 3.		Quantitative and Qualitative Disclosures About Market Risk			26
Item 4.		Controls and Procedures			27
PART II – OTHER INFORMATION
Item 1.		Legal Proceedings			27
Item 1A.		Risk Factors			27
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			27
Item 6.		Exhibits			28
SIGNATURES
EXHIBITS
EX-31.1
EX-31.2
EX-32.1
EX-32.2

Item 1. Financial Statements (Unaudited)

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

		March 31,				December 31,
(Dollars in thousands, except per share amounts)		2007				2006
Assets
Cash and due from banks		$	40,647			$	47,166
Federal funds sold and interest-bearing deposits in other banks			92,432				62,606
Securities available for sale, at fair value			761,252				735,148
Securities held to maturity, at amortized cost (fair value of $44,902 and $40,421 at March 31, 2007 and December 31, 2006, respectively)			44,848				40,388
Loans held for sale			1,078				992
Loans			929,250				926,482
Less: Allowance for loan losses			16,914				17,048
Loans, net			912,336				909,434
Premises and equipment, net			34,341				34,562
Goodwill			37,369				37,369
Other assets			38,445				39,887
Total assets		$	1,962,748			$	1,907,552
Liabilities And Shareholders’ Equity
Liabilities:
Deposits:
Noninterest-bearing demand		$	260,068			$	273,783
Interest-bearing demand, savings and money market			723,343				674,224
Certificates of deposit			688,351				669,688
Total deposits			1,671,762				1,617,695
Short-term borrowings			24,860				32,310
Long-term borrowings			38,173				38,187
Junior subordinated debentures issued to unconsolidated subsidiary trust (“Junior subordinated debentures”)			16,702				16,702
Other liabilities			26,721				20,270
Total liabilities			1,778,218				1,725,164
Shareholders’ equity:
3% cumulative preferred stock, $100 par value, authorized 10,000 shares, issued and outstanding – 1,586 shares at March 31, 2007 and December 31, 2006			159				159
8.48% cumulative preferred stock, $100 par value, authorized 200,000 shares, issued and outstanding – 174,639 shares at March 31, 2007 and December 31, 2006			17,464				17,464
Common stock, $0.01 par value, authorized 50,000,000 shares, issued 11,348,122 shares at March 31, 2007 and December 31, 2006			113				113
Additional paid-in capital			24,554				24,439
Retained earnings			150,865				148,730
Accumulated other comprehensive loss			(7,026	)			(8,404	)
Treasury stock, at cost – 76,446 and 5,351 shares at March 31, 2007 and December 31, 2006, respectively			(1,599	)			(113	)
Total shareholders’ equity			184,530				182,388
Total liabilities and shareholders’ equity		$	1,962,748			$	1,907,552

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

		Three Months Ended
		March 31,
(Dollars in thousands, except per share amounts)		2007				2006
Interest income:
Interest and fees on loans		$	16,627			$	16,632
Interest and dividends on securities			8,427				8,352
Other interest income			752				291
Total interest income			25,806				25,275
Interest expense:
Deposits			10,763				8,221
Short-term borrowings			169				112
Long-term borrowings			486				1,031
Junior subordinated debentures			432				432
Total interest expense			11,850				9,796
Net interest income			13,956				15,479
Provision for loan losses			—				250
Net interest income after provision for loan losses			13,956				15,229
Noninterest income:
Service charges on deposits			2,569				2,672
ATM and debit card income			620				534
Broker-dealer fees and commissions			383				431
Trust fees			—				194
Mortgage banking income			254				308
Income from corporate owned life insurance			20				20
Net gain on sale of student loans held for sale			112				147
Net gain on sale of commercial-related loans held for sale			—				82
Net gain on sale and disposal of other assets			57				98
Net gain on sale of trust relationships			13				—
Other			710				470
Total noninterest income			4,738				4,956
Noninterest expense:
Salaries and employee benefits			8,354				8,758
Occupancy and equipment			2,448				2,362
Supplies and postage			438				559
Amortization of other intangible assets			77				108
Computer and data processing			457				405
Professional fees and services			495				673
Other			1,659				2,410
Total noninterest expense			13,928				15,275
Income before income taxes			4,766				4,910
Income tax expense			1,151				1,171
Net income		$	3,615			$	3,739
Earnings per common share (note 3):
Basic		$	0.29			$	0.30
Diluted		$	0.29			$	0.30

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

																						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, 2006		$	159			$	17,464			$	113			$	24,439			$	148,730			$	(8,404	)		$	(113	)		$	182,388
Purchase 77,595 shares of common stock			—				—				—				—				—				—				(1,625	)			(1,625	)
Issue 6,500 shares of common stock — exercised stock options, net of tax			—				—				—				(2	)			—				—				139				137
Excess tax benefit from stock options exercised			—				—				—				3				—				—				—				3
Amortization of unvested stock options			—				—				—				114				—				—				—				114
Amortization of unvested restricted stock awards			—				—				—				—				24				—				—				24
Comprehensive income:
Net income			—				—				—				—				3,615				—				—				3,615
Net unrealized gain on securities available for sale (net of tax of $878)			—				—				—				—				—				1,376				—				1,376
Defined benefit pension plan, net of tax of $4)			—				—				—				—				—				7				—				7
Postretirement benefit plan, net of tax of $(3))			—				—				—				—				—				(5	)			—				(5	)
Other comprehensive income																															1,378
Total comprehensive income																															4,993
Cash dividends declared:
3% Preferred — $0.75 per share			—				—				—				—				(1	)			—				—				(1	)
8.48% Preferred — $2.12 per share			—				—				—				—				(370	)			—				—				(370	)
Common — $0.10 per share			—				—				—				—				(1,133	)			—				—				(1,133	)
Balance — March 31, 2007		$	159			$	17,464			$	113			$	24,554			$	150,865			$	(7,026	)		$	(1,599	)		$	184,530

