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2. Basic Earnings Per Share

4. Intangible Assets

Consolidated assets at September 30, 2003 totaled $750.4 million, a decrease of $754 thousand or 0.1% since the beginning of the year. Total loans, net of unearned income and deferred fees and costs, decreased by $33.2 million or 7.7% from December 31, 2002 to September 30, 2003. Approximately $17.3 million of this decrease is in the commercial loan portfolio, including commercial mortgages. The volume of commercial loan activity has been impacted by weakness in the local economy. Also contributing to this decline is the charge-off of approximately $2.0 million in commercial loans during the first nine months of this year. The residential mortgage portfolio is down $11.1 million, impacted by the low interest rate environment. In this rate environment, we have not only experienced an increase in refinancing of mortgages, but have also been selling more mortgages in the secondary mortgage market as opposed to retaining the interest rate risk associated with these low rates. Through September of 2003 , approximately $14.6 million in mortgages have been sold to Freddie Mac. The decrease in net loans was also impacted by a decrease in student loans of $3.1 million. During the second quarter of 2003, we sold our entire student loan portfolio to Sallie Mae due to the fact that Sallie Mae is no longer offering the option of the Corporation owning and servicing these loans until they enter repayment status. Therefore, we converted our student loan program to a new third party processor, which allows us to hold and service these loans as in the past. We expect the outstanding balances in this portfolio to build back up to the previous level of approximately $4.0-$4.5 million over the next 9-15 months. Excluding the decrease in the student loan portfolio, all other consumer loans decreased $1.7 million since year-end 2002 due primarily to decreases of $2.8 million and $274 thousand in installment loans and credit card balances, respectively. These declines have been somewhat offset by a $1.3 million increa se in home equity loans.

The composition of the loan portfolio is summarized as follows:

The Available for Sale segment of the securities portfolio totaled $283.3 million at September 30, 2003, compared to $257.2 million at the end of 2002, an increase of $26.1 million. At amortized cost, the available for sale segment of the securities portfolio is up $29.5 million since year-end. This is reflective of an increased investment in primarily federal agency bonds and mortgage-backed securities during the third quarter of 2003. These investments followed a steepening of the yield curve in mid-June, and during the third quarter we purchased approximately $50.9 million and $36.4 million in federal agency bonds and mortgage-backed securities, respectively. The pre-tax valuation adjustment for net unrealized gains has decreased $3.4 million since the beginning of the year, reflective primarily of the impact on the bond portfolio of an increase in mid to long term rates since the beginning of the year. The Held to Maturity segment of the portfolio, consisting primarily of local municipal obligations , totaled $11.7 million at September 30, 2003, an increase of $3.8 million since year-end 2002.

Deposits at September 30, 2003 totaled $555.2 million, an increase of $13.5 million or 2.5% as compared to December 31, 2002. Approximately $12.0 million of this increase is in period-end public funds deposit balances (primarily local municipal deposits). Other period-end balances increased $1.5 million, primarily the result of higher savings and non-interest bearing demand deposit account balances, offset to some extent primarily by lower time deposit 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 up $5.4 million, primarily due to a higher period-end balance of investments leveraged with term repurchase agreements through the Federal Home Loan Bank.

Other liabilities were down $2.3 million, primarily due to the payment of previously accrued federal and state income taxes during the first quarter of 2003.

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

At December 31, 2002, the Corporation's available for sale securities portfolio included an investment in a $2.5 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 September 30, 2003, the Corporation, through its loan review function, has identified 22 commercial loan relationships totaling $17.004 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 $10.834 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". 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 September 30, 2003, as well as the continued weakness in the economy that the Corporation sees in its primary market areas, the Corporation increased its provision for loan losses during the third quarter of 2003 to $2.15 million as compared to $1.35 million during the third quarter of 2002. Year to date, the provision has increased $2.3 million, from $2.05 million to $4.35 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 portfolio quality, and current economic conditions that may affect the borrowers' ability t o pay. At September 30, 2003, the Corporation's allowance for loan losses totaled $9.784 million, resulting in a coverage ratio of allowance to non-performing loans of 84.56%. 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 nine months of 2003 totaled $2.24 million as compared to $554 thousand during the first nine months 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 residential mortgage and consumer loan charge-offs. The allowance for loan losses to total loans at September 30, 2003 was 2.45% as compared to 1.78% as of December 31, 2002.

