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ARROW FINANCIAL CORPORATION

FORM 10-K

INDEX

PART I

Item 1. Business

A. General

B. Lending Activities

C. Supervision and Regulation

D. Competition

E. Statistical Disclosure (Guide 3)

F. Legislative Developments

G. Executive Officers of the Registrant

Item 2. Properties

Item 3. Legal Proceedings

Item 4. Submission of Matters to a Vote of Security Holders

PART II

Item 5. Market for the Registrant's Common Equity and Related Stockholder Matters

Item 6. Selected Financial Data

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operation

Cautionary Statement under Federal Securities Laws

Critical Accounting Policies

Peer Group Comparisons

A. Overview

B. Results of Operations

I. Net Interest Income

II. Provision for Loan Losses and Allowance for Loan Losses

III. Other Income

IV. Other Expense

V. Income Taxes

C. Financial Condition

I. Investment Portfolio

II. Loan Portfolio

a. Distribution of Loans

b. Risk Elements

III. Summary of Loan Loss Experience

IV. Deposits

V. Time Deposits of $100,000 or More

D. Liquidity

E. Capital Resources and Dividends

F. Fourth Quarter Results

Item 7A. Quantitative and Qualitative Disclosures About Market Risk

Item 8. Financial Statements and Supplementary Data

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

PART III

Item 10. Directors and Executive Officers of the Registrant

Item 11. Executive Compensation

Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

Item 13. Certain Relationships and Related Transactions

Item 14. Controls and Procedures

PART IV

Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K

Signatures

Certifications

Exhibits Index

PART I

Item 1: Business

A. GENERAL

Arrow Financial Corporation (the "Company"), a New York corporation, was incorporated on March 21, 1983 and is registered as a bank holding company within the meaning of the Bank Holding Company Act of 1956. The Company owns two nationally chartered banks in New York, Glens Falls National Bank and Trust Company, Glens Falls, New York ("GFNB"), and Saratoga National Bank and Trust Company, Saratoga Springs, New York ("SNB"), as well as five non-bank subsidiaries, the operations of which are not significant. The Company owns directly or indirectly all voting stock of all its subsidiaries.

Our Internet address is www.arrowfinancial.com. We make available free of charge on or through our Internet website our annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission.

The business of the Company consists primarily of the ownership, supervision and control of its bank subsidiaries. The Company provides its subsidiaries with various advisory and administrative services and coordinates the general policies and operation of the subsidiary banks. There were 393 full-time equivalent employees of the Company and the subsidiary banks at December 31, 2002.

	Subsidiary Banks (dollars in thousands)
	Glens Falls National Bank & Trust Co.	Saratoga National Bank & Trust Co.
Total Assets at Year-End	$1,119,659	$158,370
Trust Assets Under Administration and Investment Management at Year-End (Not Included in Total Assets)	$611,571	$ 8,860
Date Organized	1851	1988
Employees	367	26
Offices	23	3
Counties of Operation	Warren, Washington Saratoga, Essex & Clinton	Saratoga
Main Office	250 Glen Street Glens Falls, NY	171 So. Broadway Saratoga Springs, NY

The Company offers a full range of commercial and consumer financial products. The subsidiary banks' deposit base consists of deposits derived principally from the communities which the banks serve. The banks target their lending activities to consumers and small and mid-sized companies in the banks' immediate geographic areas. Through its banks' trust departments, the Company provides retirement planning, trust and estate administration services for individuals and pension, profit-sharing and employee benefit plan administration for corporations.

B. LENDING ACTIVITIES

The Company, through its subsidiary banks engages in a wide range of lending activities, including commercial and industrial lending primarily to small and mid-sized companies; mortgage lending for residential and commercial properties; and consumer installment and home equity financing. The Company also maintains an active indirect lending program through its sponsorship of dealer programs, under which it purchases dealer paper from automobile and other dealers meeting pre-established specifications. Historically, the Company has sold a portion of its residential real estate loan originations into the secondary market, primarily to the Federal Home Loan Mortgage Corporation (Freddie Mac) and state housing agencies, while retaining the servicing rights. Loan sales into the secondary market have diminished in the past several years, however, as the Company has sought to increase its own portfolio. During 2001, the Company securitized $30.2 million of residential real estate loans. This involved the sale of the mortgage loans and the concurrent purchase of Freddie Mac guaranteed mortgage-backed securities, with the sold loans representing the underlying collateral. In addition to interest earned on loans, the Company receives facility fees for various types of commercial and industrial credits, and commitment fees for extension of letters of credit and certain types of loans.

Generally, the Company continues to implement conservative lending strategies and policies that are intended to protect the quality of the loan portfolio. These include stringent underwriting and collateral control procedures and credit review systems through which intensive reviews are conducted. It is the Company's policy to discontinue the accrual of interest on loans when the payment of interest and/or principal is due and unpaid for a designated period (generally 90 days) or when the likelihood of repayment is, in the opinion of management, uncertain (see Part II, Item 7.C.II.b., "Risk Elements"). Income on such loans is thereafter recognized only upon receipt.

The Company lends primarily to borrowers within its geographic area. The loan portfolio does not include any foreign loans or any significant risk concentrations except as described in Note 26 to the Consolidated Financial Statements in Part II, Item 8 of this report. The Company does not participate in loan syndications, either as originator or as a participant. The portfolio, in general, is fully collateralized, and many commercial loans are further secured by personal guarantees.

In 2000, the Company formed a subsidiary, North Country Investment Advisers, Inc., which is an investment adviser registered with the U. S. Securities and Exchange Commission. NCIA advises two SEC-registered mutual funds, the North Country Intermediate Bond Fund and the North Country Equity Growth Fund. Currently, the investors in these funds consist primarily of individual, corporate and institutional trust customers of the Company, but both funds intend to seek a broader distribution of fund shares in forthcoming periods, involving, among other things, retail marketing initiatives.

In 2001, the Company established a subsidiary insurance agency, NC Financial Services, Inc., which is licensed by the State of New York to sell various insurance products, including life insurance, fixed annuities and long-term health care products. The agency is headquartered in Warrensburg, New York. It is expected that the agency ultimately will operate throughout the Company's service area from multiple Company locations.

C. SUPERVISION AND REGULATION

The following generally describes the regulation to which the Company and its affiliates are subject. Bank holding companies and banks are extensively regulated under both federal and state law. To the extent that the following information summarizes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular laws and regulations. Any change in applicable law or regulation may have a material effect on the business and prospects of the Company.