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

		Three Months Ended
		March 31,
(Dollars in thousands)		2007				2006
Cash flows from operating activities:
Net income		$	3,615			$	3,739
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			971				1,063
Net amortization of premiums and discounts on securities			140				222
Provision for loan losses			—				250
Amortization of unvested stock options			114				181
Amortization of unvested restricted stock awards			24				—
Tax benefit from stock options exercised			3				—
Deferred income tax expense			137				404
Proceeds from sale of loans held for sale			11,720				31,537
Originations of loans held for sale			(11,644	)			(31,695	)
Net gain on sale of loans held for sale			(161	)			(226	)
Net gain on sale of commercial-related loans held for sale			—				(82	)
Net gain on sale and disposal of other assets			(57	)			(98	)
Net gain on sale of trust relationships			(13	)			—
Decrease (increase) in other assets			448				(1,465	)
Increase (decrease) in other liabilities			6,338				(808	)
Net cash provided by operating activities			11,635				3,022
Cash flows from investing activities:
Purchase of securities:
Available for sale			(59,257	)			(13,210	)
Held to maturity			(6,241	)			(5,306	)
Proceeds from maturity, call and principal pay-down of securities:
Available for sale			35,267				26,337
Held to maturity			1,781				4,861
Net loan (increase) decrease			(3,373	)			25,932
Net proceeds from sale of commercial-related loans			—				970
Proceeds from sales of other assets			428				36
Proceeds from sale of trust relationships			13				—
Purchase of premises and equipment			(672	)			(394	)
Net cash (used in) provided by investing activities			(32,054	)			39,226
Cash flows from financing activities:
Net increase (decrease) in deposits			54,067				(39,103	)
Net (decrease) increase in short-term borrowings			(7,450	)			2,130
Repayment of long-term borrowings			(14	)			(3,016	)
Purchase of common shares			(1,625	)			(211	)
Stock options exercised			137				2
Excess tax benefit from stock options exercised			3				—
Dividends paid			(1,392	)			(1,278	)
Net cash provided by (used in) financing activities			43,726				(41,476	)
Net increase in cash and cash equivalents			23,307				772
Cash and cash equivalents at the beginning of the period			109,772				91,940
Cash and cash equivalents at the end of the period		$	133,079			$	92,712
Supplemental disclosure of cash flow information:
Cash paid during period for:
Interest		$	10,734			$	10,221
Income taxes paid			1				—
Noncash investing and financing activities:
Real estate and other assets acquired in settlement of loans		$	470			$	544

See Accompanying Notes to Unaudited Consolidated Financial Statements.

FINANCIAL INSTITUTIONS, INC. AND SUBSIDIARIES

(1) Basis of Presentation

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

FII’s primary subsidiary is its New York State-chartered Five Star Bank (100% owned) (“FSB” or the “Bank”). In addition, FII formerly qualified as a financial holding company under the Gramm-Leach-Bliley Act, which allowed the expansion of business operations to include a broker-dealer subsidiary, namely, Five Star Investment Services, Inc. (100% owned) (“FSIS”) (formerly known as The FI Group, Inc. (“FIGI”). During 2003, FII terminated its financial holding company status and now operates as a bank holding company. The change in status did not affect the broker-dealer subsidiary or activities being conducted by the Company, although future acquisition or expansion of non-financial activities may require prior Federal Reserve Bank (“FRB”) approval and will be limited to those that are permissible for bank holding companies.

In February 2001, the Company formed FISI Statutory Trust I (100% owned) (“FISI” or the “Trust”) and capitalized the entity with a $502,000 investment in the Trust’s common securities. The Trust was formed to facilitate the private placement of $16.2 million in capital securities (“trust preferred securities”). 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 condition.

In management’s opinion, the interim consolidated financial statements reflect all adjustments necessary for a fair presentation. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year ended December 31, 2007. The interim consolidated financial statements should be read in conjunction with the Company’s 2006 Annual Report on Form 10-K. The consolidated financial information included herein combines the results of operations, the assets, liabilities and shareholders’ equity of FII and its subsidiaries. All significant inter-company transactions and balances have been eliminated in consolidation. Certain amounts in the prior periods’ consolidated financial statements are reclassified when necessary to conform to the current period’s 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, cash and due from banks, federal funds sold, interest-bearing deposits in other banks and commercial paper due in less than 90 days are considered cash and cash equivalents.

(2) Recent Accounting Pronouncements

In February 2006, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 155, “Accounting for Certain Hybrid Financial Instruments.” SFAS No. 155 amends SFAS No. 133 and SFAS No. 140, and improves the financial reporting of certain hybrid financial instruments by requiring more consistent accounting that eliminates exemptions and provides a means to simplify the accounting for these instruments. Specifically, SFAS No. 155 allows financial instruments that have embedded derivatives to be accounted for as a whole (eliminating the need to bifurcate the derivative from its host) if the holder elects to account for the whole instrument on a fair value basis. SFAS No. 155 is effective for all financial instruments acquired or issued in fiscal years beginning after September 15, 2006. The Company adopted this statement effective January 1, 2007 and adoption did not have an effect on its consolidated financial position, consolidated results of operations, or liquidity.

