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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X]          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2003

OR

[   ]          TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934

                Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

                 [X] YES     [   ] NO

                As of November 3, 2003, there were issued and outstanding 15,154,897 shares of the Registrant's Common Stock.

FORM 10-Q

HUDSON RIVER BANCORP, INC.

INDEX

                                                                                                                                                     &nb sp;                                          

PART I.  FINANCIAL INFORMATION

                                ITEM 1.  Financial Statements (unaudited)

                                                                Consolidated Balance Sheets at September 30, 2003

                                                                and March 31, 2003

Consolidated Income Statements for the three and six months

ended September 30, 2003 and 2002

                                                                Consolidated Statements of Cash Flows for the six months

                                                                ended September 30, 2003 and 2002

                                                                Notes to Unaudited Consolidated Interim

                                                                Financial Statements

                                ITEM 2.  Management’s Discussion and Analysis of Financial

                                                Condition and Results of Operations

                                ITEM 3.  Quantitative and Qualitative Disclosures about

                                                Market Risk

                                ITEM 4. Controls and Procedures

PART II.  OTHER INFORMATION

                                ITEM 1.  Legal Proceedings

                                ITEM 2.  Changes in Securities and Use of Proceeds

                                ITEM 3.  Defaults Upon Senior Securities

                                ITEM 4.  Submission of Matters to a Vote of Security Holders

                                ITEM 5.  Other Information

                                ITEM 6.  Exhibits and Reports on Form 8-K

EXHIBIT INDEX

SIGNATURE PAGE

NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS

1.  The accompanying unaudited consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X.  Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.  In the opinion of management, all adjustments (consisting solely of normal recurring accruals) considered necessary for a fair presentation have been included.  The accompanying unaudited consolidated interim financial statements should be read in conjunction with the Company’s Annual Report on Form 10-K as of and for the year ended March 31, 2003.  Operating results for the three and six month periods ended September 30, 2003 are not necessarily indicative of the results that may be expected for a full year or other interim periods.

2.  Comprehensive income includes the reported net income of a company adjusted for certain items that are currently accounted for as direct entries to equity, such as the mark to market adjustment on securities available for sale, foreign currency items and minimum pension liability adjustments.  At the Company, comprehensive income represents net income plus other comprehensive income or loss, which consists of the net change in unrealized gains or losses on securities available for sale for the period, net of tax.  Accumulated other comprehensive income or loss represents the net unrealized gains or losses on securities available for sale, net of tax, as of the balance sheet dates.  Comprehensive income for the th ree month periods ended September 30, 2003 and 2002 was $6.5 million and $8.1 million, respectively.  Comprehensive income for the six month periods ended September 30, 2003 and 2002 was $14.8 million and $17.1 million, respectively.  

                3. In August 2001, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 143, “Accounting for Asset Retirement Obligations.”  SFAS No. 143 addresses the accounting for obligations associated with the retirement of tangible long-lived assets and requires a liability to be recognized for the fair value of these obligations in the period they are incurred.  Related costs are capitalized as part of the carrying amounts of the assets to be retired and amortized over the assets’ useful lives.  The Company adopted SFAS No. 143 as of April 1, 2003.  There was no material impact on the Company’s consolidated financial statements as a result of the adoption of SFAS No. 143.  

In January 2003, the FASB issued FIN No. 46, “Consolidation of Variable Interest Entities.”  The objective of this interpretation is to provide guidance on how to identify variable interest entities and how to determine whether or not those entities should be consolidated.  The interpretation requires the primary beneficiaries of variable interest entities to consolidate the variable interest entities if they are subject to a majority of the risk of loss or are entitled to receive a majority of the residual returns.  It also requires that both the primary beneficiary and all other enterprises with a significant variable interest in a variable interest entity make certain disclosures.  FIN No. 46 applies immediately to variable interest entities created after January 31, 2003, and to variable interest entities in which an enterprise obtains an interest after that date.  It applies in the fi rst fiscal year or interim period ending after December 15, 2003, to variable interest entities in which an enterprise holds a variable interest that it acquired before February 1, 2003.  The provisions of FIN No. 46 are not expected to have a material impact on the Company’s consolidated financial statements.

In April 2003, the FASB issued SFAS No. 149, “Amendment of Statement 133 on Derivative Instruments and Hedging Activities.” This statement amends and clarifies financial accounting and reporting for derivative instruments and hedging activities under SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities.” This statement is effective for contracts entered into or modified after June 30, 2003 and hedging relationships designated after June 30, 2003.  There was no material impact on the Company’s consolidated financial statements as a result of the adoption of SFAS No. 149.  

