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2. Basic Earnings Per Share

4. Intangible Assets

Forward-looking Statements

Statements included in this report include "forward-looking statements" made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995, and are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected. Chemung Financial Corporation cautions readers not to place undue reliance on any such forward-looking statements, which speak only as of the date made. The following important factors, among others, could cause Chemung Financial Corporation's actual financial performance to differ materially from that expressed in any forward-looking statement: (1) credit risk, (2) interest rate risk, (3) competition, (4) changes in the regulatory environment, and (5) changes in general business and economic trends. The foregoing list should not be construed as exhaustive, and, except as may be required by law, the Corporation disclaims any obligation to subsequently revise any f orward-looking statements to reflect events or circumstances after the date of such statements, or to reflect the occurrence of anticipated or unanticipated events.

Critical accounting policies are those most important to the portrayal of the Corporation's financial condition and results of operations, and those that require management's most difficult, subjective or complex judgments. 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 actual 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, t he assumptions and estimates used in the internal loan 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 significant impact on the overall analysis of the adequacy of the allowance for loan losses. While management has concluded that the estimated values of collateral are reasonable based upon the evaluations performed under the current circumstances, if estimated collateral values were significantly lowered, the Corporation's allowance for loan losses policy would also require additional provisions for loan losses.

Consolidated assets at June 30, 2003 totaled $755.3 million, an increase of $4.1 million or 0.5% since the beginning of the year. Total loans, net of unearned income and deferred fees and costs, decreased by $14.7 million or 3.4% from December 31, 2002 to June 30, 2003. Approximately $7.9 million of this decrease is in the residential mortgage portfolio, and can be attributed to the fact that with interest rates at historically low levels, we have been selling more mortgages in the secondary mortgage market. The decrease in net loans was also impacted by the fact that student loans are down $4.5 million. During the second quarter, we sold our entire student loan portfolio to Sallie Mae. This was done due to the fact that Sallie Mae is no longer offering the option of owning and servicing these loans until they enter repayment status. Therefore, we converted our student loan program to a new third party processor, which will allow us to hold and service these loans as in the past. We expect the outs tanding balances in this portfolio to build back up to the previous level of approximately $4.0-$4.5 million over the next 12-18 months. Total commercial loans, including commercial mortgages, have decreased $1.8 million since the beginning of the year, as the volume in this portfolio has been impacted by weakness in the economy. In addition, the Corporation charged-off $1.9 million of a commercial loan relationship in the first quarter, which also contributed to the decrease. Excluding the decrease in the student loan portfolio, all other consumer loans have decreased $563 thousand primarily due to decreases of $1.4 million and $419 thousand in installment loans and credit card balances, respectively. These declines have been somewhat offset by a $1.2 million increase in home equity loans.

The composition of the loan portfolio is summarized as follows:

The Available for Sale segment of the securities portfolio totaled $228.7 million at June 30, 2003, compared to $257.2 million at the end of 2002, a decrease of $28.5 million. At amortized cost, the available for sale segment of the securities portfolio is down $28.8 million since year-end. This decrease is primarily related to the current low rate environment and the fact that with rates continuing at such low levels, approximately $37.2 million in federal agency bonds were called during the first half of 2003. Additionally, paydowns of mortgage-backed securities during the first half of 2003 totaled $40.2 million. We have remained somewhat cautious in this rate environment and have reduced our re-investing of these funds in longer term investments, which, along with a decline in loans and an increase in deposits, have been the primary factors for our federal funds sold and interest bearing deposits position totaling $48.6 million at June 30, 2003, compared to overnight borrowings of $15.8 million at yea r-end 2002. Since mid-June, the yield curve steepened, with mid to long-term treasury rates increasing approximately 100 basis points. With this steepening of the yield curve, during July we settled on the purchase of a combination of shorter duration mortgage-backed securities, treasury bonds and callable agency bonds totaling $20.0 million, $5.0 million and $15.0 million, respectively. We have also committed to purchase $10.0 million in mortgage-backed securities and $15.0 million in federal agency bonds which will settle in August. The pre-tax valuation adjustment for net unrealized gains has increased $280 thousand since the beginning of the year, reflective primarily of an increase in the market value of equities held in the portfolio. The Held to Maturity segment of the portfolio, consisting primarily of local municipal obligations, totaled $8.8 million at June 30, 2003, an increase of $1.0 million since year-end 2002.