In March 2006, the FASB issued SFAS No. 156, “Accounting for Servicing of Financial Assets,” an amendment of SFAS No. 140, which requires that all separately recognized servicing assets and servicing liabilities be initially

measured at fair value, if practicable and permits the entities to elect either fair value measurement with changes in fair value reflected in earnings or the amortization and impairment requirements of SFAS No. 140 for subsequent measurement. SFAS No. 156 is effective for fiscal years beginning after September 15, 2006. The Company adopted this statement effective January 1, 2007 and elected to continue using the amortization and impairment requirements of SFAS No. 140 for subsequent measurement of servicing assets, therefore adoption did not have an effect on its consolidated financial position, consolidated results of operations, or liquidity.

In June 2006, the FASB issued FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes – an interpretation of FASB Statement No. 109” (“FIN 48”). FIN 48 prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return, and also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure, and transition. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company adopted this statement effective January 1, 2007 and the required disclosures are included in Note 9. The adoption of FIN 48 did not have a material effect on the Company’s consolidated financial position, consolidated results of operations, or liquidity.

In September 2006, the FASB issued SFAS No. 157, “Fair Value Measurements.” SFAS No. 157 defines fair value, establishes a framework for measuring fair value under generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement, and states that a fair value measurement should be determined based on assumptions that market participants would use in pricing the asset or liability. The Company is required to adopt SFAS No. 157 for its fiscal year beginning after November 15, 2007. The Company plans to adopt this statement on January 1, 2008 and is currently assessing the impact that the adoption will have on its consolidated financial position, consolidated results of operations, or liquidity.

In September 2006, the FASB issued SFAS No. 158, “Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — an amendment of FASB Statements No. 87, 88, 106, and 132(R).” SFAS No. 158 requires companies to recognize the over-funded or under-funded status of a defined benefit postretirement plan (other than a multi-employer plan) as an asset or liability in its balance sheet and to recognize changes in that funded status in the year in which the changes occur through comprehensive income. The Company adopted this provision of SFAS No. 158 for the year ended December 31, 2006 and the required disclosures were included in Note 13 of the annual report on Form 10-K as filed on March 13, 2007. SFAS No. 158 also requires companies to measure the funded status of a plan as of the date of the company’s fiscal year-end, with limited exceptions. The Company is required and plans to adopt this provision for the fiscal year ending December 31, 2008 and does not expect adoption to have a material effect on its consolidated financial position, consolidated results of operations, or liquidity.

In September 2006, the Emerging Issues Task Force (“EITF”) reached a final consensus on Issue 06-04, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split Dollar Life Insurance Arrangements.” In accordance with the EITF consensus, an agreement by an employer to share a portion of the proceeds of a life insurance policy with an employee during the postretirement period is a postretirement benefit arrangement required to be accounted for in accordance with SFAS No. 106 or Accounting Principles Board Opinion (“APB”) No. 12, “Omnibus Opinion — 1967.” Furthermore, the purchase of a split dollar life insurance policy does not constitute a settlement under SFAS No. 106 and, therefore, a liability for the postretirement obligation must be recognized under SFAS No. 106 if the benefit is offered under an arrangement that constitutes a plan or under APB No. 12 if it is not part of a plan. The provisions of EITF Issue 06-04 are to be applied through either a cumulative-effect adjustment to retained earnings as of the beginning of the year of adoption or retrospective application. The Company is required to adopt this statement in its fiscal year beginning after December 15, 2007, with early adoption permitted. The Company plans to adopt this statement on January 1, 2008 and is currently assessing the impact that the adoption will have on its consolidated financial position, consolidated results of operations, or liquidity.

In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities, including an amendment of FASB Statement No. 115.” SFAS No. 159 allows entities to irrevocably elect fair value as the initial and subsequent measurement attribute for certain financial assets and financial liabilities that are not otherwise required to be measured at fair value, with changes in fair value recognized in earnings as they occur. SFAS No. 159 also requires entities to report those financial assets and financial liabilities measured at fair value in a manner that separates those reported fair values from the carrying amounts of similar assets and liabilities measured using another measurement attribute on the face of the statement of financial condition. Lastly, SFAS No. 159 establishes presentation and disclosure requirements designed to improve comparability between entities that

elect different measurement attributes for similar assets and liabilities. The Company is required to adopt SFAS No. 159 for its fiscal year beginning after November 15, 2007, with early adoption permitted if an entity also early adopts the provisions of SFAS No. 157. The Company plans to adopt this statement on January 1, 2008 and is currently assessing the impact the adoption will have on its consolidated financial position, consolidated results of operations, or liquidity.

(3) Earnings Per Common Share

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

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

		Three Months Ended
		March 31,
(Dollars and shares in thousands, except per share amounts)		2007				2006
Net income		$	3,615			$	3,739
Less: Preferred stock dividends			371				372
Net income available to common shareholders		$	3,244			$	3,367
Weighted average number of common shares outstanding used to calculate basic earnings per common share			11,317				11,328
Add: Effect of common stock equivalents			43				44
Weighted average number of common shares used to calculate diluted earnings per common share			11,360				11,372
Earnings per common share:
Basic		$	0.29			$	0.30
Diluted		$	0.29			$	0.30

There were approximately 270,132 and 284,000 weighted average common stock equivalents from outstanding stock options for the three months ended March 31, 2007 and 2006, respectively, that were not considered in the calculation of diluted earnings per share since their effect would have been anti-dilutive.