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity.” This statement establishes standards for how an issuer clarifies and measures certain financial instruments with characteristics of both liabilities and equity. This statement is effective for financial instruments entered into or modified after May 31, 2003 and is otherwise effective at the beginning of the first interim period after June 15, 2003. There was no material impact on the Company’s consolidated financial statements as a result of the adoption of SFAS No. 150.

                4. The Company has a stock option plan for officers and directors and has adopted the disclosure only provisions of SFAS No. 123, “Accounting for Stock-Based Compensation” and SFAS No. 148, “Accounting for Stock-Based Compensation-Transition and Disclosure”.  The Company applies APB Opinion No. 25 and related Interpretations in accounting for its Stock Option Plan.  For fixed stock option awards, compensation expense is not recognized for awards to employees and directors since the exercise price of the option is equal to the fair value of the underlying stock at the grant date.  SFAS No. 123 requires companies not using a fair value based method of account ing for stock options or similar plans, to provide pro forma disclosure of net income and earnings per share as if that method of accounting had been applied.  The pro forma effects of stock-based compensation arrangements are based on the estimated grant date fair value of stock options that are expected to vest calculated pursuant to the provisions of SFAS No. 123.  Pro forma compensation expense, net of applicable income tax effect, is recognized over the vesting period.  

                The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions used for grants in the periods ended September 30, 2003 and 2002: dividend yield of 2.16% and 1.69%; expected volatility of 30.07% and 44.07%; risk-free interest rates of 2.19% and 5.12%; and expected lives of 3 and 5 years, respectively.  The weighted-average fair value at the grant date for the options granted during the periods ended September 30, 2003 and 2002 were $4.64 and $9.39, respectively.  

                Pro forma disclosures for the Company for the three and six months ended September 30, 2003 and 2002 utilizing the estimated fair value of all options granted since plan inception and an assumed 5% forfeiture rate (adjusted for actual forfeitures) are as follows:

Hudson River Bancorp, Inc.

Notes to Unaudited Consolidated Interim Financial Statements

(continued)

                Because the Company’s stock options have characteristics significantly different from those of traded options for which the Black-Scholes model was developed, and because changes in the subjective input assumptions can materially affect the fair value estimate, the existing model, in management’s opinion, does not necessarily provide a reliable single measure of the fair value of its stock options.  In addition, the pro forma effect on reported net income and earnings per share for the three and six months ended September 30, 2003 and 2002 may not be representative of the pro forma effects on reported net income or earnings per share for future periods.

5. The following table sets forth certain information regarding the calculation of basic and diluted earnings per share for the three and six month periods ended September 30, 2003 and 2002.  Basic earnings per share is calculated by dividing net income by the weighted-average number of common shares outstanding during the period.  Shares of restricted stock are not considered outstanding for the calculation of basic earnings per share until they become fully vested.  Diluted earnings per share is computed in a manner similar to that of basic earnings per share except that the weighted-average number of common shares outstanding is increased to include the number of additional common shares that would have been outstanding if all potentially dilutive common shares (such as stock options and unvested restricted stock) were issued during the reporting period.  Unallocated common shares held by the Company’s Employee Stock Ownership Plan are not included in the weighted-average number of common shares outstanding for either the basic or diluted earnings per share calculations.  

Hudson River Bancorp, Inc.

Notes to Unaudited Consolidated Interim Financial Statements

(continued)

6. In November 2002, the FASB issued FASB Interpretation No. 45 (“FIN No. 45”) “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others; an interpretation of FASB Statements No. 5, 57, and 107 and rescission of FASB Interpretation No. 34”.  FIN No. 45 requires certain new disclosures and potential liability recognition for the fair value at issuance of guarantees that fall within its scope.  Under FIN No. 45, the Company does not issue any guarantees that would require liability recognition or disclosure, other than its standby letters of credit.  

                The Company has issued conditional commitments in the form of standby letters of credit to guarantee payment on behalf of a customer and guarantee the performance of a customer to a third party.  Standby letters of credit generally arise in connection with lending relationships.  The credit risk involved in issuing these instruments is essentially the same as that involved in extending loans to customers. Contingent obligations under the standby letters of credit totaled $25.6 million at September 30, 2003 and represent the maximum potential future payments the Company could be required to make.  Typically, these instruments have terms of twelve months or less and expire unused; therefore, the total amounts do not necessarily represent future cash requirements.   Each customer is evaluated individually for credi tworthiness under the same underwriting standards used for commitments to extend credit and on-balance sheet instruments.  Company policies governing loan collateral apply to standby letters of credit at the time of credit extension.  Loan-to-value ratios will generally range from 50% for movable assets, such as inventory, to 100% for liquid assets, such as bank CD’s.  The fair value of the Company’s standby letters of credit at September 30, 2003 was insignificant.