Deposits at June 30, 2003 totaled $566.5 million, an increase of $24.7 million or 4.6% as compared to December 31, 2002. Approximately $10.8 million of this increase is in period-end public funds deposit balances (primarily local municipal deposits). Other period end balances increased $13.9 million, primarily the result of higher savings and non-interest bearing demand deposit account balances. The $15.8 million decrease in Federal Home Loan Bank advances reflects the repayment of overnight advances under our line of credit that were outstanding as of year-end 2002. Securities sold under agreements to repurchase are down $4.0 million, primarily due to a lower volume of investments leveraged with term repurchase agreements through the Federal Home Loan Bank.

Other liabilities were down $2.2 million, primarily due to the payment of previously accrued federal and state income taxes during the first quarter of 2003.

At December 31, 2002, the Corporation's available for sale securities portfolio included an investment in a $2.50 million par value corporate bond which was downgraded by nationally recognized rating agencies in July of 2002 to below investment grade status. Management had determined that the resulting decline in the estimated fair value of the bond was other-than-temporary, and accordingly had written the bond down to its estimated fair value, and placed the bond in non-accrual status. The write-down of the bond to 51.5% of par value resulted in a charge to earnings during the third quarter of 2002 of $1.006 million. During the first quarter of 2003, $1.0 million of this bond was sold at 85% of par, and $500 thousand was sold at 92.5% of par, resulting in first quarter gains of $540 thousand. The remaining $1.0 million was sold early in the second quarter of 2003 at 92.5% of par, resulting in an additional second quarter gain on the sale of $410 thousand.

In addition to non-performing loans, as of June 30, 2003, the Corporation, through its loan review function, has identified 23 commercial loan relationships totaling $19.615 million as potential problem loans, as compared to $8.131 million (19 relationships) at December 31, 2002. This increase is due primarily to the addition of two commercial relationships totaling $10.851 million. 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". In August 2003, a $2.3 million commercial relationship included in the above po tential problem loan total was placed in non-accrual status as a result of financial information received by the Corporation subsequent to quarter end, which revealed a deterioration in the borrower's financial condition. 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.

Given the level of non-performing and classified relationships at June 30, 2003, and in consideration of certain relationships which were downgraded during the quarter ended June 30, 2003, as well as the continued weakness that the Corporation sees in its primary market areas, the Corporation increased its provision for loan losses during the second quarter of 2003 to $1.6 million as compared to $350 thousand during the second quarter of 2002. Year to date, the provision has increased $1.5 million, from $700 thousand to $2.2 million. The allowance for loan losses is an amount that management believes will be adequate to absorb probable loan losses on existing loans. 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 por tfolio quality, and current economic conditions that may affect the borrowers' ability to pay. At June 30, 2003, the Corporation's allowance for loan losses totaled $7.756 million, resulting in a coverage ratio of allowance to non-performing loans of 86.69%. An internal review of non-performing loans and associated collateral coverage indicates that the current coverage ratio is adequate. Net loan charge-offs for the first half of 2003 totaled $2.118 million as compared to $276 thousand during the first half of 2002. This increase was due primarily to the above noted charge-off of $1.9 million on a commercial relationship, offset to some extent primarily by lower net consumer loan charge-offs. The allowance for loan losses to total loans at June 30, 2003 was 1.86% as compared to 1.78% as of December 31, 2002.

Activity in the allowance for loan losses was as follows:

At June 30, 2003, no loan concentrations to borrowers engaged in the same or similar industries exceeded 10% of total loans.

As noted above, the quarterly results were negatively impacted by a $456 thousand or 6.7% decrease in net interest income from $6.788 million in the second quarter of 2002 to $6.332 million in the second quarter of 2003. This decrease was impacted by lower average loans and securities during the quarter, as well as the declining rate environment. While average earning assets were up slightly by $4.6 million or 0.7% as compared to the second quarter of 2002, total interest and dividend income decreased $1.556 million or 13.9% as the average yield declined 95 basis points from 6.58% to 5.63%. Average loans for the quarter were down $9.3 million or 2.2% as compared to the second quarter of 2002, with the yield declining 55 basis points to 6.69%. The decrease in average loans was due primarily to decreases in average mortgages (- $8.1 million) and consumer loans (- $4.6 million), offset to some extent by a $3.4 million increase in average commercial loans. The decrease in average mortgages relates to the fa ct that in the current rate environment, much of our originated mortgages are being sold in the secondary mortgage market. Decreases in consumer loans are primarily the result of the previously mentioned sale of our student loan portfolio as well as lower average indirect auto loans, impacted by an extremely competitive rate environment. Average balances in our securities portfolio were down $12.7 million or 5.3%, with the yield decreasing 122 basis points to 4.45%. This decrease in average securities is related to the rate environment during the quarter, and, as was noted previously, we have remained somewhat cautious of investing in longer-term securities at these interest rate levels. Due to the decrease in average loans and securities, coupled with an increase in average deposits, our average fed funds sold and interest-bearing deposits increased $26.6 million when compared to the second quarter of last year. While this level of overnight investments yielding 1.19% clearly impacts short-term results , given the rate environment during the quarter, we felt it best to remain cautious and not take on undue interest rate risk associated with longer-term investment alternatives. As noted earlier in this report, in July we were able to take advantage of the steepening of the yield curve and improve earning asset yields through the purchase of approximately $65.0 million of shorter duration mortgage-backed securities, treasury bonds and callable agency bonds for the securities portfolio.