The Company is a registered bank holding company within the meaning of the Bank Holding Company Act of 1956 (BHC Act) and is subject to regulation by the Board of Governors of the Federal Reserve System (Federal Reserve Board). Additionally, as a "bank holding company" under New York state law, the Company is subject to regulation by the New York State Banking Department. The two subsidiary banks are both nationally chartered banks and are subject to supervision and examination by the Office of the Comptroller of the Currency ("OCC"). The banks are members of the Federal Reserve System and the deposits of each subsidiary bank are insured by the Bank Insurance Fund of the Federal Deposit Insurance Corporation ("FDIC") up to $100,000 per depositor. The BHC Act generally prohibits the Company from engaging, directly or indirectly, in activities other than banking, activities closely related to banking, and certain other financial activities. Under the BHC Act, a bank holding company must obtain Federal Reserve Board approval before acquiring, directly or indirectly, 5% or more of the voting shares of another bank or bank holding company (unless it already owns a majority of such shares). Bank holding companies are able to acquire banks or other bank holding companies located in all 50 states, and 48 of the 50 states permit banks headquartered in other states to branch into their states, although in some cases only by acquisition of existing banks in such states. As a result of the Gramm-Leach-Bliley Act, bank holding companies are now permitted to affiliate with a much broader array of other financial institutions than was previously permitted, including insurance companies, investment banks and merchant banks. See Item 1.F., "Legislative Developments."

An important area of banking regulation is the establishment by federal regulators of minimum capitalization standards. The Federal Reserve Board has adopted various "capital adequacy guidelines" for its use in the examination and supervision of bank holding companies. The risk-based capital guidelines assign risk weightings to all assets and certain off-balance sheet items and establish an 8% minimum ratio of qualified total capital to the aggregate dollar amount of risk-weighted assets (which is almost always less than the dollar amount of such assets without risk weighting). At least half of total capital must consist of "Tier 1" capital, which comprises common equity, retained earnings and a limited amount of permanent preferred stock, less goodwill. Up to half of total capital may consist of so-called "Tier 2" capital, comprising a limited amount of subordinated debt, other preferred stock, certain other instruments and a limited amount of the allowance for loan losses. The Federal Reserve Board's other important guideline for measuring a bank holding company's capital is the leverage ratio standard, which establishes minimum limits on the ratio of a bank holding company's "Tier 1" capital to total tangible assets (not risk-weighted). For top-rated holding companies, the minimum leverage ratio is 3%, but lower-rated companies may be required to meet substantially greater minimum ratios. The subsidiary banks are subject to similar capital requirements adopted by their primary federal regulator, the Office of the Comptroller of the Currency.

Under applicable law, federal banking regulators are required to take prompt corrective action with respect to depository institutions that do not meet minimum capital requirements. The regulators have established five capital classifications for banking institutions, the highest being "well capitalized." Under regulations adopted by the federal bank regulators, a banking institution is considered "well capitalized" if it has a total risk-adjusted capital ratio of 10% or greater, a Tier 1 risk-adjusted capital ratio of 6% or greater and a leverage ratio of 5% or greater and is not subject to any regulatory order or written directive regarding capital maintenance. The Company and each of its subsidiary banks currently qualify as "well capitalized." The year-end 2002 capital ratios of the Company and its subsidiary banks are set forth in Part II, Item 7.E. "Capital Resources and Dividends."

A holding company's ability to pay dividends or repurchase its outstanding stock, as well as its ability to expand its business through acquisitions of additional banking organizations or permitted non-bank companies, may be restricted if capital falls below these minimum capitalization standards or other informal capital guidelines that the regulators may apply from time to time to specific banking organizations. In addition to these potential regulatory limitations on the payment of dividends, the Company and its subsidiary banks' ability to pay dividends is subject to various restrictions under applicable corporate laws. The ability of the Company and the banks to pay dividends in the future is, and is expected to continue to be, influenced by regulatory policies, capital guidelines and applicable law.

In cases where banking regulators have significant concerns regarding the financial condition, assets or operations of a bank or bank holding company, the regulators may take enforcement action or impose enforcement orders, formal or informal, against the organization. Neither the Company nor any of its subsidiaries is now, or has been within the past year, subject to any formal or informal regulatory enforcement action or order.

D. COMPETITION

The Company faces intense competition in all markets it serves. Traditional competitors are other local commercial banks, savings banks, savings and loan institutions and credit unions, as well as local offices of major regional and money center banks. Also, non-banking financial organizations, such as consumer finance companies, insurance companies, securities firms, money market and mutual funds and credit card companies offer substantive equivalents of transaction accounts and various loan and financial products, even though these non-banking organizations are not subject to the same regulatory restrictions and capital requirements that apply to the Company and its subsidiary banks. As a result of the Gramm-Leach-Bliley Act (discussed further in Part I.1.F., below), such non-banking financial organizations now may be in a position not only to offer comparable products to those offered by the Company, but actually to establish, acquire or affiliate with commercial banks themselves.

E. STATISTICAL DISCLOSURE

Set forth below is an index identifying the location in this Report of various items of statistical information required to be included in this Report by the SEC's industry guide for Bank Holding Companies.

Required Information	Location in Report
Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates and Interest Differential	Part II, Item 7.B.I.
Investment Portfolio	Part II, Item 7.C.I.
Loan Portfolio	Part II, Item 7.C.II.
Summary of Loan Loss Experience	Part II, Item 7.C.III.
Deposits	Part II, Item 7.C.IV.
Return on Equity and Assets	Part II, Item 6.
Short-Term Borrowings	Part II, Item 8. Note 9.

F. LEGISLATIVE DEVELOPMENTS

The Sarbanes-Oxley Act (the "Act"), signed into law on July 30, 2002, adopted a wide range of measures applicable to publicly-traded companies. Generally, the Act seeks to improve the quality of financial reporting of these companies, strengthen the independence of their auditors, and compel them to adopt good corporate governance practices. The Act places substantial additional duties on directors, officers, auditors and attorneys of public companies. Among other specific measures, the Act requires that chief executive officers and chief financial officers certify periodically to the SEC regarding the accuracy of the company's financial statements and the integrity of its internal controls. The Act also accelerates insiders' reporting obligations for transactions in company securities, restricts certain executive officer and director transactions, imposes new obligations on corporate audit committees, and provides for enhanced review of company filings by the SEC. As part of the general effort to improve public company auditing, the Act placed limits on consulting services that may be performed by a company's independent auditors and creates a public company accounting oversight board, which will set auditing standards, inspect registered public accounting firms, and possess enforcement powers, subject to oversight by the SEC.

In November 1999, Congress enacted the Gramm-Leach-Bliley Act ("GLBA"), which permitted bank holding companies to engage in a wider range of financial activities. Under GLBA for example, bank holding companies may underwrite all types of insurance and annuity products and all types of securities products and mutual funds, and may engage in merchant banking activities. Bank holding companies that wish to engage in these or other newly-permitted financial activities generally must do so through separate "financial" subsidiaries and may themselves be required to register (and qualify to register) as so-called "financial holding companies." A bank holding company that does not register as a financial holding company will remain a bank holding company subject to substantially the same regulatory restrictions and permitted activities as applied to bank holding companies prior to GLBA (See Part I.1.C., "Supervision and Regulations," above). The Company has not yet elected to become a "financial holding company" but continues to evaluate the opportunities provided by GLBA. Under GLBA, as well as the Fair Credit Reporting Act amendment of 1996, all financial institutions have become subject to more stringent customer privacy regulations.

In 1995, the federal bank regulatory authorities promulgated a set of revised regulations addressing the responsibilities of banking organizations under the Community Reinvestment Act ("CRA"). The revised regulations place additional emphasis on the actual experience of a bank in making loans in low- and moderate-income areas within its service area as a key determinant in evaluation of the bank's compliance with the statute. As in the prior regulations, bank regulators are authorized to bring enforcement actions against banks under the CRA only in the context of bank expansion or acquisition transactions.