Hudson River Bancorp, Inc.

Management’s Discussion and Analysis

ITEM 2:     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

GENERAL

                The financial review which follows focuses on the factors affecting the consolidated financial condition and results of operations of Hudson River Bancorp, Inc. and its subsidiaries, Hudson River Bank & Trust Company (the “Bank”) and C. W. Bostwick, Inc. (“Bostwick”) (combined, the “Company”), during the three and six months ended September 30, 2003, with comparisons to 2002 as applicable.  The unaudited consolidated interim financial statements and related notes, as well as the 2003 Annual Report on Form 10-K, should be read in conjunction with this review.  Amounts in prior periods’ consolidated financial statements are reclassified whenever necessary to conform to the current period’s presentation.

                The Company’s primary market area, with 50 full-service branches as of September 30, 2003, is the Capital District region of New York state.  The Company has been, and intends to continue to be, a community-oriented financial institution offering a variety of financial services.  The Company’s principal business is attracting deposits from customers within its market area and investing those funds in primarily loans, and, to a lesser extent, in marketable securities.  The financial condition and operating results of the Company are dependent on its net interest income which is the difference between the interest income earned on its assets, and the interest expense paid on its liabilities, primarily consisting of deposits and borrowings.  Net income of the Company is also affected by provisions for loan l osses and other operating income, such as fees on deposit related services and insurance commissions; it is also impacted by other operating expenses, such as compensation and benefits, occupancy and equipment expenses, and federal and state income taxes.

                The Company’s results of operations are significantly affected by general economic and competitive conditions (particularly changes in market interest rates), government policies, changes in accounting standards and actions of regulatory agencies.  Future changes in applicable laws, regulations or government policies may have a material impact on the Company.  Lending activities are substantially influenced by the demand for and supply of housing, competition among lenders, the level of interest rates and the availability of funds.  The ability to gather deposits and the cost of funds are influenced by prevailing market interest rates, fees and terms on deposit products, as well as the availability of alternative investments including mutual funds and stocks.

OVERVIEW

                The Company earned net income for the three months ended September 30, 2003 amounting to $7.9 million, or $0.55 diluted earnings per share, up $855 thousand from the $7.1 million, or $0.49 diluted earnings per share, earned during the three months ended September 30, 2002.  Net income for the six months ended September 30, 2003 was $15.6 million, or $1.08 diluted earnings per share, up $2.1 million from the $13.5 million and $0.94 diluted earnings per share earned during the same period a year previous.  The increases over the prior year results were a result of higher other operating income, lower other operating expenses, lower provision for loan losses and lower tax expense, partially offset by a decrease in net interest income.  For the three months ended September 30, 2003, the Company’s return on average assets was 1.25%, up from 1.12% for the same period in 2002.  The Company’s return on average equity for the three months ended September 30, 2003 was 11.91%, up from 11.49% in 2002.  The Company’s return on average tangible equity for the three months ended September 30, 2003 was 16.27%, down from 16.29% for the same period in 2002.  See Table A, “Financial Highlights”.

ASSET/LIABILITY MANAGEMENT

                The Company attempts to maximize net interest income and net income, while actively managing its liquidity and interest rate sensitivity through the mix of various core deposits and other sources of funds, which in turn fund an appropriate mix of earning assets.  The changes in the Company’s asset mix and sources of funds, and the resultant impact on net interest income, are discussed below.

Hudson River Bancorp, Inc.

Management’s Discussion and Analysis

(continued)

Earning Assets

                Total average earning assets increased to $2.4 billion for the three months ended September 30, 2003, up from $2.3 billion in the same period of 2002.  For the six months ended September 30, 2003 and 2002, average earning assets were $2.3 billion.  Interest income for the three months ended September 30, 2003 was $32.4 million, down $6.8 million from 2002.  For the six months ended September 30, 2003, interest income was $66.1 million, a decrease of $12.8 million over the same period in 2002.  Lower yields on earning assets was the primary reason for the decrease, coupled with the prepayment of higher yielding loans with the proceeds being reinvested in lower yielding securities available for sale, and to a lesser extent Federal funds sold.  The yield on earning assets declined from 6.65% for the three mont hs ended September 30, 2002 to 5.47% in 2003.  For the six months ended September 30, 2003, yields declined from 6.75% in 2002 to 5.63% in 2003.  The decline in the yield on earning assets was primarily due to the declining rate environment in the marketplace and the larger amount of lower yielding securities available for sale held during the current year.  Earning assets at September 30, 2003 and March 31, 2003 were $2.3 billion.  