Total average funding liabilities have increased $5.6 million or 0.9% when compared to the second quarter of 2002. Average deposits, when compared to the second quarter of last year, are up $14.9 million or 2.8%. Average personal account balances increased $9.4 million, reflected primarily in higher average demand deposit, insured money market and savings balances. All other average deposit balances are up $5.5 million primarily due to higher average non-personal demand deposit and insured money market balances. All other funding liabilities on average were down $9.3 million, the primary factor being an $8.2 million decrease in term repurchase agreements through the Federal Home Loan Bank. While average funding sources increased $5.6 million, interest expense decreased $1.100 million or 24.8% as the cost of funds, including the effect of non-interest bearing funding sources (such as demand deposits) declined 69 basis points from 2.72% to 2.03%. The above yields and costs resulted in a net interest margi n during the second quarter of 2003 of 3.69% as compared to 3.98% during the second quarter of 2002.

Non-interest income increased $275 thousand or 8.7% from $3.156 million in the second quarter of 2002 to $3.432 million in the second quarter of this year. Net gains on securities transactions were up $410 thousand due to the gain realized during the quarter on the sale of the remaining portion of a previously classified non-performing corporate bond. Additionally, service charges increased $361 thousand, reflective of fee changes instituted during the fourth quarter of 2002, as well as the introduction of a courtesy pay program in the second quarter of this year. These increases were somewhat offset by a decrease in trust and investment services income (- $199 thousand), and a decrease in other income, which relates to decreases in non-taxable gains on stock donations (- $167 thousand) and income from our equity investment in Cephas Capital Partners, L.P. (-$159 thousand). Trust and investment services income was adversely impacted by the decline in the market value of assets under management, with much of the second quarter revenue based upon March 31, 2003 market values. The decrease in non-taxable gains on stock donations reflects the fact that the Corporation made accelerated payments on certain planned capital campaign contributions to non-profit organizations during the second quarter of last year. Lower income from the above equity investment reflects a higher level of loan loss provisions at Cephas Capital Partners, L.P.

Operating expenses were $203 thousand or 3.1% lower than the comparable period last year. Salaries and wages, and pension and other employee benefits are down $229 thousand. The $59 thousand decrease in salaries and wages reflects a reduction of nine average full time equivalent employees (FTE's) compared to a year ago. While net periodic pension expense has increased $39 thousand, and post-retirement medical benefits are up $28 thousand from the second quarter of 2002, these increases have been offset primarily by decreases in bonus and profit sharing expense of $38 thousand and $204 thousand, respectively. The decrease in operating expenses was also significantly impacted by a $166 thousand decrease in credit card and merchant deposit services processing costs, primarily related to a decline in credit card merchant deposit volume. Depreciation expense has increased $76 thousand when compared to the second quarter of last year, reflective of the continuing investment in property and equipment.

The $404 thousand decrease in income tax expense is primarily due to lower pre-tax earnings.

Net income for the six month period ended June 30, 2003 totaled $3.443 million, a 15.9% decrease as compared to June 30, 2002 results. Earnings per share declined 11.8% from $1.02 to $0.90 per share on 172,799 fewer average shares outstanding. As was the case with second quarter results, the year-to-date results have been impacted primarily by a $1.5 million increase in the provision for loan losses as well as a decrease in net interest income of $651 thousand, partially offset by a $705 thousand increase in net gains on securities transactions.