Activity in the allowance for loan losses was as follows:

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

As noted above, net interest income for the third quarter of 2003 was down $456 thousand or 6.6% from $6.928 million in the third quarter of 2002 to $6.472 million in the third quarter of 2003. This decrease was impacted primarily by a lower interest rate environment as well as a lower volume of average loans. Average earning assets were down $4.9 million or 0.7% as compared to the third quarter of 2002, with total interest and dividend income decreasing $1.737 million or 15.5% as the average yield declined 96 basis points from 6.40% to 5.44%. Average loans for the quarter were down $23.3 million or 5.4% as compared to the third quarter of 2002, with the yield declining 69 basis points to 6.52%. The decrease in average loans was due to decreases in average mortgages (- $10.5 million), consumer loans (- $7.0 million) and commercial loans (- $5.8 million). The decrease in average mortgages is due primarily to the fact that in the current rate environment, many of our originated mortgages have been sold in the secondary mortgage market as opposed to retaining the interest rate risk inherent in this environment. Mortgages sold during the first nine months of this year totaled $14.6 million. Decreases in consumer loans are primarily the result of the previously mentioned sale of our student loan portfolio, with the average of that portfolio declining $4.0 million, as well as lower average installment loans (- $4.8 million), impacted by an extremely competitive rate environment for indirect auto financing. These decreases have been somewhat offset by a $2.0 million increase in our average home equity portfolio. The decrease in average commercial loans is representative of the impact of a weak economy on commercial loan volume. While our securities portfolio on average has increased $23.2 million or 9.6% as compared to the third quarter 2002 average, the yield on the portfolio has declined 130 basis points to 4.13%. This increase in average securities is due in large part to the increased securities purchases during the third quarter of this year following a steepening of the yield curve in mid-June. With the increased investment in the securities portfolio, average fed funds sold and interest bearing deposits have decreased $4.7 million. The average yield on these assets has decreased 79 basis points to 0.93%.

Total average funding liabilities have decreased $6.7 million or 1.0% when compared to the third quarter of 2002. Average deposits, when compared to the third quarter of last year, are up $2.5 million or 0.4%. Average personal account balances increased $1.5 million, reflected primarily in higher average demand deposit and savings balances, offset to some extent by lower personal time deposit averages. All other average deposit balances are up $1.0 million, as an average increase in business and other non-personal account averages of $6.3 million was somewhat offset by a $5.3 million decrease in public fund average deposits (primarily local municipal deposits). All other funding liabilities on average were down $9.1 million due to a $9.2 million decrease in term repurchase agreements through the Federal Home Loan Bank. Interest expense was down $1.280 million or 29.9% as the cost of funds, including the effect of non-interest bearing funding sources (such as demand deposits) declined 74 basis points from 2.55% to 1.81%. The above yields and costs resulted in a net interest margin during the third quarter of 2003 of 3.72% as compared to 3.95% during the third quarter of 2002.

Non-interest income increased $1.569 million or 84.7% from $1.853 million in the third quarter of 2002 to $3.422 million in the third quarter of this year. Approximately $939 thousand of this increase is reflected in net gains on securities transactions. As previously mentioned, this increase reflects the fact that during the third quarter of last year the corporation realized a $1.006 million pre-tax charge to earnings related to the write-down of a corporate bond which at the time was considered to be other-than-temporarily impaired. The other major factor influencing the increase in non-interest income was a $430 thousand increase in service charges, 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.

Operating expenses were $30 thousand or 0.5% lower than the comparable period last year. The decrease in operating expenses is due primarily to the fact that during the third quarter of 2002, the Corporation incurred a $327 thousand prepayment penalty related to a refinance of a term advance from the Federal Home Loan Bank of New York. With interest rates at historically low levels, management had determined it advantageous to payoff an existing advance carrying a rate of 4.90% at the time, and refinance for a five-year term at a rate of 3.72%. The resulting decrease in third quarter 2003 operating expenses associated with this transaction was somewhat offset primarily by increases in salaries and benefits (+ $162 thousand) and depreciation expense (+ $76 thousand). The $162 thousand increase in salaries and benefits includes the impact of a charge of approximately $321 thousand related to severance costs associated with a severance agreement with a former employee. Excluding this charge, all other sala ries and benefits expense would have been down $159 thousand. The increase in depreciation expense is reflective of the continuing investment in property and equipment.

The $217 thousand increase in income tax expense is due in part to higher pre-tax earnings as well as the fact that during the third quarter of 2002, the Corporation realized approximately $58 thousand in New York State Empire Zone real property and tax reduction credits.

Net income for the nine month period ended September 30, 2003 totaled $4.418 million, a 10.6% decrease as compared to September 30, 2002 results. Earnings per share declined 7.2% from $1.25 to $1.16 per share on 131,400 fewer average shares outstanding. As was the case with third quarter results, the year-to-date results have been negatively impacted primarily by a $2.3 million increase in the provision for loan losses as well as a decrease in net interest income of $1.110 million. These decreases have been somewhat offset by a $2.295 million increase in non-interest income as well as a $466 thousand decrease in operating expenses.

Total average funding liabilities have increased $3.9 million or 0.6% compared to the first nine months of 2002 due to a $10.1 million or 1.9% increase in average deposits. While average public fund balances (primarily local municipal deposits) were down $5.0 million, primarily reflected in lower average time deposits, all other deposits increased on average $15.1 million. Personal deposits on average were up $8.1 million, primarily due to increases in average demand deposit, savings and insured money market balances, offset to some extent by lower average personal time deposits. The remainder of the average deposit increase is reflected primarily in non-personal demand deposit and insured money market balances. All other average funding liabilities were down $6.2 million, due primarily 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 inc reased $3.9 million, interest expense year-to-date was $3.272 million lower than last year as the cost of funds, including the impact of non-interest bearing funding sources (such as demand deposits), declined 68 basis points from 2.69% to 2.01%. The resulting net interest margin for the first nine months of 2003 of 3.75% was 25 basis points lower than the margin for the first nine months of 2002.