(4) Stock Compensation Plans

The Company has a Management Stock Incentive Plan and a Director’s Stock Incentive Plan (the “Plans”). Under the Plans, the Company may grant stock options to purchase shares of common stock, shares of restricted stock or stock appreciation rights to its directors and key employees. Grants under the Plans may be made up to 10% of the number of shares of common stock issued, including treasury shares. The exercise price of each option equals the market price of the Company’s stock on the date of the grant. The maximum term of each option is ten years and the vesting period generally ranges between three and five years. There were no stock options or restricted stock awards granted during the three months ended March 31, 2007.

Effective January 1, 2006, the Company adopted Statement of Financial Accounting Standards (“SFAS”) No. 123(R), “Share-Based Payments”, requiring the Company to recognize expense related to the fair value of the stock-based compensation awards. The following table presents the expense associated with the amortization of unvested stock compensation included in the consolidated statements of income (unaudited) for the periods indicated.

		Three Months Ended
		March 31,
(Dollars in thousands)		2007				2006
Stock options:
Management Stock Incentive Plan (1)		$	93			$	143
Director Stock Incentive Plan (2)			21				38
Total amortization of unvested stock options			114				181
Restricted stock awards:
Management Stock Incentive Plan (1)			24				—
Total amortization of unvested restricted stock awards			24				—
Total amortization of unvested restricted stock compensation		$	138			$	181

(5) Loans

Loans outstanding, including net unearned income and net deferred fees and costs of $4.5 million at March 31, 2007 and December 31, 2006, are summarized as follows:

		March 31,				December 31,
(Dollars in thousands)		2007				2006
Commercial		$	115,211			$	105,806
Commercial real estate			249,179				243,966
Agricultural			54,273				56,808
Residential real estate			162,846				163,243
Consumer indirect			107,729				106,391
Consumer direct and home equity			240,012				250,268
Total loans			929,250				926,482
Allowance for loan losses			(16,914	)			(17,048	)
Loans, net		$	912,336			$	909,434

The Company has reclassified its residential real estate and consumer loan portfolios for all periods presented to more consistently reflect management of the loan portfolio. Consumer indirect loans, primarily automobile loans, are shown on a separate line from the consumer direct and home equity category. Consumer indirect loans totaled $107.7 million and $106.4 million at March 31, 2007 and December 31, 2006, respectively. Closed-end home equity loans, formerly included in the residential real estate category, are presented in the consumer direct and home equity category. Closed-end home equity loans totaled $103.5 million and $105.2 million at March 31, 2007 and December 31, 2006, respectively.

The Company’s significant concentrations of credit risk in the loan portfolio relates to a geographic concentration in the communities that the Company serves.

(6) Retirement and Postretirement Benefit Plans

The Company adopted SFAS No. 158 effective December 31, 2006, which required the over-funded or under-funded status of its defined benefit pension and postretirement benefit plans to be recognized as an asset or liability in the consolidated statements of financial condition. Future changes in the funded status of the defined benefit and postretirement plans will be recognized in the year in which the changes occur on a net of tax basis through comprehensive income or loss.

Defined Benefit Pension Plan

The Company participates in The New York State Bankers Retirement System, which is a defined benefit pension plan covering substantially all employees. The benefits are based on years of service and the employee’s highest average compensation during five consecutive years of employment.

The defined benefit plan was closed to new participants effective December 31, 2006. Only employees hired on or before December 31, 2006 and who meet participation requirements on or before January 1, 2008 shall be eligible to receive benefits.

Net periodic pension cost consists of the following components:

		Three Months Ended
		March 31,
(Dollars in thousands)		2007				2006
Service cost		$	375			$	431
Interest cost on projected benefit obligation			368				335
Expected return on plan assets			(477	)			(466	)
Amortization of net transition asset			—				(7	)
Amortization of unrecognized loss			8				56
Amortization of unrecognized prior service cost			3				4
Net periodic pension cost		$	277			$	353

The Company’s funding policy is to contribute, at a minimum, an actuarially determined amount that will satisfy the minimum funding requirements determined under the appropriate sections of Internal Revenue Code. The minimum required contribution is zero for the year ended December 31, 2007, however the Company is considering making a discretionary contribution to the pension plan during 2007.

Postretirement Benefit Plan

Prior to December 31, 2001, an entity acquired by the Company provided health and dental care benefits to certain retired employees who met specified age and service requirements through a postretirement health and dental care plan in which both the acquired entity and the retiree shared the cost. The plan was amended in 2001 to curtail eligible benefit payments to only retired employees and active participants who were fully vested under the plan.

(7) Commitments and Contingencies

In the normal course of business there are outstanding commitments to extend credit not reflected in the accompanying consolidated financial statements. These commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company uses the same credit policy to make such commitments as it uses for on-balance-sheet items. Unused lines of credit and loan commitments totaling $246.4 million and $258.6 million were contractually available at March 31, 2007 and December 31, 2006, respectively, and are not reflected in the consolidated statements of financial condition (unaudited). Since commitments to extend credit and unused lines of credit may expire without being fully drawn upon, the amount does not necessarily represent future cash commitments.

