2. Earnings Per Share

Forward-looking Statements

This Management's Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. The Corporation intends its forward-looking statements to be covered by the safe harbor provisions for forward-looking statements in these sections. All statements regarding the Corporation's expected financial position and operating results, the Corporation's business strategy, the Corporation's financial plans, forecasted demographic and economic trends relating to the Corporation's industry and similar matters are forward-looking statements. These statements can sometimes be identified by our use of forward-looking words such as "may," "will," "anticipate," "estimate," "expect," or "intend." The Corporation cannot promise you that its expectations in such forward-looking statements will turn out to be correct. The Corporation's actual results could be materially different from its expectations because of various factors, including credit risk, interest rate risk, competition, changes in the regulatory environment, and changes in general business and economic trends.

Critical accounting policies include the areas where the Corporation has made what it considers to be particularly difficult, subjective or complex judgments in making estimates, and where these estimates can significantly affect the Corporation's financial results under different assumptions and conditions. The Corporation prepares its financial statements in conformity with accounting principles generally accepted in the United States. As a result, the Corporation is required to make certain estimates, judgements and assumptions that it believes are reasonable based upon the information available. These estimates, judgements and assumptions affect the reported amounts of assets and liabilities at the date of the financial statement and the reported amounts of revenue and expenses during the periods presented. Actual results could be different from these estimates.

Management considers the accounting policy relating to the allowance for loan losses to be a critical accounting policy given the inherent uncertainty in evaluating the level of the allowance required to cover probable credit losses inherent in the loan portfolio, and the material effect that such judgments can have on the Corporation's results of operations. While management's current evaluation of the allowance for loan losses indicates that the allowance is adequate, under adversely different conditions or assumptions, the allowance would need to be increased. For example, if historical loan loss experience significantly worsened or if current economic conditions significantly deteriorated, additional provisions for loan losses would be required to increase the allowance. In addition, the assumptions and estimates used in the internal reviews of the Corporation's non-performing loans and potential problem loans, and the associated evaluation of the related collateral coverage for these loans, has a signif icant impact on the overall analysis of the adequacy of the allowance for loan losses. While management has concluded that the current evaluation of collateral values is reasonable under the circumstances, if collateral evaluations were significantly lowered, the Corporation's allowance for loan losses policy would also require additional provisions for loan losses.

Consolidated assets at June 30, 2004 totaled $734.2 million, a decrease of $13.0 million or 1.7% since the beginning of the year. This reduction is reflected primarily in the $14.3 million decrease in cash and cash equivalents, due in large part to the $12.4 million decrease in federal funds sold. This decrease is directly related to the decrease in period-end deposits, as will be further discussed in this analysis.

Total loans, net of unearned income and deferred fees and costs, decreased by $2.6 million or 0.7% from December 31, 2003 to June 30, 2004. Approximately $1.4 million of this decrease was in the consumer loan portfolio, affected primarily by a decrease of $2.1 million in consumer installment loans, offset to some extent primarily by an $804 thousand increase in student loans. The installment loan decrease continues to be impacted by the extremely competitive pricing environment for indirect auto loans. The residential mortgage portfolio has decreased $424 thousand during the first six months of 2004, and total commercial loans, including commercial mortgages were down $710 thousand, impacted by a $1.6 million decrease in floor plan balances.

The composition of the loan portfolio is summarized as follows:

The available for sale segment of the securities portfolio totaled $283.8 million at June 30, 2004, compared to $282.9 million at the end of 2003, an increase of approximately $900 thousand or 3.2%. Unrealized appreciation related to the available for sale portfolio decreased $5.5 million since the beginning of the year, reflective of the impact on the bond portfolio of higher mid to long term rates. At amortized cost, the available for sale portfolio was up $6.4 million since year-end 2003. This increase is primarily reflected in a $13.6 million increase in federal agency bonds, offset to some extent primarily by a $6.2 million decrease in mortgage-backed securities. During the first six months of 2004, the Corporation purchased approximately $44.8 million of federal agency bonds, with approximately $28.2 million of agency bonds being called. Additionally, the Corporation sold a $3.0 million agency bond in March, realizing a pre-tax gain on the sale of $219 thousand. Although the Corporation purchased appro ximately $15.2 million of mortgage-backed securities during the first six months of this year, this portfolio declined due to the level of paydowns in the portfolio. The held to maturity segment of the portfolio, consisting primarily of local municipal obligations, totaled $14.9 million at amortized cost as of June 30, 2004, an increase of $1.8 million since year-end 2003.

A $2.1 million increase in other assets is related primarily to an increase in net deferred tax assets since the beginning of 2004.

Deposits at June 30, 2004 totaled $531.8 million, a decrease of $19.3 million or 3.5% as compared to December 31, 2003. While period-end non-interest bearing demand deposits were down $5.2 million, most of the decrease in deposits was due to a $14.1 million reduction in interest bearing balances. This decrease in interest bearing balances was impacted primarily by lower insured money market, time and Now account balances, offset to some extent by higher savings account balances. The decrease in interest bearing balances from December 31, 2003 to June 30, 2004 reflects the fact that in the absence of loan growth during the first half of 2004, the Corporation has not been aggressive in the pricing of these deposit products. The $10.9 million increase in securities sold under agreements to repurchase reflects an increase in security purchases leveraged with repurchase agreements through the Federal Home Loan Bank of New York.

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

In addition to non-performing loans, as of June 30, 2004, the Corporation, through its loan review function, has identified 23 commercial loan relationships totaling $17.249 million in potential problem loans, as compared to $16.874 million (22 relationships) at December 31, 2003. Potential problem loans are loans that are currently performing, but where known information about possible credit problems of the related borrowers causes management to have serious doubts as to the ability of such borrowers to comply with the present loan repayment terms, and which may result in the disclosure of such loans as non-performing at some time in the future. At the Corporation, potential problem loans are typically loans that are performing but are classified in the Corporation's loan rating system as "substandard". Management cannot predict the extent to which economic conditions may worsen or other factors which may impact borrowers and the potential problem loans. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on non-accrual, become restructured, or require increased allowance coverage and provisions for loan losses.

Management's evaluation of the adequacy of the allowance for loan losses is performed on a periodic basis and takes into consideration such factors as the historical loan loss experience, review of specific problem loans (including evaluation of the underlying collateral), changes in the composition and volume of the loan portfolio, overall portfolio quality, and current economic conditions that may affect the borrowers' ability to pay. During 2002 and 2003, the Corporation significantly increased the allowance for loan losses through an increased provision for loan loss expense in light of continuing loan quality issues related to the impact of a weak local economic environment on several large commercial relationships. With the level of non-performing relationships beginning to stabilize, and seeing some positive indications of improving business conditions for these clients, the Corporation reduced its provision for loan losses during the second quarter of 2004 to $333 thousand as compared to $1.6 million during the second quarter of 2003. The year-to-date provision of $833 thousand is down $1.367 million compared to the first six months of 2003. At June 30, 2004, the Corporation's allowance for loan losses totaled $10.322 million, resulting in a coverage ratio of allowance to non-performing loans of 90.3%. The allowance for loan losses is an amount that management believes will be adequate to absorb probable loan losses on existing loans. Net loan charge-offs for the first six months of 2004 totaled $359 thousand as compared to $2.118 million during the first half of 2003. This $1.759 million decrease was due primarily to lower commercial loan charge-offs, as during the first quarter of 2003, the Corporation charged-off $1.9 million of a commercial relationship. The allowance for loan losses to total loans at June 30, 2004 was 2.66% as compared to 2.52% as of December 31, 2003.