The FDIC levies assessments on various deposit obligations of the Company's banking subsidiaries. Since 1996, the premium paid by the best-rated banks (including the Company's subsidiary banks) has been a flat charge of $2 thousand per year. Also in that year, Congress enacted the Deposit Insurance Funds Act, under which deposits insured by the Bank Insurance Fund ("BIF"), such as the deposits of the Company's banks, are subject to assessment for payment on bond obligations financing the FDIC's Savings Association Insurance Fund ("SAIF") at a rate 1/5 the rate paid on deposits by SAIF-insured thrift institutions. Accordingly, the deposits of the Company's banks were assessed an additional 1.160 cents per $100 of insured deposits in 1999, 1.220 cents per $100 of insured deposits in 1998 and an additional 1.256 cents in 1997. Beginning in 2000, the BIF and SAIF rates were equalized. For institutions with the lowest risk classification (including the Company) the BIF rate increased to 2.120 and the SAIF rate decreased from 5.800 to 2.120. The rate is adjusted quarterly, depending on the need of the fund. At December 31, 2002 the rate had decreased to 1.680 cents per $100 of insured deposits.

Various federal bills that would significantly affect banks are introduced in Congress from time to time. The Company cannot estimate the likelihood of any currently pending banking bills being enacted into law, or the ultimate effect that any such potential legislation, if enacted, would have upon its financial condition or operations.

G. EXECUTIVE OFFICERS OF THE REGISTRANT

The names and ages of the executive officers of the Company and positions held by each are presented in the following table. The officers are elected annually by the Board of Directors.

Name	Age	Positions Held and Years from Which Held
Thomas L. Hoy	54	President and CEO since January 1, 1997 and President and CEO of Glens Falls National Bank since 1995. Mr. Hoy was Executive Vice President of Glens Falls National Bank prior to 1995. Mr. Hoy has been with the Company since 1974.
John J. Murphy	51	Executive Vice President, Treasurer and CFO since 1993. Mr. Murphy has served as Senior Vice President, Treasurer and CFO of the Company since 1983. Mr. Murphy has been with the Company since 1973.
John C. Van Leeuwen	59	Senior Vice President and Chief Credit Officer since 1995. Prior to 1995, Mr. Van Leeuwen served as Vice President and Loan Review Officer. Mr. Van Leeuwen has been with the Company since 1985.
Gerard R. Bilodeau	56	Senior Vice President and Secretary since 1994. Mr. Bilodeau was Vice President and Secretary from 1993 to 1994 and was Director of Personnel prior to 1993. Mr. Bilodeau has been with the Company since 1969.

Item 2: Properties

The Company is headquartered at 250 Glen Street, Glens Falls, New York. The building is owned by the Company's subsidiary, Glens Falls National Bank, and serves as the bank's main office. Glens Falls National Bank owns nineteen additional offices and leases three others at market rates. The Company's other subsidiary bank, Saratoga National Bank, owns its three offices. Rental costs of premises did not exceed 5% of operating costs in 2002.

In the opinion of management of the Company, the physical properties of the Company and the subsidiary banks are suitable and adequate.

Item 3: Legal Proceedings

The Company is not the subject of any material pending legal proceedings, other than ordinary routine litigation occurring in the normal course of its business.

On an ongoing basis, the Company's subsidiary banks are the subjects of or parties to various legal claims which arise in the normal course of their business. The various pending legal claims against the subsidiary banks will not, in the opinion of management based upon consultation with counsel, result in any material liability.

Item 4: Submission of Matters to a Vote of Security Holders

None in the fourth quarter of 2002.

PART II

Item 5: Market for the Registrant's Common Equity and Related Stockholder Matters

The common stock of Arrow Financial Corporation is traded on The Nasdaq Stock Market^SM under the symbol AROW.

The high and low prices listed below represent actual sales transactions, as reported by Nasdaq, and have been restated for the November 2002 five percent stock dividend.

	Sales Price		Cash Dividends Declared
	Low	High
2001
First Quarter	$16.327	$21.429	$.190
Second Quarter	17.574	23.129	.209
Third Quarter	20.907	27.102	.209
Fourth Quarter	25.952	28.571	.219
2002
First Quarter	$26.667	$28.810	$.219
Second Quarter	26.524	34.210	.238
Third Quarter	26.695	34.505	.238
Fourth Quarter	24.810	34.970	.250

The payment of dividends by the Company is at the discretion of the Board of Directors and is dependent upon, among other things, the Company's earnings, financial condition and other factors, including applicable legal and regulatory restrictions. See "Capital Resources and Dividends" in Part II, Item 7.E. of this report.

There were approximately 2,915 holders of record of common stock at December 31, 2002. The Company has no other class of stock outstanding.

Item 6: Selected Financial Data

FIVE YEAR SUMMARY OF SELECTED DATA

Arrow Financial Corporation and Subsidiaries

(Dollars In Thousands, Except Per Share Data)

Consolidated Statements of Income Data:		2002	2001	2000	1999	1998
Interest and Dividend Income		$75,145	$78,357	$75,624	$67,135	$63,033
Interest Expense		25,106	33,172	37,368	29,266	28,142
Net Interest Income		50,039	45,185	38,256	37,869	34,891
Provision for Loan Losses		2,288	2,289	1,471	1,424	1,386
Net Interest Income After Provision for Loan Losses		47,751	42,896	36,785	36,445	33,505
Other Income 1		11,213	10,324	10,784	9,382	8,172
Net Gains (Losses) on Securities Transactions		100	195	(595)	(4)	408
Other Expense 2		31,397	30,544	27,582	27,298	24,506
Income Before Provision for Income Taxes		27,667	22,871	19,392	18,525	17,579
Provision for Income Taxes		8,773	7,055	5,711	5,666	5,744
Net Income		$18,894	$15,816	$13,681	$12,859	$11,835
Earnings Per Common Share: 3
Basic		$ 2.37	$ 1.97	$ 1.70	$ 1.53	$ 1.36
Diluted		2.32	1.94	1.69	1.51	1.34
Per Common Share: 3
Cash Dividends		$ .95	$ .83	$ .73	$ .66	$ .59
Book Value		12.78	11.42	10.11	8.82	8.99
Tangible Book Value 4		11.56	10.17	8.74	7.37	7.50
Consolidated Year-End Balance Sheet Data:
Total Assets		$1,271,421	$1,151,007	$1,081,354	$1,001,107	$939,029
Securities Available-for-Sale		326,661	251,694	229,026	228,364	267,731
Securities Held-to-Maturity		74,505	74,956	60,580	55,467	63,016
Loans		811,292	755,124	735,769	655,820	546,126
Nonperforming Assets		2,756	3,798	2,630	2,745	3,592
Deposits		958,007	885,498	858,925	795,197	775,597
Federal Home Loan Bank Advances		145,000	115,000	85,200	85,000	45,000
Other Borrowed Funds		53,498	42,645	42,697	36,021	24,032
Shareholders' Equity		101,402	91,504	80,781	72,287	77,146
Selected Key Ratios:
Return on Average Assets		1.55%	1.41%	1.30%	1.33%	1.36%
Return on Average Equity		19.49	18.17	18.60	17.02	15.51
Dividend Payout		40.95	42.65	43.01	43.98	43.78

¹ Other Income in 2000 includes the net gain on the sale of the credit card portfolio of $825.