The Company guarantees the obligations or performance of customers by issuing stand-by letters of credit to third parties. The risk involved in issuing stand-by letters of credit is essentially the same as the credit risk involved in extending loan facilities to customers, and they are subject to the same credit origination, portfolio maintenance and management procedures in effect to monitor other credit and off-balance-sheet products. Typically, these instruments have terms of five years or less and expire unused; therefore, the amount does not necessarily represent future cash requirements. Stand-by letters of credit totaled $5.6 million and $5.8 million at March 31, 2007 and December 31, 2006, respectively. As of March 31, 2007, the fair value of the stand-by letters of credit was not material to the Company’s consolidated financial statements.

From time to time the Company is a party to or otherwise involved in legal proceedings arising in the normal course of business. Management does not believe that there is any pending or threatened proceeding against the Company, which, if determined adversely, would have a material adverse effect on the Company’s business, results of operations or financial condition.

(8) Supervision and Regulation

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

The Company is also subject to 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, 2007 and December 31, 2006, the Company and FSB met all capital adequacy requirements to which they are subject.

(9) Income Taxes

The Company adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) effective January 1, 2007. There was no cumulative effect adjustment related to the adoption of FIN 48. As of January 1, 2007, the Company’s unrecognized tax benefits totaled $50,000, of which $32,000 would impact the Company’s effective tax rate, if recognized or reversed. The Company is currently under examination by New York State and expects to conclude the examination during 2007 at which point the uncertain tax position would be settled.

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

Federal			2003 - 2005
New York			2002 - 2005

The Company accounts for interest and penalties related to uncertain tax positions as part of its provision for federal and state income taxes. As of January 1, 2007, the Company had accrued $17,000 of interest related to uncertain tax positions. As of March 31, 2007, the total amount of accrued interest was $19,000.

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, 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 revenues are dependent primarily on net interest income, which is the difference between the income earned on loans and securities and the interest paid on deposits and borrowings. Revenues are also affected by service charges on deposits, ATM and debit card income, broker-dealer fees and commissions, mortgage banking income, gain or loss on the sale of securities, gain or loss on sale of loans held for sale, gain or loss on the sale and disposal of other assets and other miscellaneous noninterest income.

The Company’s expenses primarily consist of the provision (credit) for loan losses, salaries and employee benefits, occupancy and equipment, supplies and postage, amortization of other intangible assets, computer and data processing, professional fees and services, other miscellaneous noninterest expense and income tax expense (benefit).

Results of operations are also affected by the general economic and competitive conditions, particularly changes in interest rates, government policies and the actions of regulatory authorities.

OVERVIEW

Net income for the quarter was $3.6 million, or $0.29 per diluted share, compared with $3.7 million, or $0.30 per diluted share, for the first quarter of 2006. The decline in net income was primarily the result of a decline in net interest income, which was $14.0 million for the first quarter of 2007, down $1.5 million from $15.5 million in the first quarter of 2006. Net interest margin declined 26 basis points, to 3.38%, for the first quarter of 2007 compared with the same period last year. The flat-to-inverted interest rate yield curve, which prevailed throughout much of 2006 and continues in 2007, negatively affected net interest margin and net interest income, as did changes in the mix of deposits that increased cost of funds.

The decline in net interest income was partially offset by a reduction of $1.4 million, or 9%, in noninterest expense in the first quarter of 2007 to $13.9 million compared with $15.3 million for the first quarter of 2006. The lower expense levels reflect operational efficiencies gained from the consolidation of administrative and operational functions, improved asset quality and lower advertising costs.

The Company also experienced an increase of $2.8 million in loans to $929.3 million at March 31, 2007 compared to $926.5 million at December 31, 2006. Commercial loans increased $12.1 million over December 31, 2006, as our commercial business development programs over the past year delivered results during the first quarter of 2007.

Asset quality continued to improve, as the Company’s provision for loan losses for the first quarter of 2007 was zero, compared with $250,000 for the first quarter of 2006. Net loan charge-offs of $134,000 for the first quarter represented 6 basis points of average loans (annualized) and compared with $190,000 and 8 basis points for the first quarter of 2006. Nonperforming assets totaled $17.0 million at March 31, 2007, unchanged from December 31, 2006, but the overall level of criticized and classified loans declined $3.8 million during the first quarter of 2007. The allowance for loan losses was $16.9 million at March 31, 2007 or 1.82% of loans, comparable to $17.0 million and 1.84% at December 31, 2006.

CRITICAL ACCOUNTING POLICIES

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

The Company has numerous accounting policies, of which the most significant are presented in Note 1 of the notes to consolidated financial statements included in the Company’s Annual Report on Form 10-K as of December 31, 2006, dated March 13, 2007, as filed with the Securities and Exchange Commission. These policies, along with the disclosures presented in the other financial statement notes and in this discussion, provide information on how

significant assets, liabilities, revenues and expenses are reported in the consolidated financial statements and how those reported amounts are determined. Based on the sensitivity of financial statement amounts to the methods, assumptions, and estimates underlying those amounts, management has determined that the accounting policies with respect to the allowance for loan losses, goodwill and defined benefit pension plan require particularly subjective or complex judgments important to the Company’s consolidated financial statements, results of operations, and, as such, are considered to be critical accounting policies as discussed below.

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

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

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

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

Goodwill: Statement of Financial Accounting Standards (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead, these assets are subject to at least an annual impairment review, and more frequently if certain impairment indicators are in evidence. Changes in the estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity. During the fourth quarter of 2006, the Company evaluated goodwill for impairment using a discounted cash flow analysis and determined no impairment existed. There were no material events or transactions that occurred subsequent to that evaluation that indicates any impairment at the current period end.