Loans

                The average balance of loans decreased to $1.6 billion for the three months ended September 30, 2003, down $229.3 million from the $1.9 billion average for the same period in the prior year.  The yield on loans for the quarter decreased 67 basis points, from 7.48% in 2002 to 6.81% in 2003.  The decrease in both balance and yield is attributed to the impact of a decrease in market interest rates during the past twelve months.  These market rate decreases have caused an increase in prepayments of the portfolio’s higher rate loans, and new loan originations are being made at lower rates relative to the Company’s loan portfolio.  Interest income on loans for the three months ended September 30, 2003 decreased to $27.9 million from $35.1 million in 2002.  The decrease in average balances for the quar ter resulted in a $4.1 million decrease in interest income earned on loans.  Additionally, lower rates resulted in a $3.0 million decrease in interest income earned for the quarter ended September 30, 2003 from the same period in the prior year.  

On a year to date basis, average loans were $1.6 billion for the six months ended September 30, 2003, down from $1.9 billion in 2002.  The yield on loans for the six months ended September 30, 2003 was 6.97%, down from 7.51% in 2002.  The impact of lower average balances and lower yields resulted in a decrease of $13.7 million in interest income earned for the six months ended September 30, 2003 compared to the same period in the previous year, with $8.7 million a result of the decrease in average balances and $5.0 million a result of a reduction in interest rates.    

                Total loans were $1.6 billion at both September 30, 2003 and March 31, 2003.  Commercial loans increased slightly to $119.8 million at September 30, 2003 from $112.9 million at March 31, 2003.  Financed insurance premiums increased $4.0 million to $45.2 million at September 30, 2003 from $41.2 million at March 31, 2003.  These increases were offset by a decrease in loans secured by residential real estate from $968.9 million, or 58.8% of total loans at March 31, 2003, to $926.1 million, or 57.7% of total loans at September 30, 2003.  Commercial real estate loans decreased $6.6 million to $404.0 million at September 30, 2003 from $410.6 million at March 31, 2003.  Consumer loans decreased from $29.1 million at March 31, 2003 to $25.0 million at September 30, 2003.  Manufactured housing loans decrea sed $3.9 million to $56.7 million at September 30, 2003.  Management intends to continue to reduce the portfolio of manufactured housing loans gradually through normal paydown activity while it continues its focus on commercial real estate and commercial lending, as well as residential lending.  Prepayments as a result of the lower rate environment of other loan types, particularly in residential loans, also reduced the balance of loans during the six months ended September 30, 2003.  Management expects the prepayment trend to continue although at a slower rate as long as rates remain at these historically low levels.  While the Company does retain many refinanced mortgages, borrowers may refinance at other institutions if the Company’s loan rates are not as low as the then current market.  Many lenders in the Company’s market area have been and continue to be very aggressive in pricing residential and commercial real estate loans.  See Table D, “Loan Portfolio Analysis.”

Hudson River Bancorp, Inc.

Management’s Discussion and Analysis

(continued)

Securities

                The average balance of securities available for sale (“securities”) increased $264.0 million to $472.0 million for the three months ended September 30, 2003, up from $207.9 million for the three months ended September 30, 2002.  Average securities for the six months ended September 30, 2003 were $430.5 million, an increase of $218.4 million from the corresponding period in the previous year.  Interest income earned on securities was $3.9 million for the three months ended September 30, 2003, up from the $2.9 million earned in 2002.  The increase in average balances for the quarter resulted in a $2.5 million increase in interest income earned on securities that was partially offset by a $1.5 million decrease in interest income earned due to lower rates.  On a year to date basis, interest income on securiti es increased from $5.9 million in 2002 to $7.4 million in 2003, as an increase in average balances more than offset the impact of a decline in rates earned.  

                Securities at September 30, 2003 were $529.4 million, up $187.9 million from the $341.5 million the Company held as of March 31, 2003.  The increase was due to the aforementioned reinvestment of Federal funds sold into securities, offset slightly by sales, maturities, calls and paydowns of securities.  Management anticipates further increases in securities as the level of Federal funds sold is reduced and reinvested into higher yielding securities.