² Amortization of goodwill was discontinued effective January 1, 2002 upon the third quarter adoption of SFAS No. 147.

³ Per share amounts have been adjusted for subsequent stock splits and dividends, including the most recent November 2002 five percent stock dividend.

⁴ Tangible book value excludes from total equity intangible assets, primarily goodwill and intangible assets associated with prior branch purchases.

Item 7: Management's Discussion and Analysis of Financial Condition and Results of Operations

Cautionary Statement under Federal Securities Laws: The information contained in this Annual Report on Form 10-K contains statements that are not historical in nature but rather are based on management's beliefs, assumptions, expectations, estimates and projections about the future. These statements are "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, and involve a degree of uncertainty and attendant risk. Words such as "expects," "believes," "anticipates," "estimates" and variations of such words and similar expressions are intended to identify such forward-looking statements. Some of these statements, such as those included in the interest rate sensitivity analysis in section 7A, below, entitled "Quantitative and Qualitative Disclosures About Market Risk," are merely presentations of what future performance or changes in future performance would look like based on hypothetical assumptions and on simulation models. Others are based on management's general perceptions of market conditions and trends in activity, both locally and nationally, as well as current management strategies for future operations and development.

Examples of forward-looking statements in this Report are referenced in the table below:

Topic	Section	Page	Location
Impact of Legislative Developments	Part I, Item 1.F.	7	Last sentence
Impact of Changing Interest Rates on Earnings	Part II, Item 7.C.II.a.	29	1st Paragraph, 1st sentence
	Part II, Item 7.C.IV.	35	Last paragraph in item "IV. DEPOSITS"
Adequacy of the Allowance for Loan Losses	Part II, Item 7.B.II.	18	5th paragraph
	Part II, Item 7.C.III.	33	2nd paragraph under the "ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES"
Liquidity	Part II, Item 7.D.	37	Last paragraph in "D. LIQUIDITY"

These statements are not guarantees of future performance and involve certain risks and uncertainties that are difficult to quantify or, in some cases, to identify. In the case of all forward-looking statements, actual outcomes and results may differ materially from what the statements predict or forecast.

Factors that could cause or contribute to such differences include, but are not limited to, unexpected changes in economic and market conditions, including unanticipated fluctuations in interest rates; new developments in state and federal regulation; enhanced competition from unforeseen sources; new emerging technologies; unexpected loss of key personnel; and similar risks inherent in banking operations or business generally. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to revise or update these forward-looking statements to reflect the occurrence of unanticipated events.

Critical Accounting Policies: In order to prepare the Company's consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, management was required to make estimates and assumptions that affected the amounts reported in these statements. There are uncertainties inherent in making these estimates and assumptions which could materially affect the results of operations and financial position. Management considers the allowance for loan losses and liabilities for retirement plans to be critical accounting policies. The adequacy of the allowance for loan losses is sensitive to changes in current economic conditions that may make it difficult for borrowers to meet their contractual obligations. A severe downward trend in the economy, regional or national, may require the Company to increase the allowance for loan losses resulting in a negative impact on its results of operations and financial condition. The Company has a variety of pension and retirement plans. Liabilities under these plans rely on estimates of future salary increases, numbers of employees and employee retention, discount rates and long-term rates of investment return. Changes in these assumptions due to changes in the financial markets, the economy or the Company's own operations may result in material changes to the Company's results of operations and financial condition.

The following discussion and analysis focuses on and reviews the Company's results of operations for each of the years in the three-year period ended December 31, 2002 and the financial condition of the Company as of December 31, 2002 and 2001. The discussion below should be read in conjunction with the consolidated financial statements and other financial data presented elsewhere herein.

A. OVERVIEW

Summary of 2002 Financial Results

The Company reported net income of $18.9 million for 2002 an increase of $3.1 million, or 19.5%, compared to net income of $15.8 million for 2001. Diluted earnings per share increased $.38, or 19.6%, from 2001 to 2002 and $.25, or 14.8%, from 2000 to 2001. The increase in net income between 2001 and 2002 was primarily attributable to an 11.0% increase in net interest income between the two years, itself attributable primarily to a comparable increase in average earning assets.

Selected Financial Information:

(Dollars In Thousands, Except Per Share Amounts)

Per share amounts have been restated for the 2002 five percent stock dividend.

	2002	2001	2000
Net Interest Income (tax-equivalent basis)	$52,179	$47,026	$39,856
Net Securities Gains (Losses)	100	195	(595)
Goodwill and Intangible Asset Amortization 1	37	944	944
Net Income	18,894	15,816	13,681
Diluted Average Shares Outstanding	8,156	8,153	8,091
Diluted Earnings Per Share	$2.32	$1.94	$1.69
Cash Dividends	.95	.83	.73
Stock Dividends	5%	5%	---
Core Diluted Earnings Per Share 2	$2.29	$1.92	$1.68
Average Assets	$1,216,381	$1,122,605	$1,051,525
Average Earning Assets	1,158,490	1,066,240	992,957
Average Paying Liabilities	970,128	897,737	849,620
Average Equity	96,952	87,035	73,552
Return on Average Assets	1.55%	1.41%	1.30%
Return on Average Equity	19.49	18.17	18.60
Net Interest Margin 3	4.50	4.41	4.01
Efficiency Ratio 4	49.47	51.61	52.60
Tangible Book Value per Share 5	$11.56	$10.17	$8.74
Net Loans Charged-off as a Percentage of Average Loans	.11%	.17%	.08%
Provision for Loan Losses as a Percentage of Average Loans	.30	.31	.21
Allowance for Loan Losses as a Percentage of Period-end Loans	1.38	1.29	1.19
Allowance for Loan Losses as a Percentage of Nonperforming Loans	436.89	282.72	424.67
Nonperforming Loans as a Percentage of Period-end Loans	.32	.46	.28
Nonperforming Assets as a Percentage of Period-end Total Assets	.22	.33	.24

¹ Amortization of goodwill was discontinued, effective January 1, 2002, upon the adoption of SFAS No. 147.

² Core Diluted Earnings Per Share excludes gains/losses on securities and OREO transactions and one-time material non-recurring items of income and

expense. The amounts necessary to reconcile reported net income to core net income for 2002, 2001 and 2000 include (net of tax): securities

gains (losses) ($60, $116 and $(352)), OREO transactions ($14, $61 and $17), non-recurring other income of $158 in 2002, gain on the sale of credit card

loans of $488 in 2000 and non-recurring other expense of $51 in 2000.

³ Net Interest Margin is the ratio of tax-equivalent net interest income to average earning assets.

⁴ The Efficiency Ratio is the ratio of noninterest expense less goodwill and other intangible asset amortization to the sum of tax-

equivalent net interest income and other income less net securities gains or losses.