Defined Benefit Pension Plan: Management is required to make various assumptions in valuing its defined benefit pension plan assets and liabilities. These assumptions include, but are not limited to, the expected long-term rate of return on plan assets, the weighted average discount rate used to value certain liabilities and the rate of compensation increase. The Company uses a third-party specialist to assist in making these estimates and assumptions. Changes in these estimates and assumptions are reasonably possible and may have a material impact on the Company’s consolidated financial statements, results of operations or liquidity.

SELECTED FINANCIAL DATA

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

		At or For the Three Months Ended March 31,
(Dollars in thousands, except per share amounts)		2007				2006
Per common share data:
Net income — basic		$	0.29			$	0.30
Net income — diluted		$	0.29			$	0.30
Cash dividends declared		$	0.10			$	0.08
Book value		$	14.81			$	13.55
Tangible book value		$	11.42			$	10.14
Common shares outstanding:
Weighted average shares – basic			11,316,811				11,328,404
Weighted average shares – diluted			11,360,202				11,372,253
Period end			11,271,676				11,320,000
Performance ratios (annualized) and data:
Return on average assets			0.77	%			0.77	%
Return on average common equity			7.96	%			8.82	%
Return on average tangible common equity			10.35	%			11.75	%
Common dividend payout ratio			34.48	%			26.67	%
Net interest margin (tax-equivalent)			3.38	%			3.64	%
Efficiency ratio (1)			69.53	%			69.99	%
Full-time equivalent employees			634				661
Asset quality data:
Loans past due 90 days or more		$	7			$	35
Nonaccrual loans			15,778				18,561
Total nonperforming loans			15,785				18,596
Other real estate owned (ORE) and repossessed assets (repos)			1,216				879
Total nonperforming assets		$	17,001			$	19,475
Gross loan charge-offs		$	692			$	1,304
Net loan charge-offs		$	134			$	190
Allowance for loan losses		$	16,914			$	20,291
Asset quality ratios:
Nonperforming loans to total loans			1.70	%			1.93	%
Nonperforming assets to total loans, ORE and repos			1.83	%			2.02	%
Nonperforming assets to total assets			0.87	%			0.98	%
Allowance for loan losses to total loans			1.82	%			2.10	%
Allowance for loan losses to nonperforming loans			107	%			109	%
Net loan charge-offs to average loans (annualized)			0.06	%			0.08	%
Capital ratios:
Period-end common equity to total assets			8.50	%			7.74	%
Period-end tangible common equity to total tangible assets			6.69	%			5.91	%
Leverage ratio			8.99	%			8.11	%
Tier 1 risk-based capital ratio			15.58	%			14.07	%
Total risk-based capital ratio			16.83	%			15.32	%

Noninterest expense		$	13,928			$	15,275
Less: Other real estate expense			88				71
Amortization of other intangible assets			77				108
Net expense (numerator)		$	13,763			$	15,096
Net interest income		$	13,956			$	15,479
Plus: Tax-equivalent adjustment			1,114				1,217
Net interest income (tax-equivalent)			15,070				16,696
Plus: Noninterest income			4,738				4,956
Less: Net gain on sale of commercial-related loans held for sale			—				82
Less: Net gain on sale of trust relationships			13				—
Net revenue (denominator)		$	19,795			$	21,570

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,
		2007												2006
		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		$	57,405			$	752				5.32	%		$	16,400			$	185				4.59	%
Commercial paper due in less than 90 days			—				—				—	%			9,276				106				4.63	%
Investment securities (1):
Taxable			570,139				6,264				4.40	%			578,268				6,092				4.21	%
Non-taxable			239,855				3,277				5.46	%			262,537				3,477				5.30	%
Total investment securities			809,994				9,541				4.71	%			840,805				9,569				4.55	%
Loans held for sale			400				8				8.47	%			657				12				7.45	%
Loans (2):
Commercial and agricultural			409,290				7,785				7.71	%			446,049				8,104				7.37	%
Residential real estate			163,046				2,643				6.48	%			166,288				2,675				6.43	%
Consumer indirect			105,856				1,755				6.72	%			85,692				1,256				5.94	%
Consumer direct and home equity			243,435				4,436				7.39	%			277,537				4,585				6.70	%
Total loans			921,627				16,619				7.30	%			975,566				16,620				6.89	%
Total interest-earning assets			1,789,426			$	26,920				6.06	%			1,842,704			$	26,492				5.79	%
Allowance for loans losses			(17,159	)											(20,528	)
Other noninterest-earning assets (3)			142,326												155,657
Total assets		$	1,914,593											$	1,977,833
Interest-bearing liabilities:
Savings and money market		$	334,455			$	1,370				1.66	%		$	349,492			$	927				1.08	%
Interest-bearing demand			355,785				1,593				1.82	%			397,066				1,560				1.59	%
Certificates of deposit			683,361				7,800				4.63	%			667,273				5,734				3.48	%
Short-term borrowings			29,052				169				2.36	%			21,778				112				2.08	%
Long-term borrowings			38,177				486				5.17	%			76,614				1,031				5.46	%
Junior subordinated debentures and trust preferred securities			16,702				432				10.35	%			16,702				432				10.35	%
Total interest-bearing liabilities			1,457,532				11,850				3.30	%			1,528,925				9,796				2.60	%
Noninterest-bearing demand deposits			254,274												259,050
Other noninterest-bearing liabilities			19,834												17,335
Total liabilities			1,731,640												1,805,310
Shareholders’ equity (3)			182,953												172,523
Total liabilities and shareholders’ equity		$	1,914,593											$	1,977,833
Net interest income — tax-equivalent							15,070												16,696
Less: tax equivalent adjustment							1,114												1,217
Net interest income						$	13,956											$	15,479
Net interest rate spread											2.76	%											3.19	%
Net earning assets		$	331,894											$	313,779
Net interest income as a percentage of average interest-earning assets (“net interest margin”)											3.38	%											3.64	%
Ratio of average interest-earning assets to average interest-bearing liabilities											122.77	%											120.52	%

