2. Earnings Per Share

4. Intangible Assets

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 March 31, 2004 totaled $758.2 million, an increase of $11.0 million or 1.5% since the beginning of the year. Total loans, net of unearned income and deferred fees and costs, decreased by $2.9 million or 0.7% from December 31, 2003 to March 31, 2004. Approximately $2.2 million of this decrease was in the consumer loan portfolio, affected primarily by declines in consumer installment and home equity loans of $2.2 million and $913 thousand, respectively. The installment loan decrease continues to be impacted by the extremely competitive pricing environment for indirect auto loans. The above consumer loan decreases were offset to some extent primarily by a $976 thousand seasonal increase in student loans. The residential mortgage portfolio decreased $416 thousand during the first quarter, and total commercial loans, including commercial mortgages were down $281 thousand.

The composition of the loan portfolio is summarized as follows:

The available for sale segment of the securities portfolio totaled $286.6 million at March 31, 2004, compared to $282.9 million at the end of 2003, an increase of $3.7 million or 1.3%. At amortized cost, the available for sale portfolio was up $1.3 million since year-end 2003. This increase is primarily reflected in a $6.9 million increase in mortgage backed securities, offset to some extent primarily by a $6.2 million decrease in federal agency bonds. The decline in federal agency bonds was impacted by the fact that with the decrease in interest rates during the month of March, approximately $18.2 million of federal agency bonds were called. Additionally, the Corporation sold a $3.0 million agency bond in March, realizing a pre-tax gain on the sale of $219 thousand. Unrealized appreciation related to the available for sale portfolio increased $2.4 million since the beginning of the year, reflective of the impact on the bond portfolio of lower mid to long term rates. The held to maturity segment of the portfolio, consisting primarily of local municipal obligations, totaled $15.1 million at amortized cost as of March 31, 2004, an increase of $2.0 million since year-end 2003.

The $10.1 million increase in total cash and cash equivalents is due to a $13.5 million increase in federal funds sold, offset somewhat by a $2.9 million decrease in cash and due from banks as well as a $502 thousand reduction in interest-bearing deposits. The increase in federal funds sold is related to the volume of federal agency bonds called during the month of March. As of quarter-end, all of the proceeds from these calls had not been re-invested, however, the Corporation utilized proceeds from these called bonds to purchase an additional $14.8 million in federal agency bonds during the month of April.

Deposits at March 31, 2004 totaled $550.4 million, a decrease of $622 thousand or 0.1% as compared to December 31, 2003. Period-end public fund deposit balances (primarily local municipal deposits) were up $10.6 million. Other period-end balances decreased $11.2 million, impacted primarily by lower insured money market, time and Now account balances, offset to some extent by higher savings balances. The $8.9 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 March 31, 2004, the Corporation, through its loan review function, has identified 23 commercial loan relationships totaling $16.710 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 othe r 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. With the level of non-performing and classified 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 first quarter of 2004 to $500 thousand as compared to $600 thousand during the first three months of 2003. At March 31, 2004, the Corporation's allowance for loan losses totaled $10.268 million, resulting in a coverage ratio of allowance to non-performing loans of 87.8%. 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 quarter of 2004 totaled $80 thousand as compared to $1.961 million during the first quarter of 2003. This $1.881 million decrease was due to the fact that 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 March 31, 2004 was 2.65% as compared to 2.52% as of December 31, 2003.

Results of Operations

Net interest income before the provision for loan losses was down $113 thousand or 1.7%. Despite a $10.6 million or 1.5% increase in average earning assets, total interest and dividend income decreased $882 thousand or 8.7% from $10.155 million in the first quarter of 2003 to $9.273 million in the first quarter of 2004, as the yield on earning assets declined 65 basis points from 5.97% to 5.32%. Due primarily to the decrease in loans throughout 2003, average loan balances were down $40.0 million compared to first quarter 2003 averages, with the yield down 59 basis points to 6.23%. While the average balance of the securities portfolio increased $49.3 million or 19.9%, the yield on these investments was down 41 basis points to 4.37%. Average fed funds sold and interest-bearing deposits increased $1.3 million, with the yield down 26 basis points to 0.93%.

Total average funding liabilities increased $5.5 million or 0.8% when compared to the first quarter of 2003 due to a $6.4 million increase in average deposits. Average non-interest bearing demand deposits were up $10.9 million due to increases in both personal and non-personal average balances. Increases in average insured money market and Now account balances of $7.3 million and $3.6 million, respectively, were due primarily to higher average public fund balances. An increase in average personal savings balances was the primary factor in the $6.1 million increase in average savings accounts. The above increases were offset somewhat by a $21.5 million decrease in average time deposits. All other average funding liabilities were down $914 thousand due to lower average overnight borrowings under our line of credit with the Federal Home Loan Bank of New York. Average interest bearing liabilities decreased $5.4 million or 1.0% compared to first quarter 2003 averages, and interest expense decreased $770 tho usand or 21.5% as the cost of funds, including the impact of non-interest bearing funding sources (such as demand deposits), was down 50 basis points to 1.70%. The resulting net interest margin for the first quarter of 2004 of 3.71% was 15 basis points lower than the first quarter 2003 margin of 3.86%.