⁵ Tangible Book Value is calculated based on total equity less intangible assets, including goodwill associated with prior

branch acquisitions.

Peer Group Comparisons: At certain points in the ensuing discussion and analysis, the Company's performance is compared with that of its peer group of financial institutions. Peer data has been obtained from the Federal Reserve Board's "Bank Holding Company Performance Report." Unless otherwise specifically stated, the Company's peer group is comprised of the group of 166 domestic bank holding companies with $1 to $3 billion in total consolidated assets.

At December 31, 2002, the Company's tangible book value per share (calculated based on shareholders' equity reduced by intangible assets including goodwill, mortgage servicing rights and intangible pension plan assets) amounted to $11.56, an increase of $1.39, or 13.7%, from year-end 2001. The increase was primarily attributable to retained earnings and net unrealized gains, net of tax, on securities available-for-sale during 2002, offset in part by periodic repurchases of the Company's common stock. As of the last trading day of 2002, the average of the Company's bid and asked stock price was $30.80, resulting in a trading multiple of 2.66 to tangible book value.

The Board of Directors increased the quarterly cash dividend twice in 2002, to $.25 per share by the fourth quarter. Total cash dividends (as adjusted) were $.95 for 2002, compared to $.83 for 2001, an increase of $.12 or 14.5%.

Nonperforming loans amounted to $2.6 million at December 31, 2002, a decrease of $876 thousand from the prior year-end. Loans charged-off (net of recoveries) against the allowance for loan losses were $815 thousand for 2002, as compared to $1.3 million for the prior year. At year-end 2002, the allowance for loan losses, at $11.2 million, represented a coverage ratio to total loans of 1.38%, as compared to 1.29% at the prior year-end.

Sale of Credit Card Portfolio and Servicing Business in 2000

Prior to 2000, the Company serviced its own credit card portfolio as well as the credit card portfolios for several smaller financial institutions. In 2000, the Company determined that it would no longer engage in the consumer credit card servicing business and that it would sell the business as well as its existing consumer credit card balances to MBNA America Bank, N.A., an organization widely recognized as an industry leader. The decision to discontinue this activity was driven by the fact that the consumer credit card business, including both card issuance and account servicing, has increasingly become a commodity operation that requires great scale. Management also expected that its credit card customers would receive a broader array of account benefits and services under MBNA's programs after the sale, and such has been the case. The sale, which resulted in a net gain of $825 ($488 net of tax), was completed in the third quarter of 2000. The Company continues to manage its merchant credit card and debit card programs.

B. RESULTS OF OPERATIONS

The following analysis of net interest income, the provision for loan losses, noninterest income, noninterest expense and income taxes, highlights the factors that are primarily responsible for the Company's results of operations for 2002 and the prior two years.

I. NET INTEREST INCOME (Tax-equivalent Basis)

Net interest income represents the difference between interest and dividends earned on loans, securities and other earning assets and interest paid on deposits and other sources of funds. Changes in net interest income result from changes in the level and mix of earning assets and sources of funds (volume) and changes in the yields earned and interest rates paid (rate). Net interest margin is the ratio of net interest income to average earning assets. Net interest income may also be described as the product of average earning assets and the net interest margin.

COMPARISON OF NET INTEREST INCOME

(Dollars In Thousands) (Tax-equivalent Basis)

		Years Ended December 31,			Change From Prior Year
					2002		2001
		2002	2001	2000	Amount	%	Amount	%
Interest and Dividend Income		$77,285	$80,198	$77,224	$(2,913)	(3.6)%	$ 2,974	3.9%
Interest Expense		25,106	33,172	37,368	(8,066)	(24.3)	(4,196)	(11.2)
Net Interest Income		$52,179	$47,026	$39,856	$ 5,153	11.0	$ 7,170	18.0

On a tax-equivalent basis, net interest income was $52.2 million in 2002, an increase of $5.2 million, or 11.0%, from $47.0 million in 2001. This compared to a $7.2 million, or 18.0%, increase between 2000 and 2001. Factors contributing to the increase in net interest income are discussed in the following section.

ANALYSIS OF CHANGES IN NET INTEREST INCOME

The following table presents net interest income components on a tax-equivalent basis and reflects changes between periods attributable to movement in either the average daily balances or average rates for both earning assets and interest-bearing liabilities. Changes attributable to both volume and rate have been allocated proportionately between the categories.

CHANGE IN NET INTEREST INCOME

(In Thousands) (Fully Taxable Basis)

		2002 Compared to 2001			2001 Compared to 2000
		Change in Net Interest Income			Change in Net Interest Income
		Due to:			Due to:
Interest and Dividend Income:		Volume	Rate	Total	Volume	Rate	Total
Federal Funds Sold		$ ---	$ (452)	$ (452)	$ 597	$ (154)	$ 443
Securities Available-for-Sale:
Taxable		2,740	(2,602)	138	4	(1,268)	(1,264)
Non-Taxable		399	(22)	377	67	(26)	41
Securities Held-to-Maturity:
Taxable		(3)	(6)	(9)	2	2	4
Non-Taxable		535	(310)	225	512	34	546
Loans		2,129	(5,321)	(3,192)	4,081	(877)	3,204
Total Interest and Dividend Income		5,800	(8,713)	(2,913)	5,263	(2,289)	2,974
Interest Expense:
Deposits:
Interest-Bearing NOW Deposits		1,298	(1,251)	47	529	(1,561)	(1,032)
Regular and Money Market Savings		664	(2,233)	(1,569)	276	(811)	(535)
Time Deposits of $100,000 or More		(1,988)	(1,959)	(3,947)	(777)	(2,015)	(2,792)
Other Time Deposits		126	(2,650)	(2,524)	(231)	(628)	(859)
Total Deposits		100	(8,093)	(7,993)	(203)	(5,015)	(5,218)
Short-Term Borrowings		141	(737)	(596)	58	(578)	(520)
Long-Term Debt		812	(289)	523	1,941	(399)	1,542
Total Interest Expense		1,053	(9,119)	(8,066)	1,796	(5,992)	(4,196)
Net Interest Income		$4,747	$ 406	$5,153	$3,467	$3,703	$7,170

The following table reflects the components of the Company's net interest income, setting forth, for years ended December 31, 2002, 2001 and 2000 (I) average balances of assets, liabilities and shareholders' equity, (II) interest and dividend income earned on earning assets and interest expense incurred on interest-bearing liabilities, (III) average yields earned on earning assets and average rates paid on interest-bearing liabilities, (IV) the net interest spread (average yield less average cost) and (V) the net interest margin (yield) on earning assets. Rates are computed on a tax-equivalent basis. The yield on securities available-for-sale is based on the amortized cost of the securities. Nonaccrual loans are included in average loans, while unearned income has been eliminated.