Federal Funds Sold

The average balance of Federal funds sold of $237.1 million for the three months ended September 30, 2003 and $267.8 million for the six months ended September 30, 2003 generated $615 thousand and $1.6 million in interest income for the three month and six month periods, respectively.  The three month average balance was down $12.4 million from the $249.4 million reported for the three months ended September 30, 2002, and the six month average balance increased $45.9 million to $267.8 million for the period ending September 30, 2003.  The yield on Federal funds sold decreased from 1.76% for the three months ended September 30, 2002 to 1.03% for the three months ended September 30, 2003.  The yield for the six month period declined 60 basis points from 1.77% for 2002 to 1.17% for 2003.  The decrease in yield is attributed to the lower interest rate environment.  At September 30, 2003, Federal funds sol d amounted to $170.8 million compared to $303.3 million at March 31, 2003.  The Company is currently utilizing Federal funds for short-term liquidity.  As noted above, the balance of Federal funds should continue to decrease as management redeploys some Federal funds sold into higher yielding securities and as loan demand increases and prepayment activity declines.    

FHLB of New York Stock

                During September 2003, the FHLB reported that it had suspended its quarterly dividend on its stock.  At September 30, 2003, the Company had $18.5 million of FHLB of New York stock.  As a result, income for the three and six months ended September 30, 2003 were adversely impacted by approximately $250 thousand.  Future quarterly earnings will be impacted to the extent the FHLB of New York continues the dividend suspension or reduces the dividend rate from that previously paid.

Funding Sources

                The Company utilizes traditional deposit products such as time, savings and N.O.W. and money market deposits as its primary source for funding.  Other sources such as short-term FHLB advances and long-term FHLB borrowings, however, are utilized as necessary to support the Company’s growth in assets and to achieve interest rate sensitivity objectives.  Interest-bearing liabilities were $2.0 billion at September 30, 2003 and March 31, 2003.  The average balance of interest-bearing liabilities was also $2.0 billion for the three and six month periods ended September 30, 2003 and 2002.  Interest expense for the three months ended September 30, 2003 was $11.3 million, down $3.5 million from the same period in 2002.  The decline in the average rates paid from 2.88% to 2.22% for the three months ended Septem ber 30, 2003 was the primary reason for the decline in interest expense. Interest expense for the six months ended September 30, 2003 was $23.3 million, down $7.2 million from the same period in 2002.  The decrease in interest expense was also due substantially to a decline in the average rates paid from 2.97% in 2002 to 2.30%  in 2003.

Hudson River Bancorp, Inc.

Management’s Discussion and Analysis

(continued)

Deposits

                The average balance of savings accounts increased $66.1 million to $603.3 million for the three months ended September 30, 2003, up from $537.2 million for the same period in 2002.  On a year to date basis, the average balance of savings accounts was $595.2 million in 2003, up from $526.2 million in 2002.  The fluctuation in average balance can be primarily attributed to depositors placing money in liquid accounts due to lower rates offered on time deposit accounts and uncertainties associated with the stock market.  

Interest expense on savings accounts decreased from $2.6 million for the quarter ended September 30, 2002 to $1.8 million for the quarter ended September 30, 2003 as the decrease in average rates paid more than offset the increase in interest expense resulting from an increase in  the average balance.  The average rates paid on these deposits decreased to 1.16% from 1.93% for the three months ended September 30, 2003 and 2002, respectively.    

Interest expense on N.O.W. and money market accounts decreased $372 thousand to $717 thousand for the three months ended September 30, 2003 from $1.1 million for the three months ended September 30, 2002.  The average balance of N.O.W. and money market accounts increased to $364.7 million from $304.3 million for the three-month period ended September 30, 2002.  A decrease in average rates paid from 1.42 % to 0.78% more than offset the effect of the higher average balances.  For the six months ended September 30, 2003, the average balance of N.O.W. and money market accounts increased from $298.8 million in 2002 to $361.8 million in 2003.  This increase in the average balance resulted in an increase in interest expense on N.O.W. and money market accounts of $387 thousand for the six months ended September 30, 2003.  This was more than offset by a $960 thousand reduction in interest expense on N.O.W. and money market accounts for the six months ended September 30, 2003 resulting from a 56 basis point decrease in rates paid on these accounts.

                The average balance of time deposits decreased from $743.7 million for the three months ended September 30, 2002 to $653.8 million for the three months ended September 30, 2003.  On a year to date basis, the average balance of time deposits decreased from $762.0 million in 2002 to $661.2 million in 2003.  Interest expense on time deposits decreased $1.8 million for the three months ended September 30, 2003 from the comparable period in 2002.  Average rates paid on time deposits of 2.56% for the three months ended September 30, 2003 were down from 3.23% in 2002.  The decrease in average rates paid from 3.35% for the six months ended September 30, 2002 to 2.64% in 2003, resulted in the $2.5 million decrease in interest expense, while the decrease in the average balance of time deposits resulted in a $1.6 million decrea se in interest expense for the six months ended September 30, 2003.