The provision for loan losses during the first quarter of 2004 totaled $500 thousand as compared to $600 thousand during the first quarter of 2003, a decrease of $100 thousand. As discussed more fully under the "Asset Quality" section of this report.

Despite a $321 thousand decrease in net gains on securities transactions, total non-interest income increased $69 thousand or 2.2% when compared to the first quarter of 2003. During the first quarter of 2003, the Corporation realized gains of $540 thousand on the sale of $1.5 million of a previously classified non-performing corporate bond. During the first quarter of 2004, the Corporation realized a gain of $219 thousand on the sale of a $3.0 million federal agency bond. Excluding the gains on securities transactions, all other non-interest income increased $390 thousand or 14.8%, significantly impacted by a $256 thousand increase in service charges on deposit accounts. This increase is related primarily to the introduction of a courtesy pay, overdraft privilege program during the second quarter of 2003. Other areas of note include a $58 thousand increase in fees generated by the $1.3 billion managed by our Trust and Investment Center, reflective of the impact of improved market performance when compar ed to last year. Additionally, we realized a $39 thousand increase in revenue generated by CFS Group, Inc., and a $38 thousand increase in credit card merchant earnings.

Operating expenses were $162 thousand or 2.6% lower than the comparable period last year. Much of this decrease can be traced to measures taken during 2003 to reduce staffing positions, which contributed importantly to a $93 thousand reduction in salaries and wages. A $60 thousand decrease in pension and other employee benefits is due primarily to decreases in profit sharing and pension expenses of $96 thousand and $10 thousand, respectively, offset to some extent primarily by a $62 thousand increase in health insurance costs. Net occupancy expenses increased $51 thousand, impacted by higher real estate taxes, building depreciation, maintenance costs and utilities. The $67 thousand reduction in other operating expenses is primarily related to decreases in marketing and advertising expenses, and loan expenses.

The $79 thousand increase in income tax expense is primarily related to the $218 thousand increase in pre-tax income.

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. At March 31, 2004, the Corporation maintained a $74.957 million line of credit with the FHLB, as compared to $74.804 million at March 31, 2003.

Cash generated in both periods was used primarily to fund the purchase of earning assets as well as to reduce FHLB advances in 2003. During the first quarter of 2004, the purchase of securities totaled $29.8 million. Other significant uses of cash during the first quarter of 2004 included the payment of cash dividends ($859 thousand), funding of deposit decreases ($622 thousand) and the purchase of treasury shares ($413 thousand). During the first quarter of 2003, the purchase of securities totaled $16.2 million. Other significant uses of cash during the first quarter of 2003 included the repayment of FHLB advances ($15.8 million), the payment of cash dividends ($869 thousand) and the purchase of treasury shares ($368 thousand).

As of March 31, 2004, the Corporation's consolidated leverage ratio was 9.64%. The Tier I and Total Risk Adjusted Capital ratios were 15.98% and 17.91%, 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.

When shares of the Corporation become available in the market, the Corporation may purchase them, as market conditions warrant, after careful consideration of its capital position. During the first quarter of 2004, the Corporation purchased 11,896 shares at an average price of $34.73 per share. During the first quarter of 2003, 13,545 shares were purchased at an average price of $27.18 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 March 31, 2004, it is estimated that an immediate 200-basis point decrease in interest rates would negatively impact the next 12 months net interest income by 15.60% and an immediate 200-basis point increase would positively impact the next 12 months net interest income by 3.09%. 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 calla ble 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 because the Corporation does not believe that an immediate 200-basis point decrease in interest rates across the yield curve is 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 7.41% and a positive impact of 3.60% 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 March 31, 2004, it is estimated that an immediate 200-basis point decrease in interest rates would negatively impact the market value of our capital account by 11.47% and an immediate 200-basis point increase in interest rates would negatively impact the market value by 4.13%. 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 the first quarter of 2004.

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 Company's disclosure controls and procedures as of March 31, 2004. Based upon that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that, the Company's disclosure controls and procedures are effective in alerting them in a timely manner to material information relating to the Corporation required to be included in this report and other reports that it files or submits under the Securities Exchange Act of 1934.

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

EXHIBIT INDEX

FOR THE PERIOD ENDING March 31, 2004

CHEMUNG FINANCIAL CORPORATION

ELMIRA, NEW YORK