AVERAGE CONSOLIDATED BALANCE SHEETS AND NET INTEREST INCOME ANALYSIS

Arrow Financial Corporation and Subsidiaries

(Fully Taxable Basis using a marginal tax rate of 35%)

(Dollars In Thousands)

Years Ended December 31	2002			2001			2000
		Interest	Rate		Interest	Rate		Interest	Rate
	Average	Income/	Earned/	Average	Income/	Earned/	Average	Income/	Earned/
	Balance	Expense	Paid	Balance	Expense	Paid	Balance	Expense	Paid
Federal Funds Sold	$ 19,418	$ 308	1.59%	$ 19,410	$ 760	3.92%	$ 5,125	$ 317	6.19%
Securities Available-
for-Sale:
Taxable	277,657	14,236	5.13	228,588	14,098	6.17	228,530	15,362	6.72
Non-Taxable	11,119	547	4.92	3,053	170	5.57	1,904	129	6.78
Securities Held-to-Maturity:
Taxable	544	33	6.07	593	42	7.08	560	38	6.79
Non-Taxable	74,456	4,753	6.38	66,278	4,528	6.83	58,779	3,982	6.77
Loans	775,296	57,408	7.40	748,318	60,600	8.10	698,059	57,396	8.22
Total Earning Assets	1,158,490	77,285	6.67	1,066,240	80,198	7.52	992,957	77,224	7.78
Allowance For Loan Losses	(10,556)			(9,038)			(8,301)
Cash and Due From Banks	31,386			28,850			25,802
Other Assets	37,061			36,553			41,067
Total Assets	$1,216,381			$1,122,605			$1,051,525
Deposits:
Interest-Bearing NOW Deposits	$ 282,365	4,431	1.57	$ 209,719	4,384	2.09	$ 189,667	5,416	2.86
Regular and Money Market Savings	230,039	3,170	1.38	198,573	4,739	2.39	188,303	5,274	2.80
Time Deposits of $100,000 or More	81,770	2,269	2.77	135,982	6,216	4.57	149,834	9,008	6.01
Other Time Deposits	201,253	7,543	3.75	198,745	10,067	5.07	203,116	10,926	5.38
Total Interest-Bearing Deposits	795,427	17,413	2.19	743,019	25,406	3.42	730,920	30,624	4.19
Short-Term Borrowings	39,468	562	1.42	34,711	1,158	3.34	33,515	1,678	5.01
Long-Term Debt	135,233	7,131	5.27	120,007	6,608	5.51	85,185	5,066	5.95
Total Interest- Bearing Funds	970,128	25,106	2.59	897,737	33,172	3.70	849,620	37,368	4.40
Demand Deposits	132,208			122,618			114,062
Other Liabilities	17,093			15,215			14,291
Total Liabilities	1,119,429			1,035,570			977,973
Shareholders' Equity	96,952			87,035			73,552
Total Liabilities and Shareholders' Equity	$1,216,381			$1,122,605			$1,051,525
Net Interest Income (Fully Taxable Basis)		52,179			47,026			39,856
Reversal of Tax Equivalent Adjustment		(2,140)			(1,841)			(1,600)
Net Interest Income		$50,039			$45,185			$38,256
Net Interest Spread			4.08%			3.82%			3.38%
Net Interest Margin			4.50%			4.41%			4.01%

CHANGES IN NET INTEREST INCOME DUE TO RATE

YIELD ANALYSIS		December 31,
		2002	2001	2000
Yield on Earning Assets		6.67%	7.52%	7.78%
Cost of Interest-Bearing Liabilities		2.59	3.70	4.40
Net Interest Spread		4.08%	3.82%	3.38%
Net Interest Margin		4.50%	4.41%	4.01%

Of the $5.2 million increase in net interest income in 2002 over the prior year, $4.7 million was attributable to increased volume of earning assets and only $406 thousand to rate change (i.e., the fact that the cost of deposits and other funds decreased at a faster rate than the yield on earning assets). This contrasted with the prior year, when rate changes generated a $3.7 million increase in net interest income out of a total increase of $7.2 million.

The following items have a major impact on changes in net interest income due to rate: general interest rate changes, the ratio of the Company's rate sensitive assets to rate sensitive liabilities (interest rate sensitivity gap) during periods of interest rate changes and the level of nonperforming loans. The Federal Reserve Board attempts to influence prevailing federal funds and prime interest rates and sets changes to the Federal Reserve Bank discount rate. The following chart presents rate changes in recent years:

Key Interest Rate Changes 1999 - 2002

		Federal
Date	Discount Rate	Funds Rate	Prime Rate
November 6, 2002	.75%	1.25%	4.25%
December 11, 2001	1.25	1.75	4.75
November 6, 2001	1.50	2.00	5.00
October 2, 2001	2.00	2.50	5.50
September 17, 2001	2.50	3.00	6.00
August 21, 2001	3.00	3.50	6.50
June 27, 2001	3.25	3.75	6.75
May 15, 2001	3.50	4.00	7.00
April 18, 2001	4.00	4.50	7.50
March 20, 2001	4.50	5.00	8.00
January 31, 2001	5.00	5.50	8.50
January 3, 2001	5.50	6.00	9.00
May 16, 2000	6.00	6.50	9.50
March 21, 2000	5.50	6.00	9.00
February 2, 2000	5.25	5.75	8.75
November 16, 1999	5.00	5.50	8.50
August 25, 1999	4.75	5.25	8.25
June 30, 1999	4.50	5.00	8.00

The Company's net interest income, for the past several years, has been very sensitive to changes in interest rates. As indicated in the table above, prevailing interest rates economy-wide began to increase in the second half of 1999 through the second half of 2000. This marked a turnaround from a long period of flat or slowly-declining prevailing interest rates. The 1999 rate hikes had a moderate negative impact on the Company's financial results for 1999, which continued to show decreases from prior periods in the average rate earned on earning assets and the average rate paid on earning liabilities, as well as decreases in the Company's net interest spread and net interest margin. However, the full and negative impact of rising rates was felt in 2000, when the decrease in net interest income due to rates was significant.

In the first quarter of 2001, the Federal Reserve Board reversed direction and began decreasing short-term interest rates rapidly and significantly in response to perceived weakening in the economy. By December 2001, the total decrease in prevailing short-term interest rates for the year was 475 basis points. After eleven months with no rate changes, the Federal Reserve Board decreased rates another 50 basis points in November 2002. As a result, the Company experienced a decrease in the cost of deposits in all quarters of 2001 and 2002. Although decreases in deposit rates began to be experienced in the first quarter of 2001, the Company did not experience a decrease in the average yield in its loan portfolio until the second quarter of 2001. Since that time, yields on the loan portfolio have decreased each successive quarter in 2001 and 2002, as well. See the "Loan Portfolio" section in the discussion of "Financial Condition" later on in this Report, for a more complete analysis of yield trends in the loan portfolio.

When the Federal Reserve Board decreased short-term interest rates by 50 basis points in November 2002, this decrease had a limited impact on the Company's deposit rates, because rates on several of the Company's deposit products, such as savings and NOW accounts, were already priced at such low levels that a 50 basis point decrease in rates was not practical or sustainable, although the Company did lower rates to a much smaller extent on certain non-maturity deposit products.

Most important, the decreasing rate environment had a positive impact on net interest income during 2001 and 2002, as net interest margins increased both years.