Total deposits were $1.8 billion at both September 30, 2003 and March 31, 2003.  Noninterest-bearing deposits increased during this same time period from $190.3 million at March 31, 2003 to $216.2 million at September 30, 2003.  Increases were generally the result of the Company’s continued focus on providing commercial services to its customers, including commercial deposits, and general economic conditions which resulted in more customers moving funds from time deposits to demand accounts and other savings products.

Short-term FHLB Advances and Long-term FHLB Borrowings

                The Company had nominal average short-term FHLB advances during the quarters ended September 30, 2003 and 2002.  The average balance of long-term FHLB borrowings decreased from $415.9 million for the three months ended September 30, 2002 to $375.5 million for the three months ended September 30, 2003.  On a year to date basis, the average balance of long-term FHLB borrowings decreased from $425.4 million in 2002 to $380.8 million in 2003.  The decrease for both the three and six month periods is primarily attributed to the calls, maturities, and scheduled repayment of borrowings.  

 The Company had no short-term FHLB advances at September 30, 2003 or March 31, 2003.   Long-term FHLB borrowings were $365.1 million at September 30, 2003 down from $386.6 million at March 31, 2003.  The decrease in this category as mentioned previously, was primarily attributed to the calls, maturities and scheduled repayment of borrowings.  The interest rates on the long-term FHLB borrowings are generally fixed with maturities ranging from one month to nine years, with call options ranging from one month to three years.

Net Interest Income

Net interest income for the three months ended September 30, 2003 was $21.1 million, down from the $24.4 million for the three months ended September 30, 2002.  For the six months ended September 30, 2003, net interest income decreased $5.6 million to $42.8 million from $48.4 million for the same period a year previous.  The decrease was the result of a decline in the average balance of loans and lower rates earned on average earning assets, offset in part by lower balances of time deposit accounts and long-term FHLB borrowings as well as lower rates paid on interest-bearing liabilities.  As a result of these volume and rate fluctuations, the Company’s net interest margin for the three months ended September 30, 2003 was 3.56%, down from 4.14% for the three months ended September 30, 2002.  For the six months ended September 30, 2003, the net interest margin was 3.65%, down from 4.14% for the same period in 2002. See Table B, “Average Balances, Interest and Yields” and Table C, “Volume and Rate Analysis.”

Noninterest Sensitive Assets and Liabilities

                Noninterest sensitive assets include accrued interest receivable, premises and equipment, other real estate owned and repossessed property, goodwill,  other intangible assets, and other assets.  Total noninterest sensitive assets amounted to $151.3 million at September 30, 2003, down $3.8 million from the March 31, 2003 level.  This decrease can be attributed to depreciation and amortization on fixed assets and other intangible assets; a decrease in accrued interest receivable due to a decline in the balance of the loan portfolio and average rates during the period; and a $3.4 million decrease in the level of the Company’s net taxes receivable primarily due to the fluctuation in timing and amount of income tax payments made.

Noninterest sensitive liabilities include noninterest-bearing deposit accounts (primarily checking accounts) and other liabilities.  Noninterest-bearing deposits increased from $190.3 million at March 31, 2003 to $216.2 million at September 30, 2003.  This increase is primarily a result of the growth in the Company’s commercial accounts, which are generally noninterest-bearing.  There were no significant changes in the level of other liabilities during the six months ended September 30, 2003.

Hudson River Bancorp, Inc.

Management’s Discussion and Analysis

(continued)

RISK MANAGEMENT

Credit Risk

                Credit risk is managed through the interrelationship of loan officer lending authorities, Board of Director oversight, loan policies, a credit administration department, an internal loan review function, and a problem loan committee.  These components of the Company’s underwriting and monitoring functions are critical to the timely identification, classification and resolution of problem credits.  

Nonperforming Assets

                Nonperforming assets include nonperforming loans (loans in a nonaccrual status, loans that have been restructured, and loans past due 90 days or more and still accruing interest) and assets which have been foreclosed or repossessed.  Foreclosed assets typically represent residential or commercial properties, while repossessed property is primarily manufactured homes abandoned by their owners or repossessed by the Company.

Total nonperforming assets at September 30, 2003 and March 31, 2003 were $21.0 million or 0.83% of total assets at September 30, 2003 and 0.84% at March 31, 2003.  Nonperforming loans at September 30, 2003 increased $141 thousand from March 31, 2003.  This increase is primarily a function of increases in commercial real estate and commercial loans of $882 thousand and $2.4 million, respectively, offset by decreases of residential real estate, financed insurance premiums, and manufactured housing nonaccruals of $1.3 million, $1.0 million, and $585 thousand, respectively.  The increase to the commercial loans nonaccruals is primarily attributed to the addition during the second quarter of one commercial customer whose loan totaled $2.0 million.  The loan was considered in the evaluation of the level of the allowance for loan losses.  Management believes that the Company maintains adequate reserves for a nticipated losses relative to this loan.