Non-interest income was $2.295 million or 29.7% higher than a year ago. Net gains on securities transactions have increased $1.643 million. As noted above, this increase has been impacted by the $1.006 million write-down of a corporate bond during the third quarter of last year. This bond has since been sold, with $950 thousand in gains recognized during the first half of 2003. Also having a significant impact on the increase in non-interest income was a $948 thousand increase in service charge revenue for reasons stated above as well as a $226 thousand increase in gains on the sale of mortgages. These increases were somewhat offset primarily by decreases in trust and investment services income (- $221 thousand), non-taxable gains on stock donations (- $164 thousand) and credit card merchant earnings (- $133 thousand). The decrease in trust and investment services income is primarily a function of the lower market value of assets during the first half of 2003. The decrease in non-taxable gains on stoc k donations reflects the fact that the Corporation made accelerated payments during 2002 on certain planned capital campaign contributions to non-profit organizations. Credit card merchant earnings have been impacted by a lower volume of merchant deposit activity.

Operating expenses year-to-date are $466 thousand or 2.4% lower than a year ago. Despite the charges totaling $321 thousand related to severance costs associated with a severance agreement with a former employee, salaries and wages, and pension and other employee benefits are down $127 thousand. Excluding these charges, salaries and wages are down $332 thousand due primarily to a reduction in the number of employees, with the average number of full time equivalent employees (FTE's) down by nineteen as compared to last year. Also, when excluding the above, while net periodic pension expense and post-retirement medical benefits have increased $308 thousand and $84 thousand, respectively, these increases have been offset primarily by reductions in profit sharing and health insurance expenses of $350 thousand and $127 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 fro m the impact of a declining stock market on asset values, compensation increases and the discount rate used in calculating future benefit obligations. Also, as noted above, the decrease in year-to-date operating expenses has been impacted by the $327 thousand prepayment penalty incurred during the third quarter of last year related to the refinancing of a term advance from the Federal Home Loan Bank of New York. Additionally, year-to-date credit card and merchant deposit services processing costs have decreased $285 thousand related to a decline in credit card merchant deposit volume. The above significant expense reductions have been somewhat offset primarily by a $229 thousand increase in depreciation expense.

Income tax expense is down $127 thousand, primarily due to the reduced level of pre-tax income during the first nine months of 2003.

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 $74.957 million line of credit at September 30, 2003. This compares to $74.804 million at September 30, 2002.

During the first nine months of 2003, cash and cash equivalents increased $4.5 million, as compared to an increase of $28.7 million during the first nine 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 ($122.8 million), a net decrease in loans (including proceeds from sales of student loans) of $30.8 million, an increase in deposits ($13.5 million) and an increase in securities sold under agreements to repurchase ($5.4 million). During the first nine months of 2002, primary sources of cash included proceeds from maturities, sales and principal payments on securities ($114.5 million), an increase in deposits ($33.5 million), and an increase in securities sold under agreements to repurchase ($7.3 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 nine months of 2003, the purchase of securities totaled $156.3 million. Other significant uses of cash during the first nine months of 2003 included the repayment of Federal Home Loan Bank advances ($15.8 million), the payment of cash dividends ($2.6 million), purchases of premises and equipment ($1.4 million), and the purchase of treasury shares ($1.2 million). During the first nine months of 2002, the purchase of securities and funding of loans, net of repayments, totaled $106.7 million and $9.4 million, respectively. Other significant uses of cash during the first nine months of 2002 included the repayment of Federal Home Loan Bank advances, net of new advances ($12.6 million), the purchase of treasury shares ($5.3 million), purchases of premises and equipment ($3.4 million), and the payment of cash dividends ($2.7 million).

As of September 30, 2003, the Corporation's consolidated leverage ratio was 9.39%. The Tier I and Total Risk Adjusted Capital ratios were 15.24% and 17.08%, 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 third quarter of 2003, 21,110 shares were purchased at an average price of $32.03 per share. Year-to-date purchases total 39,148 shares at an average price of $29.91 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, two 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 September 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 17.79% and an immediate 200-basis point increase would positively impact the next 12 months net interest income by 0.05%. The risk to declining interest rates continues to be 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 c allable US agency securities, mortgage-backed securities and mortgage loans, result 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 likely 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 7.60% and a negative impact of 1.38% 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 September 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 9.06% and an immediate 200-basis point increase in interest rates would negatively impact the market value by 8.81%. 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 Management'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 are reasonably likely to materially affect, the Company's internal control over financial reporting.

EXHIBIT INDEX

FOR THE PERIOD ENDING September 30, 2003

CHEMUNG FINANCIAL CORPORATION

ELMIRA, NEW YORK