Total average funding liabilities have increased $9.3 million or 1.4% due to a $14.0 million or 2.6% increase in average deposits. While average public fund balances (primarily local municipal deposits) were down $4.8 million compared to the first half of 2002, all other deposits increased on average $18.8 million. Personal deposits on average were up $11.5 million, primarily due to increases in average insured money market and savings balances. The remainder of the average deposit increase is reflected primarily in non-personal insured money market balances. All other average funding liabilities were down $4.7 million, much of this decrease related to lower average securities sold under agreements to repurchase, reflecting a reduced level of securities leveraged with term repurchase agreements through the Federal Home Loan Bank. While average funding liabilities increased $9.3 million, interest expense year-to-date was $1.992 million lower than last year as the cost of funds, including the impact of no n-interest bearing funding sources (such as demand deposits), declined 65 basis points from 2.76% to 2.11%. The resulting net interest margin for the first six months of 2003 of 3.77% was 25 basis points lower than the margin for the first half of 2002.

Non-interest income was $722 thousand or 12.3% higher than a year ago. Net gains on securities transactions have increased $705 thousand resulting from gains realized on the sale of a corporate bond that had been classified as non-performing. Also having a significant impact on the increase in non-interest income was a $518 thousand increase in service charge revenue for reasons stated above. As was the case with the second quarter results, these increases were somewhat offset primarily by decreases in trust and investment services income (- $216 thousand), non-taxable gains on stock donations (- $171 thousand) and income from our equity investment in Cephas Capital Partners, L.P. (- $159 thousand).

Operating expenses year-to-date are $435 thousand or 3.4% lower than a year ago. This reduction in operating expenses has been impacted by a $289 thousand decrease in salaries and wages, and pension and other employee benefits. Approximately $114 thousand of this decrease is due to lower salaries, as the average number of full time equivalent employees (FTE's) has been reduced by nine as compared to average FTE's during the first six months of last year. While net periodic pension expense and post-retirement medical benefits have increased $168 thousand and $56 thousand, respectively, these increases have been partially offset by reductions in bonus and profit sharing accruals of $106 thousand and $253 thousand, respectively. The increase in the 2003 net periodic pension expense is based upon actuarial estimates of future benefit obligations related to the plan, and has resulted primarily from the impact of a declining stock market on asset values, compensation increases and the discount rate used in cal culating future benefit obligations. Additionally, year-to-date credit card and merchant deposit services processing costs are down $332 thousand. The above significant expense reductions have been somewhat offset primarily by a $153 thousand increase in depreciation expense.

Income tax expense is down $344 thousand, primarily due to the reduced level of pre-tax income during the first half of 2003.

Average Consolidated Balance Sheet and Interest Analysis (Dollars in thousands)

For the purpose of these computations, non-accruing loans are included in the daily average loan amounts outstanding. Daily balances were used for average balance computations. Investment securities are stated at amortized cost. No tax equivalent adjustments have been made in calculating yields on obligations of states and political subdivisions.

The following table sets forth for the periods indicated, a summary of the changes in interest and dividends earned and interest paid resulting from changes in volume and changes in rates (in thousands of dollars):

The Corporation is a member of the Federal Home Loan Bank of New York ("FHLB") which allows it to access borrowings which enhance management's ability to satisfy future liquidity needs. The Corporation maintained a $74.804 million line of credit at June 30, 2003. This compares to $73.197 million at June 30, 2002.

During the first six months of 2003, cash and cash equivalents increased $47.6 million, as compared to an increase of $2.2 million during the first six months of last year. In addition to cash provided by operating activities, other primary sources of cash in 2003 included proceeds from maturities, sales and principal payments on securities ($87.1 million), an increase in deposits ($24.7 million), and a net decrease in loans (including proceeds from sales of student loans) of $12.5 million. During the first six months of 2002, primary sources of cash included proceeds from maturities, sales and principal payments on securities ($66.6 million), an increase in deposits ($17.5 million), and an increase in securities sold under agreements to repurchase ($8.7 million).

Cash generated in both periods was used primarily to fund growth in earning assets as well as to reduce Federal Home Loan Bank advances. During the first six months of 2003, the purchase of securities totaled $59.3 million. Other significant uses of cash during the first six months of 2003 included the repayment of Federal Home Loan Bank advances, net of new advances ($15.8 million), a net decrease in securities sold under agreements to repurchase ($4.0 million), and the payment of cash dividends ($1.7 million). During the first six months of 2002, the purchase of securities and funding of loans, net of repayments, totaled $69.8 million and $11.3 million, respectively. Other significant uses of cash during the first half of 2002 included the repayment of Federal Home Loan Bank advances, net of new advances ($12.6 million), purchases of premises and equipment ($2.5 million), and the payment of cash dividends ($1.8 million).