The net interest margin for 2002 was 4.50%, an increase of 9 basis points from the 4.41% margin for 2001. The net interest spread between the two years increased by 26 basis points. These increases in margin and spread were attributable to the fact that during a period of decreasing market rates the Company's paying liabilities repriced downward at a faster rate than its earning assets. In turn, a major factor influencing this development was the relocation of a significant dollar amount of maturing time deposits into other lower cost deposit accounts, a relocation that often accompanies falling interest rates but also often proves temporary.

In both rising and falling rate environments, the Company faces significant competitive pricing pressures in its marketplace for both deposits and loans, and thus ultimately both assets and liabilities may be expected to reprice proportionately in response to changes in market rates.

The net interest margin for 2001 was 4.41%, an increase of 40 basis points from the 4.01% margin for 2000. The net interest spread between the two years increased by 44 basis points. As in 2002, these significant increases in margin and spread were attributable to the fact that during a period of decreasing market rates the Company's paying liabilities repriced downward at a faster rate than its earning assets.

A discussion of the impact on net interest income resulting from changes in interest rates vis a vis the repricing patterns of the Company's earning assets and interest-bearing liabilities is included later in this report under Item 7A, "Quantitative and Qualitative Disclosures About Market Risk."

CHANGES IN NET INTEREST INCOME DUE TO VOLUME

AVERAGE BALANCES

(Dollars In Thousands)

		Years Ended December 31,			Change From Prior Year
					2002		2001
		2002	2001	2000	Amount	%	Amount	%
Earning Assets		$1,158,490	$1,066,240	$992,957	$92,250	8.7%	$73,283	7.4%
Interest-Bearing Liabilities		970,128	897,737	849,620	72,391	8.1	48,117	5.7
Demand Deposits		132,208	122,618	114,062	9,590	7.8	8,556	7.5
Total Assets		1,216,381	1,122,605	1,051,525	93,776	8.4	71,080	6.8
Earning Assets to Total Assets		95.24%	94.98%	94.43%	.26%	0.3	.55%	0.6

In general, changes in the volume of earning assets and interest-bearing liabilities will result in corresponding changes in net interest income. That is, as assets and liabilities increase, so will net interest income. However, changes due to volume can be enhanced or restricted by shifts within the relative mix of earning assets or interest-bearing liabilities between instruments of different rates. The change in net interest income due to changes in volume was an increase of $4.7 million in 2002 and an increase of $3.5 million in 2001.

During 2002, average earning assets increased $92.3 million, an increase of 8.7%. Average paying liabilities grew at a somewhat slower pace, increasing by $72.4 million, or 8.1%. The combined effect of these changes in volume was to increase net interest income by approximately 10.0%, before giving effect to the 1.0% positive impact on net interest income resulting from the change in interest rates discussed in the previous section.

During 2002, the Company experienced its growth in average earning assets primarily within the investment portfolio (which accounted for approximately 71% of the increase) and secondarily within the loan portfolio (approximately 29%). While it is the intention of the Company ultimately to invest the greatest portion of its earning assets into high quality loans, most of the increase in the sources of funds from December 31, 2001 to December 31, 2002 was redeployed, at least for the present, into the investment securities portfolio. As reported on the Consolidated Statement of Cash Flows, the cash flow received from the maturities and calls of securities in the available-for-sale portfolio amounted to $91.3 million for 2002. Most of these cash flows are from the monthly amortization of mortgage-backed securities. Among other needs, this cash flow is available to fund loan growth or for redeployment in the available-for-sale portfolio.

The fastest growing segment of the loan portfolio for several years preceding 2001 was indirect consumer loans, which are primarily auto loans financed through local dealerships from whom the Company acquires the dealer paper. While this segment still represents the largest portion of the loan portfolio, the outstanding balances of indirect loans remained little changed at year-end 2002 from year-end 2001 and 2000. For 2002, the average balances of indirect loans were actually $12.4 million below the average balances for 2001, as the portfolio experienced a net decrease prior to recovering in the fourth quarter of 2002. The increase in the average loan balances from 2001 to 2002 was attributable to the residential real estate ($25.3 million) and the commercial loan ($17.9 million) portfolios.

The Company's $72.4 million growth in average paying liabilities in 2002 was experienced primarily in traditional banking deposit products, which increased by $52.4 million, or 7.1%, from year-end 2001 to year-end 2002, and secondarily in Federal Home Loan Bank (FHLB) borrowings, which increased by $15.2 million, or 13.2%, from year-end 2001 to year-end 2002. The increase in deposit balances during 2002 was generated by the Company's pre-existing branch network, although the Company's Saratoga National Bank and Trust Company franchise did open its third branch (the second branch in Saratoga Springs) at the beginning of 2002. No other branches were added or acquired in 2002.

During 2001, average earning assets increased $73.3 million, an increase of 7.4%. Average paying liabilities grew at a somewhat slower pace, increasing by $48.1 million, or 5.7%. The combined effect was to increase net interest income by approximately 8.7%, before giving effect to the positive impact on net interest income resulting from the change in interest rates discussed in the previous section.

In 2001 (unlike in 2002) the Company experienced its growth in average earning assets principally within the loan portfolio. During 2001, the Company securitized approximately $30 million of residential real estate loan balances and retained ownership of the resulting mortgage-backed securities for the purpose of providing additional liquidity and collateral for pledging purposes. Without the securitization, increases in loan balances would have represented over 70% of the increase in average earning assets between the two years.

The outstanding balances of indirect consumer loans remained little changed at year-end 2001 from year-end 2000. During 2001, adjusted for reductions of loans through securitizations, residential real estate loans increased $32.8 million, or 15.5%. Commercial loans increased by $21.3 million, or 17.4%, representing the other area of significant growth within the loan portfolio.

The Company's growth in average paying liabilities in 2001 was experienced both in traditional banking deposit products, which increased by $26.6 million, or 3.1%, from year-end 2000 to year-end 2001, and in borrowings, which increased by $29.8 million, or 35.0%, from year-end 2000 to year-end 2001. The increase in deposit balances during 2001 was generated by the Company's pre-existing branch network. No branches were added or acquired in 2001. The primary source of new borrowings by the Company in 2001 was advances from the FHLB (see Note 10 to the Consolidated Financial Statements in Part II, Item 8 of this report).

Increases in the volume of loans and deposits, as well as yields and costs by type, are discussed later in this report under Item 7.C. "Financial Condition."

II. PROVISION FOR LOAN LOSSES AND ALLOWANCE FOR LOAN LOSSES

Management considers its accounting policy relating to the allowance for loan losses to be a critical accounting policy given the inherent uncertainty involved in evaluating the level of the allowance required to cover credit losses inherent in the loan portfolio, and the material effect that such judgments can have on the Company's results of operations. See Note 1 to the consolidated financial statements, as well as the discussion below, for a description of the Company's policy with respect to estimating the level of the allowance for loan losses.

Through the provision for loan losses, an allowance (reserve) is maintained for estimated loan losses. Actual loan losses are charged against this allowance when loans are deemed uncollectible. In evaluating the adequacy of the allowance for loan losses, management considers various risk factors influencing asset quality. The analysis is performed on a loan by loan basis for impaired and large balance loans, and by portfolio type for smaller balance homogeneous loans. This analysis is based on judgments and estimates and may change in response to economic developments or other conditions that may influence borrowers' financial conditions or prospects.