Net Interest Income

For the three months ended March 31, 2007, net interest income was $14.0 million, down $1.5 million in comparison with $15.5 million for the same period last year. Net interest margin was 3.38% for the three months ended March 31, 2007, a 26 basis point decline from 3.64% for the same period last year. The yield on interest-earning assets increased 27 basis points, to 6.06%, for the quarter ended March 31, 2007, compared to the same quarter a year ago. The Company’s cost of funds increased 53 basis points, to 2.68%, for the first quarter of 2007, versus the same quarter last year. The Company’s funding sources are more heavily influenced by the short-end of the interest rate yield curve, so the flat-to-inverted yield curve has led to a more rapid increase in the cost of funds versus the yield on interest-earning assets. In addition, the cost of funds was adversely impacted by a change in the mix of funding sources as customers shifted deposits to higher cost certificates of deposit from lower cost interest-bearing demand, savings and money market accounts. Average earning assets were $1.789 billion for the first quarter of 2007, down 3% from $1.843 billion for the first quarter of 2006. The reduction in average earning assets reflects lower deposit levels as a result of managing overall liquidity needs consistent with spread opportunities and the overall cost of funding.

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,
		2007 vs. 2006
		Increase/(Decrease)								Total
		Due To								Increase/
(Dollars in thousands)		Volume				Rate				(Decrease)
Interest-earning assets:
Federal funds sold and interest-bearing deposits		$	537			$	30			$	567
Commercial paper due in less than 90 days			(106	)			—				(106	)
Investment securities (1):
Taxable			(82	)			254				172
Non-taxable			(302	)			102				(200	)
Total investment securities			(384	)			356				(28	)
Loans held for sale			(7	)			3				(4	)
Loans (2):
Commercial and agricultural			(686	)			367				(319	)
Residential real estate			(54	)			22				(32	)
Consumer indirect			334				165				499
Consumer direct and home equity			(621	)			472				(149	)
Total loans			(1,027	)			1,026				(1	)
Total interest-earning assets			(987	)			1,415				428
Interest-bearing liabilities:
Savings and money market			(63	)			506				443
Interest-bearing demand			(144	)			177				33
Certificates of deposit			183				1,883				2,066
Short-term borrowings			42				15				57
Long-term borrowings			(490	)			(55	)			(545	)
Total interest-bearing liabilities			(472	)			2,526				2,054
Net interest income		$	(515	)		$	(1,111	)		$	(1,626	)

Provision for Loan Losses

The provision for loan losses represents management’s estimate of the adjustment necessary to maintain the allowance for loan losses at a level representative of probable credit losses inherent in the portfolio. There was no provision for loan losses recorded for the first quarter of 2007, compared with a provision for loan losses of $250,000 for the first quarter of 2006.

Net loan charge-offs in the first quarter of 2007 were $134,000 compared to $190,000 for the prior year’s first quarter. Net loan charge-offs to average loans (annualized) for the first quarter 2007 was 0.06% compared with 0.08% in the same quarter last year.

The improvement in the provision for loans losses resulted from the improved risk-rating profile of the loan portfolio, the lower level of net loan charge-offs, a smaller loan portfolio in comparison to a year ago and a change in the mix of the loan portfolio to loan categories with reduced credit risk.

Noninterest Income

The following table details the major categories of noninterest income for the periods presented:

		Three Months Ended
		March 31,
(Dollars in thousands)		2007				2006
Noninterest income:
Service charges on deposits		$	2,569			$	2,672
ATM and debit card income			620				534
Broker-dealer fees and commissions			383				431
Trust fees			—				194
Mortgage banking income			254				308
Income from corporate owned life insurance			20				20
Net gain on sale of student loans held for sale			112				147
Net gain on sale of commercial-related loans held for sale			—				82
Net gain on sale and disposal of other assets			57				98
Net gain on sale of trust relationships			13				—
Other			710				470
Total noninterest income		$	4,738			$	4,956

Noninterest income for the three months ending March 31, 2007 and 2006 was $4.7 million and $5.0 million, respectively.

Service charges on deposits are down 4% in the first quarter of 2007 compared with the first quarter a year ago. The decline is due in part to a decrease in transaction-type deposit accounts compared to a year ago, which was partially offset by a fee increase imposed during the second quarter of 2006.

Automated Teller Machine (“ATM”) and debit card income, which represents fees for foreign ATM usage and income associated with customer debit card purchases, totaled $620,000 and $534,000 for the three months ended March 31, 2007 and 2006, respectively. ATM and debit card income has increased as a result of higher ATM usage fees and an increase in customer utilization of debit card point-of-sale transactions.