As of June 30, 2003, the Corporation's consolidated leverage ratio was 9.45%. The Tier I and Total Risk Adjusted Capital ratios were 14.85% and 16.68%, respectively. All of the above ratios are in excess of the requirements for being considered "well capitalized" by the FDIC, the Federal Reserve and the New York State Banking Department.

On May 9, 2001, the Corporation announced that its Board of Directors authorized the repurchase of up to 400,000 shares, or approximately 10% of its outstanding common shares, principally through open market transactions from time to time as market conditions warrant over a two-year period. During the two-year period this program was in place, a total of 248,018 shares were purchased at an average price of $28.08 per share. While the authorization for this share repurchase program expired on May 9, 2003, the Corporation may continue to evaluate future share repurchases as market conditions warrant, after careful consideration of its capital position. During the second quarter of 2003, 4,493 shares were purchased at an average price of $28.19 per share. Year-to-date purchases total 18,038 shares at an average price of $27.43 per share.

As intermediaries between borrowers and savers, commercial banks incur both interest rate risk and liquidity risk. The Corporation's Asset/Liability Committee (ALCO) has the strategic responsibility for setting the policy guidelines on acceptable exposure to these areas. These guidelines contain specific measures and limits regarding these risks, which are monitored on a regular basis. The ALCO is made up of the president, three executive vice presidents, asset liability management officer, senior lending officer, senior marketing officer, chief financial officer, and others representing key functions.

The ALCO is also responsible for supervising the preparation and annual revisions of the financial segments of the annual budget, which is built upon the committee's economic and interest-rate assumptions. It is the responsibility of the ALCO to modify prudently the Corporation's asset/liability policies.

Interest rate risk is the risk that net interest income will fluctuate as a result of a change in interest rates. It is the assumption of interest rate risk, along with credit risk, that drives the net interest margin of a financial institution. For that reason, the ALCO has established tolerance limits based upon a 200-basis point change in interest rates. At June 30, 2003, it is estimated that an immediate 200-basis point decrease in interest rates would negatively impact the next 12 months net interest income by 17.09% and an immediate 200-basis point increase would positively impact the next 12 months net interest income by 6.59%. The risk to declining interest rates is slightly over the allowable tolerance of 15.0% established by ALCO. Management attributes this to the overall low level of current interest rates and corresponding large percentage decrease that results when an immediate 200-basis point shock is modeled. Additionally, the Corporation's significant holdings of callable US agency securities, mortgage-backed securities and mortgage loans, results in less interest income in periods of declining interest rates, as the cash flow from called bonds and increased prepayments results in higher levels of repricing of assets at lower interest rates. Although currently outside of the policy guideline, management is comfortable with this exposure, as an immediate 200-basis point decrease in interest rates across the yield curve is not possible given the current interest rate environment. A more realistic approach includes estimates of an immediate 100-basis point decline and an immediate 300-basis point increase in interest rates. When applied, these scenarios estimate a negative impact to net interest income of 7.84% and positive impact of 6.50% respectively. Both are well within the Corporation's policy guidelines.

A related component of interest rate risk is the expectation that the market value of our capital account will fluctuate with changes in interest rates. This component is a direct corollary to the earnings-impact component: an institution exposed to earnings erosion is also exposed to shrinkage in market value. At June 30, 2003, it is estimated that an immediate 200-basis point decrease in interest rates would negatively impact the market value of our capital account by 13.84% and an immediate 200-basis point increase in interest rates would negatively impact the market value by 0.65%. Both are within the established tolerance limit of 15.0%.

Management does recognize the need for certain hedging strategies during periods of anticipated higher fluctuations in interest rates and the Board-approved Funds Management Policy provides for limited use of certain derivatives in asset liability management. These strategies have not been employed during 2003.

Information required by this Item is set forth herein in Manangement's Discussion and Analysis of Financial Condition and Results of Operations under the heading "Interest Rate Risk".

The Company's management, including the Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) (the "Exchange Act") as of the end of the period covered by this report. Based upon that evaluation, the Company's management, including the Chief Executive Officer and Chief Financial Officer, concluded that, the Company's disclosure controls and procedures were effective in ensuring that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commissions rules and forms.

There were no significant changes in the Company's internal control over financial reporting that occurred during the Company's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.

EXHIBIT INDEX

FOR THE PERIOD ENDING June 30, 2003

CHEMUNG FINANCIAL CORPORATION

ELMIRA, NEW YORK