The determination of actual provisions for loan losses on an ongoing basis is largely influenced by the prevailing level of nonperforming loans, the level of loans actually charged-off against the allowance for loan losses during the prior periods, contemporary changes in the mix and volume of loan categories within the loan portfolio and overall changes in the size of the portfolio.

The quality of the Company's loan portfolio remains strong and, to date, has not been negatively affected either by the loan growth experienced in recent periods or by the recent weakening in the national and regional economy. At period-end, the ratio of nonperforming loans (loans 90 days or more and accruing interest plus nonaccrual loans) as a percentage of total loans was .32% for the Company. The September 30, 2002 ratio for the Company's peer group was .77%.

While management believes that the 2002 year-end allowance was adequate under the circumstances, there can be no assurances that future economic or financial developments, including general interest rate increases or a slowdown in the economy, might not lead to increased provisions to the allowance or a higher incidence of loan charge-offs.

The provision for loan losses was $2.3 million for 2002, virtually unchanged from 2001. During 2002, loan losses charged against the allowance, net of recoveries, were $815 thousand, a decrease of $481 thousand, or 37.1%, from the 2001 amount. During the second quarter of 2001, the Company charged-off $512 thousand on one commercial loan. Disregarding this item, net charge-offs for 2002 increased by $31 thousand, or 4.0%, over 2001. Net charge-offs as a percentage of average loans outstanding was .11% for 2002. Net charge-offs, on an annualized basis, for the Company's peer group at September 30, 2002 was .27% of average loans, or 145.5% higher than the Company's ratio. If the current economic recession continues or worsens, management anticipates that net charge-offs will exceed the levels experienced in recent years.

At December 31, 2002, nonperforming loans amounted to $2.6 million, a decrease of $876 thousand, or 25.5%, from the balance at year-end 2001. The decrease was primarily attributable to one $749 thousand commercial loan that was designated as nonperforming at year-end 2001, which was paid-off in full by the borrower during December 2002. While nonperforming loans and net loans charged-off improved in 2002, as compared to 2001, the continued growth in the loan portfolio resulted in the 2002 provision for loan losses remaining consistent with 2001.

At December 31, 2002, the allowance for loan losses was $9.7 million, or 1.38%, of total loans, as compared to $8.7 million, or 1.29% of total loans at December 31, 2001. The allowance for loan losses represented 437% of the amount of nonperforming loans at December 31, 2002, as compared to 283% of nonperforming loans at December 31, 2001.

During 2001, loan losses charged against the allowance, net of recoveries, were $1.3 million, an increase of $768 thousand, or 145%, from the prior year amount. During the second quarter of 2001, the Company charged-off $512 thousand on one commercial loan. Management believes that the factors that led to this charge-off were unique and isolated and are not indicative of any emerging pattern of increasing charge-offs above historical levels.

Net charge-offs as a percentage of average loans outstanding was .17% for 2001. The provision for loan losses, as a percentage of average loans outstanding was .31% for 2001. Net charge-offs, on an annualized basis, for the Company's peer group at September 30, 2001 was .26% of average loans, or 52.9% higher than the Company's ratio.

At December 31, 2001, nonperforming loans amounted to $3.4 million, an increase of $1.4 million, or 67.3%, from the balance at year-end 2000. The increase was primarily attributable to two commercial loans, totaling $1.6 million, which were placed on nonaccrual status during the fourth quarter of 2001.

The provision for loan losses was $1.5 million for 2000, an increase of $47 thousand, or 3.3%, from 1999. At December 31, 2000, nonperforming loans amounted to $2.1 million, essentially unchanged from the balance at December 31, 1999. At December 31, 2000, the allowance for loan losses was $8.7 million, or 1.19% of total loans. The allowance for loan losses represented 425% of the amount of nonperforming loans at that date. During 2000, loan losses charged against the allowance, net of recoveries, were $528 thousand, or .08%, of average loans for the period, an increase of $146 thousand, or 38%, from the prior year amount. The principal reason for the increase in net loan losses in 2000 as compared with 1999 was a recovery of $315 thousand in the 1999 period related to the final repayment of a large commercial loan. Excluding the large recovery, net loan losses for 1999 would have exceeded those for 2000, and would have represented .12% of average loans. The provision for loan losses charged to expense for 2000 was $1.5 million, or .21%, of average loans for the period.

SUMMARY OF THE ALLOWANCE AND PROVISION FOR LOAN LOSSES

(Dollars In Thousands) (Loans, Net of Unearned Income)

Years-Ended December 31,		2002	2001	2000	1999	1998
Loans at End of Period		$ 811,292	$ 755,124	$ 735,769	$ 655,820	$546,126
Average Loans		775,296	748,318	698,059	600,719	514,348
Total Assets at End of Period		1,271,421	1,151,007	1,081,354	1,001,107	939,029
Nonperforming Assets:
Nonaccrual Loans:
Construction		$ ---	$ ---	$ ---	$ ---	$ ---
Commercial Real Estate		69	87	94	50	191
Commercial Loans		375	1,610	161	147	671
Residential Real Estate Loans		516	469	572	873	1,049
Consumer Loans		1,511	1,034	930	720	359
Total Nonaccrual Loans		2,471	3,200	1,757	1,790	2,270
Loans Past Due 90 or More Days and
Still Accruing Interest		91	238	298	307	657
Restructured Loans in Compliance with
Modified Terms		---	---	---	---	---
Total Nonperforming Loans		2,562	3,438	2,055	2,097	2,927
Repossessed Assets		143	66	150	62	38
Other Real Estate Owned		51	294	425	586	627
Total Nonperforming Assets		$ 2,756	$ 3,798	$ 2,630	$ 2,745	$3,592
Allowance for Loan Losses:
Balance at Beginning of Period		$ 9,720	$ 8,727	$ 7,784	$ 6,742	$6,191
Loans Charged-off:
Commercial, Financial
and Agricultural		(24)	(653)	(42)	(75)	(166)
Real Estate - Commercial		---	---	(20)	(33)	(43)
Real Estate - Construction		---	(2)	(2)	---	---
Real Estate - Residential		(37)	(103)	(29)	(64)	(133)
Installment Loans to Individuals		(1,060)	(883)	(764)	(861)	(836)
Total Loans Charged-off		(1,121)	(1,641)	( 857)	(1,033)	(1,178)
Recoveries of Loans Previously Charged-off:
Commercial, Financial
and Agricultural		33	65	34	326	19
Real Estate - Commercial		17	16	15	18	---
Real Estate - Construction		---	---	---	---	---
Real Estate - Residential		3	21	11	12	23
Installment Loans to Individuals		253	243	269	295	301
Total Recoveries of Loans Previously Charged-off		306	345	329	651	343
Net Loans Charged-off		(815)	(1,296)	(528)	(382)	(835)
Provision for Loan Losses
Charged to Expense		2,288	2,289	1,471	1,424	1,386
Balance at End of Period		$11,193	$ 9,720	$ 8,727	$ 7,784	$6,742
Nonperforming Asse