Broker-dealer fees and commissions declined $48,000 in the first quarter of 2007 versus first quarter 2006 as a result of lower sales volumes. There were no trust fees in the three months ended March 31, 2007 versus $194,000 in the first quarter of 2006, as the Company sold its trust relationships at the end of the third quarter in 2006.

Mortgage banking income, which includes gains and losses from the sale of residential mortgage loans, mortgage servicing income and the amortization and impairment (if any) of mortgage servicing rights, have declined in 2007, reflecting both seasonal patterns and an overall slowing in residential real estate activity.

Other noninterest income increased by $240,000 to $710,000 in the first quarter of 2007 versus $470,000 for the same period a year ago, primarily the result of an increase in income in one of our Small Business Investment Company (“SBIC”) limited partnership investments.

Noninterest Expense

The following table details the major categories of noninterest expense for the periods presented:

		Three Months Ended
		March 31,
(Dollars in thousands)		2007				2006
Noninterest expense:
Salaries and employee benefits		$	8,354			$	8,758
Occupancy and equipment			2,448				2,362
Supplies and postage			438				559
Amortization of other intangible assets			77				108
Computer and data processing			457				405
Professional fees and services			495				673
Other			1,659				2,410
Total noninterest expense		$	13,928			$	15,275

Noninterest expense for the first quarter of 2007 decreased $1.4 million, or 9% to $13.9 million from $15.3 million for the first quarter of 2006. The lower expense levels reflect operational efficiencies gained from the consolidation of administrative and operational functions, improved asset quality and lower advertising costs.

For the first quarter of 2007, salaries and benefits declined $404,000 from the first quarter of 2006. This decline resulted from lower salaries expense due to reduced staffing levels and less temporary help in the first quarter of 2007 versus first quarter of 2006. The Company reduced the number of full-time equivalent employees (“FTEs”) by 4% to 634 at March 31, 2007, down from 661 at March 31, 2006. The higher level of temporary help during the first quarter of 2006 was associated with completing the December 2005 reorganization. The reduction in salaries expense was partially offset by an increase in benefits expense in the first quarter of 2007 in comparison to the same quarter a year ago, which was a result of a rise in health care costs and an increase in the Company’s 401(k) benefit plan match, offset by a decrease in unemployment insurance. In addition, salaries and benefits included $117,000 and $143,000 of management stock compensation expense (excludes director stock compensation expense) for the three months ended March 31, 2007 and 2006, respectively.

The Company experienced a 4% increase in occupancy and equipment expense in the first quarter of 2007 compared to the same quarter a year ago, primarily the result of an increase in service contracts expense. The Company has actively managed to reduce costs and lower overhead, but those efforts were more than offset by rising service contract expense and real estate taxes.

Supplies and postage are down 22% when comparing the three months ended March 31, 2007 and 2006. The decline resulted from the purchase of branding-related stationery and supplies during the first quarter of 2006 due to the reorganization.

Amortization of other intangibles declined during the first quarter of 2007 versus the same quarter a year ago as a result of certain intangible assets being fully amortized during 2006.

Computer and data processing costs increased $52,000 to $457,000 for the three months ended March 31, 2007 compared to the same quarter last year.

Professional fees have declined 26% for the three-month period ended March 31, 2007 as compared to the same period a year ago. The decline in professional fees is primarily related to lower legal and external loan review costs associated with commercial-related loans.

Other expenses have decreased 31% for the three-month period ended March 31, 2007 as compared to the same period a year ago. Advertising and promotions were down in the first quarter of 2007 compared to the prior year as a result of the major branding campaign that was initiated in the prior year due to the consolidation of our banks. In addition, lower expense in the areas of commercial and consumer loans was realized as a result of the Company’s improved underwriting process and credit quality of the loan portfolio.

The efficiency ratio was 69.53% and 69.99% for the first quarter of 2007 and 2006, respectively. The 2007 efficiency ratio, as compared to 2006, reflects the lower level of noninterest expense offset by the decline in net interest income. The efficiency ratio represents noninterest expense less other real estate expense and amortization of intangibles divided by net interest income (tax-equivalent) plus other noninterest income less net gain on sale of

trust relationships and net gain on sale of commercial-related loans held for sale.

Income Tax Provision

The income tax provision provides for Federal and New York State income taxes, which amounted to $1.1 million and $1.2 million for the three months ended March 31, 2007 and 2006, respectively. The effective tax rates recorded for the first quarter of 2007 and 2006 were comparable at 24.2% and 23.8%, respectively.

ANALYSIS OF FINANCIAL CONDITION

Lending Activities

Loans Held for Sale

Loans held for sale (not included in the table below) totaled $1.1 million and $992,000 at March 31, 2007 and December 31, 2006, respectively, all of which were residential real estate loans.

Loan Portfolio Composition

The following table sets forth selected information regarding the composition of the Company’s loan portfolio at the dates indicated:

		March 31,								December 31,
(Dollars in thousands)		2007								2006
Commercial		$	115,211				12.4	%		$	105,806				11.4	%
Commercial real estate			249,179				26.8				243,966				26.3
Agricultural			54,273				5.9				56,808				6.2
Residential real estate			162,846				17.5				163,243				17.6
Consumer indirect			107,729				11.6				106,391				11.5
Consumer direct and home equity			240,012				25.8				250,268				27.0
Total loans			929,250				100.0				926,482				100.0
Allowance for loan losses			(16,914	)							(17,048	)
Total loans, net		$	912,336							$	909,434