As of September 30, 2003, there were $38.2 million of other loans not included in the category of nonperfoming loans where known information about the possible credit or other problems of borrowers caused management to have doubts as to the ability of the borrower to comply with present loan repayment terms.  These loans have been considered by management in conjunction with the analysis of the adequacy of the allowance for loan losses.

Allowance and Provision For Loan Losses

                The allowance for loan losses at September 30, 2003 was $38.9 million, up from $38.3 million at March 31, 2003.  The allowance as a percentage of nonperforming loans increased from 189.95% at March 31, 2003 to 191.76% at September 30, 2003.  The adequacy of the allowance for loan losses is evaluated quarterly by management based upon a review of significant loans, with particular emphasis on nonperforming and delinquent loans that management believes warrant special attention, as well as an analysis of the higher risk elements of the Company’s loan portfolio.  Increases in adversely rated and nonaccrual commercial and commerci al real estate loans during the six months ended September 30, 2003 resulted in higher reserves allocated to these loan categories by management.  Decreases in the outstanding balances of residential loans, manufactured housing loans, and consumer loans resulted in reduced amounts of general reserves allocated to these loan types.  The increase in outstanding finance insurance premiums resulted in higher amounts of allowance allocated to financed insurance premiums.  As a result of management’s evaluation of current economic trends, and the ultimate impact on the repayment ability of the Company’s customers, the unallocated portion of the allowance for loan losses increased slightly during the six months ended September 30, 2003.  At September 30, 2003, the balance of the allowance for loan losses is management’s best estimate of probable loan losses existing in the loan portfolio.  Net charge-offs for the three months ended September 30, 20 03 were $1.1 million, down from $1.5 million for the same period in 2002.  For the six months ended September 30, 2003, net charge-offs were $1.8 million, down from $2.2 million for the same period in 2002.

As a result of management’s analysis of the risk characteristics of the lending portfolio, as well as the trends and levels of nonperforming and other delinquent loans, a provision for loan losses of $1.2 million was recorded for the three months ended September 30, 2003.  The $1.2 million provision is down $300 thousand from the $1.5 million provision recorded for the three months ended September 30, 2002.  For the six months ended September 30, 2003, the Company recorded a provision for loan losses of $2.4 million, down from $3.0 million in the prior year.   The provision as a percentage of average loans declined from 0.32% for the three months ended September 30, 2002 to 0.29% in 2003.  The decline in t his ratio is primarily a result of the decrease in the provision charged to operations.  The Company continues to maintain certain portfolios of loans with higher credit risk, such as manufactured housing loans, commercial loans and financed insurance premium loans.  The growth in loan balances, net charge-offs, risk elements of the Company’s loan portfolio, economic conditions in the Company’s market area and nonperforming loan balances are the primary factors which are considered in determining the levels of the Company’s provision for loan losses.  See Table E, “Non-Performing Assets” and Table F, “Loan Loss Experience.”

Hudson River Bancorp, Inc.

Management’s Discussion and Analysis

(continued)

Market Risk

Interest rate risk is the most significant market risk affecting the Company.  Other types of market risk, such as foreign currency exchange rate risk and commodity price risk, do not arise in the normal course of the Company’s business activities.

                Interest rate risk is defined as an exposure to a movement in interest rates that could have an adverse effect on the Company’s net interest income.  Net interest income is susceptible to interest rate risk to the degree that interest-bearing liabilities mature or reprice on a different basis than earning assets.  When interest-bearing liabilities mature or reprice more quickly than earning assets in a given period, a significant increase in market rates of interest could adversely affect net interest income.  Similarly, when earning assets mature or reprice more quickly than interest-bearing liabilities, falling interest rates could result in a decrease in net income.

                In an attempt to manage its exposure to changes in interest rates, management monitors the Company’s interest rate risk.  Management’s asset/liability committee meets monthly to review the Company’s interest rate risk position and profitability, and to recommend strategies for consideration by the Board of Directors.  Management also reviews loan and deposit pricing, and the Company’s securities portfolio, formulates investment and funding strategies, and oversees the timing and implementation of transactions to assure attainment of the Board’s objectives in the most effective manner.  Notwithstanding the Company’s interest rate risk management activities, the potential for changing interest rates is an uncertainty that can have an adverse effect on net income.

