2. Earnings Per Share

The review that follows focuses on the significant factors affecting the financial condition and results of operations of Chemung Financial Corporation (the "Corporation") during the three and nine month periods ended September 30, 2004, with comparisons to the comparable periods in 2003, as applicable. The following discussion and the unaudited consolidated interim financial statements and related notes included in this report, should be read in conjunction with our 2003 Annual Report on Form 10-K. The results for the periods presented are not necessarily indicative of results to be expected for the entire fiscal year or any other interim period.

Forward-looking Statements

This 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 materi ally 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 sig nificant 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 September 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 $11.8 million decrease in cash and cash equivalents, due 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 $12.0 million or 3.1% from December 31, 2003 to September 30, 2004. This decrease is primarily related to management's decision during the third quarter to sell the consumer credit card portfolio as well as certain non-performing and potential problem commercial loans. Accordingly, approximately $11.0 million of loans were reclassified during the quarter as held for sale. In regard to the consumer credit card portfolio, the Corporation entered into an agreement during the third quarter with TCM Bank, N.A. (TCM) to sell approximately $7.6 million in consumer credit card accounts. TCM specializes in credit card financing and administration. The decision to sell this portfolio was motivated by the increasing cost of processing and administration associated with the credit card portfolio, as well as TCM's ability to offer enhancements to our credit card holders. Following the sale, the Corporation, through a three-y ear participation agreement with TCM, will participate in the funding of 45.0% of the portfolio. This will provide the Corporation with ongoing revenue from the credit card portfolio, without the expense of processing and administration. We will also continue to offer credit cards under the Bank's name, acting as an agent for TCM. This sale will take place during the fourth quarter, and the Corporation expects to realize a total gain on the sale of this portfolio of approximately 16.5% of the amount sold.

As noted above, management also decided during the quarter to sell certain non-performing and potential problem commercial loans. Accordingly, during the quarter, these loans were written-down to the lower of cost or estimated fair value, which resulted in a charge to the allowance for loan losses of $772 thousand during the quarter. The carrying value of these loans, now classified as held for sale, totals $3.3 million. It is expected that these loans will be sold during the fourth quarter, and the Corporation does not anticipate this transaction to have a material impact on fourth quarter operating results. Aside from the impact of the above, loans were down $1.0 million since the beginning of the year. Approximately $5.2 million of this decrease was in commercial loans, including commercial mortgages, impacted in part by a $3.7 million decrease in floor plan balances. This decrease was primarily related to the sale of automobile dealerships during 2004 with whom we had a floor plan relationship. While mortgage activity has been fairly steady through the first nine months of 2004, total residential mortgages have decreased approximately $1.3 million since the end of 2003. In total, the consumer loan portfolio, excluding the transfer of consumer credit cards to held for sale, has grown $5.3 million during the first nine months of 2004, impacted primarily by increases in consumer installment and student loans of $2.1 million and $2.3 million, respectively. In addition to the above noted areas, home equity outstandings have increased $1.1 million since the beginning of the year.

The composition of the loan portfolio is summarized as follows:

The available for sale segment of the securities portfolio totaled $281.3 million at September 30, 2004, compared to $282.9 million at the end of 2003, a decrease of approximately $1.6 million or 0.6%. Unrealized appreciation related to the available for sale portfolio has increased $136 thousand since the beginning of the year. At amortized cost, the available for sale portfolio was down $1.7 million since December 31, 2003. This decrease is primarily reflected in a $14.4 million decrease in mortgage-backed securities, offset primarily by a $13.6 million increase in federal agency bonds. During the first nine months of 2004, the Corporation purchased approximately $44.8 million of federal agency bonds, with approximately $28.2 million of federal agency bonds being called. Additionally, the Corporation sold a $3.0 million federal agency bond in March, realizing a pre-tax gain on the sale of $219 thousand. Although the Corporation has purchased approximately $15.0 million of mortgage-backed securities du ring the first nine months of this year, this portfolio has 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 $15.4 million at amortized cost as of September 30, 2004, an increase of $2.3 million since December 31, 2003.

Deposits at September 30, 2004 totaled $527.2 million, a decrease of $23.8 million or 4.3% as compared to December 31, 2003. While period-end non-interest bearing demand deposits were down $4.1 million, most of the decrease in deposits was due to a $19.7 million reduction in interest bearing balances. This decrease in interest bearing balances was impacted primarily by lower insured money market, and time balances, offset to some extent by higher savings account balances. The decrease in interest bearing balances from December 31, 2003 to September 30, 2004 reflects the fact that in the absence of loan growth during the first nine months of 2004, the Corporation has not been aggressive in the pricing of these deposit products. The $11.0 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: