2. Earnings Per Share

Forward-looking Statements

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

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

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

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

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

The composition of the loan portfolio is summarized as follows:

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

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

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

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

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

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

Net interest income before the provision for loan losses was down $64 thousand or 1.0%. As compared to the second quarter of 2003, average earning assets increased $8.7 million or 1.3%. However, total interest and dividend income decreased $696 thousand or 7.2% from $9.671 million in the second quarter of 2003 to $8.975 million in the second quarter of 2004, as the yield on earning assets declined 46 basis points from 5.63% to 5.17%. Due primarily to decreases in loans throughout 2003, average loan balances were down $34.8 million or 8.3% compared to second quarter 2003 averages, with the yield down 54 basis points to 6.15%. While the average balance of the securities portfolio increased $61.0 million or 26.7%, the yield on these investments was down 27 basis points to 4.18%. Average fed funds sold and interest-bearing deposits were down $17.5 million, with the yield down 24 basis points to 0.95%.

Total average funding liabilities increased $2.0 million or 0.3% when compared to the second quarter of 2003 due primarily to a $9.4 million increase in average securities sold under agreements to repurchase funded through the Federal Home Loan Bank of New York. This was offset to some extent by a $7.3 million decrease in average deposits. Average non-interest bearing demand deposits were up $8.0 million due to increases in both personal and non-personal average balances. Average time deposits decreased $21.8 million, primarily due to lower average personal balances. The decrease in average time deposits was offset to some extent by increases in average savings and insured money market account balances of $5.5 million and $1.8 million, respectively. Average interest bearing liabilities decreased $6.0 million or 1.1% compared to second quarter 2003 averages, and interest expense decreased $632 thousand or 18.9% as the cost of funds, including the impact of non-interest bearing funding sources (such as demand deposits), was down 38 basis points to 1.65%. The resulting net interest margin for the second quarter of 2004 of 3.61% was 8 basis points lower than the second quarter 2003 margin of 3.68%.

As discussed more fully under the Asset Quality section of this report, with non-performing loans beginning to stabilize, the provision for loan losses during the second quarter of 2004 totaled $333 thousand as compared to $1.6 million during the second quarter of 2003, a decrease of $1.267 million.

Despite a $410 thousand decrease in net gains on securities transactions, total non-interest income increased $36 thousand or 1.0% when compared to the second quarter of 2003. During the second quarter of 2003, the Corporation realized gains of $410 thousand on the sale of the remaining balance of a previously other-than-temporary impaired corporate bond. There were no such securities gains realized during the second quarter of this year. Excluding the gains on securities transactions, all other non-interest income increased $446 thousand or 14.7%. This increase was significantly impacted by a $152 thousand increase in fee income generated by our Trust and Investment Center, reflective of improved market conditions as compared to last year. Additionally, revenue from our equity investment in Cephas Capital Partners, L.P. increased $181 thousand, which included a $136 thousand gain resulting from an equity position held by Cephas in a company which was subsequently sold. Service charges on deposit accounts in creased $50 thousand, primarily related to higher fee income generated by a courtesy pay, overdraft privilege program which was introduced during the second quarter of 2003.

Operating expenses were $298 thousand or 4.7% higher than the comparable period last year. Pension and other employee benefits increased $141 thousand, primarily the result of increases in health insurance and profit sharing expenses of $45 thousand and $88 thousand, respectively. The profit sharing expense increase was due to the higher level of net income in 2004 as compared to 2003. Net occupancy expenses increased $56 thousand, impacted by higher real estate taxes, building depreciation, maintenance costs and utilities. The $167 thousand increase in other operating expenses is primarily related to increases in professional services costs, credit card and merchant deposit services processing costs, and marketing and advertising expenses.

The $346 thousand increase in income tax expense is primarily related to the higher level of pre-tax income.

Net income for the six month period ended June 30, 2004 totaled $4.176 million, an increase of $733 thousand or 21.3% as compared to June 30, 2003 results. Earnings per share increased 22.2% from $0.90 to $1.10 per share on 40,660 fewer average shares outstanding. As was the case with second quarter results, the improvement in year-to-date earnings has been impacted primarily by a reduction in the provision for loan loss expense as well as an increase in non-interest income, offset to some extent by lower net interest income and higher operating expenses.

Net interest income before the provision for loan losses was down $177 thousand or 1.4%, with the net interest margin declining 11 basis points from 3.77% to 3.66%, reflective of both lower interest rates and average loan balances. As compared to the first six months of 2003, average earning assets increased $9.6 million or 1.4%. However, total interest and dividend income decreased $1.578 million or 8.0% as the yield on earning assets declined 55 basis points to 5.25%. As noted in the above discussion of second quarter results, due primarily to decreases in loans throughout 2003, average loan balances during the first six months of 2004 were down $37.4 million or 8.8% compared to comparable period averages during 2003, with the yield down 56 basis points to 6.19%. While the average balance of the securities portfolio increased $55.2 million or 23.2%, the yield on these investments was down 34 basis points to 4.28%. Average fed funds sold and interest-bearing deposits were down $8.2 million, with the yield d own 25 basis points to 0.94%.

Total average funding liabilities increased $3.7 million or 0.6% when compared to the first six months of last year due primarily to a $5.4 million increase in average securities sold under agreements to repurchase funded through the Federal Home Loan Bank of New York. This was offset to some extent by a $1.1 million decrease in overnight advances under our line of credit with the Federal Home Loan Bank, and a $489 thousand decrease in year-to-date average deposits. Average non-interest bearing demand deposits were up $9.4 million as both personal and non-personal average balances increased. Average interest-bearing deposits decreased $9.9 million, impacted primarily by a $21.7 million decrease in average time deposits, offset to some extent primarily by increases in average savings and insured money market account balances of $5.8 million and $4.5 million, respectively. While total average interest bearing liabilities decreased $5.7 million or 1.0% compared to the first six months of 2003, interest expense decreased $1.402 million or 20.3%, as the cost of funds, including the impact of non-interest bearing funding sources (such as demand deposits), was down 44 basis points to 1.67%.

Due in large part to the decrease in the second quarter provision, the year-to-date provision for loan loss expense has decreased $1.367 million from $2.2 million to $833 thousand.

Despite a $731 thousand decrease in net gains on securities transactions, total non-interest income increased $105 thousand, as with the exception of securities gains, all other non-interest income rose $836 thousand or 14.8%. Similar to the second quarter, and for reasons noted above, the increase was primarily the result of a $209 thousand increase in fee income generated by our Trust and Investment Center, a $306 thousand increase in service charges on deposit accounts, and a $181 thousand increase in revenue from our equity investment in Cephas Capital Partners, L.P. In addition to the above, credit card merchant discount fees increased $76 thousand, and revenue generated by CFS Group, Inc. was up $67 thousand.

Operating expenses were $136 thousand or 1.1% higher than a year ago. Pension and other employee benefits increased $81 thousand, primarily the result of a $107 thousand increase in health insurance expense. Net occupancy expenses were up $107 thousand, impacted by higher real estate taxes, building depreciation, maintenance costs and utilities. The $99 thousand increase in other operating expenses is primarily related to increases in professional services costs and credit card and merchant deposit services processing costs, offset to an extent primarily by lower loan and ORE expenses. Salaries and wages for the first six months of 2004 were $184 thousand lower than a year ago, reflective of reduced staff size.

Income tax expense increased $425 thousand, primarily due to the increased level of pre-tax income during the first half of 2004.

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):