                In adjusting the Company’s asset/liability position, the Board and management attempt to manage the Company’s interest rate risk while enhancing net interest margin.  At times, depending on the level of general interest rates, the relationship between long- and short-term interest rates, market conditions and competitive factors, the Board and management may determine to increase the Company’s interest rate risk position somewhat in order to increase its net interest margin.  The Company’s results of operations and net portfolio values remain vulnerable to changes in interest rates and to fluctuations in the difference between long- and short-term interest rates.

                Interest rate risk analyses performed by the Company indicate that the Company is asset sensitive as of September 30, 2003.  As a result, rising interest rates projected over a 12-month horizon are estimated to have a  positive effect on net interest income; conversely, falling interest rates projected over the same 12-month horizon are estimated to have a negative effect on net interest income.  The Company’s interest rate sensitivity has not significantly changed since March 31, 2003.  Consistent with the asset/liability management philosophy described above, the Company has taken steps to manage its interest rate risk by attempting to match the repricing periods of its earning assets to its interest-bearing liabilities, while still allowing for maximization of net interest income.  The Company&rsqu o;s purchases of securities, retention or sale of fixed rate loan products, utilization of longer term borrowings, and emphasis on lower cost, more stable non-certificate deposit accounts are methods the Company has utilized to manage its interest rate risk.  Management continuously evaluates various alternatives to address interest rate risk including, but not limited to, the purchase of interest rate swaps, caps, and floors, leveraging scenarios, and changes in asset or funding mix.

                The sensitivity analysis performed by the Company does not represent a Company forecast and should not be relied upon as being indicative of expected operating results.  The results are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, and reinvestment/replacement of asset and liability cash flows.  While assumptions are developed based upon current economic and local market conditions, the Company cannot make assurances as to the predicative nature of these assumptions including how customer preferences or competitor influences might change.  Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will differ due to: prepay ment/refinancing levels likely deviating from those assumed, the varying impact of interest rate changes on caps and floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal/external variables.  Furthermore, the sensitivity analysis does not reflect actions that management might take in responding to or anticipating changes in interest rates.    

Liquidity Risk

Liquidity is defined as the ability to generate sufficient cash flow to meet all present and future funding commitments, depositor withdrawals and operating expenses.  Management monitors the Company’s liquidity position on a daily basis and evaluates its ability to meet depositor withdrawals or make new loans or investments.

                The Company’s cash inflows result primarily from loan repayments; sales, maturities, principal payments, and calls of securities; new deposits; and borrowings from the Federal Home Loan Bank of New York.  The Company’s cash outflows consist of new loan originations; security purchases; deposit withdrawals; repayments of borrowings; operating expenses; and treasury stock purchases.  Net cash outflows from investing activities, primarily consisting of purchases of securities offset by maturities and calls of securities, were $147.7 million in the six months ended September 30, 2003, as compared to $110.5 million of net cash inflows from investing activities for the same period in 2002, primarily from loan repayments and maturities and calls of securities.  Net cash provided by financing activities, primarily consisti ng of increases in deposits offset mostly by repayments of long-term FHLB borrowings was $7.1 million in 2003.  In 2002, financing activities used net cash amounting to $54.0 million.  Repayment of long-term FHLB borrowings impacted cash flows from financing activities for the six months ended September 30, 2002.  Management closely monitors the timing of cash inflows and outflows although changes in interest rates, economic conditions, and competitive forces strongly impact the predictability of these cash flows.  The Company attempts to provide stable and flexible sources of funding through the management of its liabilities, including core deposit products offered through its branch network, and through the use of borrowings.  Management believes that the level of the Company’s liquid assets combined with daily monitoring of cash inflows and outflows provide adequate liquidity to fund outstanding loan commitments, meet daily withdrawal requirements of depositors, and meet all other daily obligations of the Company.

                Management prepares monthly calculations of both short-term and long-term liquidity.  The Company defines short-term liquidity as the ability to meet its cash requirements over a 30-day period.  Factors considered in assessing short-term liquidity are maturities of long-term borrowings and time deposits, repayment of short-term borrowings, funding of outstanding loan commitments, and estimated customer deposit withdrawals; offset by short-term investments held by the Company, estimated loan repayments by customers and estimated cash flows from securities available for sale.  Long-term liquidity includes all of the factors used in short-term liquidity, as well as additional cash flows from the sale of securities available for sale and funds available from outstanding borrowing lines of credit and other funding sources. &nb sp;The excess of the estimated sources of funds in the short-term or long-term over the estimated uses of funds over the same time periods represents the Company’s liquidity.  As a result of the level of the Company’s Federal funds sold as of September 30, 2003, and continued expectations of customer loan repayments, the Company’s short-term and long-term liquidity ratios are higher than the required levels outlined in the Company’s liquidity policy.